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Rethinking Global Supply Chains
In recent years, supply chain management thinking has emphasized optimizing costs by creating global supply chains and relying on one or two key suppliers for a given product or component, even if they are located in a faraway country. Supply chains have become increasingly global. Global supply chains have made it possible for original equipment manufacturers (OEMs) and Tier 1 vendors in the automotive supply chain, for example, to meet aggressive cost targets while keeping the price of new vehicles low. Lower transportation costs, falling trade barriers, the growth of subcontracting, and use of the Internet as a low-cost global communication tool have enabled many companies to shift to a global sourcing model. That prevailing wisdom is now being challenged.
The coronavirus pandemic, an unanticipated “black swan” event of unprecedented magnitude, shut down much of the world economy, disrupting supply chains throughout the globe. China had become a major world supplier to the pharmaceutical, electronics, metals, and auto industries, as well as a wide range of consumer and industrial products, including surgical gowns, masks, and other personal protective equipment. When China shut its factories and halted domestic and international travel to stop the spread of the virus, companies in other countries had to shut down or delay production and deliveries as well. As coronavirus closed borders across the world, China reportedly met its internal demand for masks at the expense of countries who import Chinese masks, like the United States. Supply chains were also disrupted as individual countries shut down production, transportation, and retail sales to block the spread of coronavirus infections.
Subcontracting has become more prevalent, driven by increased sophistication of components, manufacturing processes that require specialists, and the desire on the part of producers to have more flexible capacity that can be turned on and off depending on demand. The result is supply chains with deeper tiering. Suppliers draw upon their suppliers, who in turn draw on their own networks of suppliers in multistage production networks. It is becoming more common to have four or more tiers of suppliers. This level of complexity makes it very difficult for companies to have visibility into who all their suppliers actually are. Without this knowledge, many companies are caught off guard when major disruptions occur.
Over the past decade, there have been other “black swan” events, including the U.S.–China trade war and the 2011 east Japan earthquake and tsunami. Some companies responded by setting up alternative sources for their supply chains. But many refused to change, believing it would be nearly impossible to replace key Chinese suppliers. No one realized what would happen when the world’s second largest economy completely shut down. The coronavirus pandemic should be a wake-up call.
What can companies do now to mitigate global supply chain risk? First, businesses should eliminate their dependence on sourcing from a single supplier, region, or country. They should develop alternate supply sources and increase their safety stocks. These moves will increase costs, but they will make supply chains more resilient. However, supply availability can depend on the unique capabilities of a vendor or the location of specific resources. If a firm can easily locate and work with an alternative supplier, it may be able to get by with less safety stock. Firms with a complex manufacturing process that needs certification will need more. For example, Novo Nordisk, which manufactures half of the world’s insulin supply at its facility in Kalundborg, Denmark, maintains a five-year reserve because insulin is such an essential medication for diabetes.
Second, companies should consider more regionalization of production and even localization of suppliers if feasible. When Toyota pioneered lean production in Japan in the 1970s, its suppliers were colocated nearby. Toyota continues to practice localization more than many of its competitors. More than 350 suppliers for Toyota’s Georgetown, Kentucky factory are located in the United States, with over 100 within the state of Kentucky. Coca-Cola was well-positioned to weather pandemic supply chain disruptions because its production is localized. Beverages sold in the United States are produced there. Drinks in Germany are made in Germany. Drinks in Kenya are made in Kenya. Unfortunately, many companies have chosen to adopt lean and just-in-time production methods that span global networks, focusing on price rather than supplier diversity. The coronavirus pandemic exposed the vulnerability of this approach.
Third, companies should consider reducing the number of products they make. Kimberly-Clark, which makes Cottonelle toilet paper, Huggies diapers, and other household goods, saw a surge in sales in the first quarter of 2020 as consumers bought more staples to use while staying at home. Kimberly-Clark decided to limit the number of products it produces. By making a smaller array of products, the company could ease pressure on factories that had to ramp up production to meet this new level of demand.
All of these measures require a new mindset that recognizes that some amount of profit will have to be sacrificed in exchange for supply security, and that supply chains should be designed with more awareness of risks.