Since the unfolding of the Coronacrisis, gradually more and more attention is being given to the consequences for the global economy. It has been interesting to witness initial reports affected the Chinese travel industry (24 January), international air travel (29 January), jet fuel in China (January 30), Chinese retail (5 February). Only later the effects of Chinese manufacturing closings reached the mass media, affecting the supply of retailers abroad with products and global supply chains with parts and raw materials. The first announcements affected car manufacturers in Asia (having little inventory due to just-in-time single sourcing policies and being in close proximity to the parts manufacturers in China), with the world’s largest car plant of Hyundai as a prime example. Then followed the high value retail products abroad that use air freight to supply their retail stores worldwide, with Apple becoming testimony that single sourcing may look good on the balance sheet but leads to dramatic effects in case a crisis hits.
The news unfolds as more parts of the supply chain were hit. One of the first to recognize that this virus outbreak could lead to massive disruption of global supply chains was my good friend Professor Yossi Sheffi of MIT. In late January, he sent out a first survey to supply chain leaders on which he reported on January 31 on LinkedIn. Interestingly, at that time most companies were waiting and watching, rather than investigating and acting. In an interview on CNBC, Yossi made an interesting observation that this is a crisis where both supply of the world’s most critical manufacturing base is hit at the same time as the world’s second-largest consumer market.
It is remarkable that still much of the responses are slow. One explanation could be that companies are silent about anticipated supply, as they are currently looking to find alternative sources of supply. In that case, it might indeed be better to be ahead of the competition, and keep quiet about shortages. However, I fear that many companies are not aware and have not yet made this a C-level priority. Shortages may not be visible yet, as many companies had extra inventories prior to the Chinese New Year, and shipments take 4-6 weeks to reach Europe or North America. Hence, for products that are normally transported via ocean, shortages may only start to become apparent next month. If there is a lot of safety stock, maybe only in April. And then the virus might be contained, so why worry?
What will happen in the next weeks and months?
Over the next weeks we will see more and more shortages appearing. Dutch retail chain Action announced this week that it is seeking alternative sources for its products. Action sells extremely cheap products that are mostly sourced in China. They were one of the first to recognize their problems at the retail side. Other retailers with extensive sourcing in China announce in the media that they do not expect any problems. It is hard to imagine that a company extensively sourcing in China will not be facing some empty shelves next month.
Moreover, even if you are not sourcing from China, it is likely that some of your suppliers or your suppliers’ suppliers are sourcing from China. It may only need to be a small single-sourced part somewhere that can take down an entire supply chain. As CNN said: “You can’t build a car with 99% of the parts”.
It is also reported to me (have not found any confirmation of this news yet from additional independent sources) that apparently in China road transport capacity is very difficult to get, since there are many transport restrictions in place.
The good news is that some car manufacturers are partially restarting their operations in China as of next week, as Toyota announced yesterday. However, others argue that the main problems are with second and third tier suppliers, for instance in the electronics industry. There is little visibility on these, often much smaller, companies.
Actually, even if the virus were contained some time in April, I predict that the effects on global supply chains will be visible for a long time, possibly far into 2021. The reason is that also the coronacrisis will lead to a bullwhip effect, just like other recent shocks such as Brexit, the US/China tariff war, and (with a much larger effect) the collapse of Lehman Brothers. The corona bullwhip is a complicated one to estimate. I would estimate the following effects based on current information and based on common knowledge of the bullwhip effect:
- Increases in prices for fast capacity-constrained transport modes, such as airline prices. Since many will try to obtain whatever stock is available and many flights have been canceled (belly capacity reported represents more than 50% of airfreight capacity out of China), this will lead to an increase in freight prices.
- Inflation of orders at Chinese suppliers and their alternatives in other countries. If there is a shortage of products, companies will place more and inflated orders at alternative suppliers. If alternatives are available (which in many cases will not be at short notice), they are likely to become capacity constrained soon. This will give them an opportunity to inflate their prices, but also they may induce their (potential customers) to inflate their orders in order to secure whatever is available.
- Propagation of this effect upstream the supply chain. From bullwhip theory we know that such inflated orders in case of shortage are increasing further upstream. Hence companies that are typically upstream, such as the chemical industry, could be affected only months later but in much larger quantities.
How can this be moderated?
Bullwhip theory that the effect can be moderated by information sharing. I understand from many of my corporate relationships that it has been very difficult to get updates on the actual status of their supplies from China. Many workers in China are still off, or do home office, and it is very difficult to obtain information. If there is anything the Chinese government can do, is to encourage the companies in China to provide transparency.
If this were not possible, companies in Europe and North America should still try and share as much as possible. If this were not possible for competitive reasons, it may make sense to report this anonymously. To any of my LinkedIn contacts, I would really appreciate a LinkedIn direct message if you want to share your current status, which will help me get a better picture. Also, please make use of the invitation of Professor Sheffi to take part in his online survey on the Coronacrisis.
In conclusion
From an academic perspective, we never want to waste a good crisis for future learning. We can only hope that companies would do the same. Really embedding on dual-sourcing strategies is the only way to move forward in a world that is increasingly connected and can be disturbed more and more easily by such crises.
This Article was published on LinkedIn in February 2020