Talking Trade blog
Shifting supply chains in disruption
Published 30 April 2020
Companies have always understood that global or regional supply chains can be fragile. Typically, natural disasters like typhoons, floods or earthquakes reinforce the message that over-reliance on one source of supply for key parts or services in a chain can become a problem.
However, these sources of disruption are usually seen as local and temporary. Any problems in the chain that noted during the disaster may be remedied, or even forgotten once the crisis has passed.
The start of the grinding US-China trade war in early 2018, by contrast, suddenly forced many firms to confront issues of vulnerability head on. Firms were found to be over-reliant on China and Chinese content for a smoothly functioning operation. The sudden imposition of tariffs worth billions of dollars at levels up to 25% meant business-as-usual was not going to happen.
Many experts expected that firms would begin shifting supply chains out of China as a result. In some circumstances, this did take place. Companies moved, especially to Vietnam or Mexico.
But many companies examined their supply chains and made no changes. Many decided that the US-China trade war was likely to be temporary and therefore not worth a response, or they looked at alternatives and found most to be lacking. Companies tend to be located in China for very sound and sensible reasons—the domestic market is extremely attractive and Chinese firms can respond with speed and scale that cannot be found elsewhere.
The announcement of the Phase 1 deal between the US and China that took effect on February 14, 2020, led many firms to conclude that average 19.3% tariffs that remain in place can either be managed or would, eventually, be reduced.
However, the impact of the US-China trade war now seems relatively minor, compared to the destruction wrought by COVID-19 on supply chains.
Starting in January, China began quickly shutting down firms. Even in areas outside of the epicenter, production inside China began to collapse.
Companies that rely on Chinese inputs and manufacturing discovered the exquisite interconnectedness of today’s supply chains. As the virus spread to other locations like South Korea, companies suffered more disruption in supply.
It was not just that vital components were suddenly stuck, even relatively minor inputs like screws suddenly were unavailable. The movement of people compounded challenges, since firms could not get staff in and out of various locations to manage a wide range of issues. Logistics got snarled, with costs and availability changing rapidly.
The extreme level of disruption appears to have caused firms to finally think seriously about their existing supply chain footprints. Companies in multiple sectors have now vowed to develop more resilient chains.
In many cases, firms have supply chains that have evolved organically, with little coherent planning. Staff, to pick one example, often run disparate parts of global firms from locations that may not make sense if viewed from the perspective of today. Companies might have an office in one location that was originally set up because a key staff member liked the area, only to watch it evolve into a much larger operation than ever anticipated at the outset.
Companies typically do not design supply chains from scratch, but bolt on different parts over time, as the firm grows or acquires new companies or moves into new sectors.
The net result is often supply chain footprints that actually make little rational sense. Warehouses might be located in places that no longer have the transport links originally intended. Traffic, as an example, could be so heavy that goods are stuck in transit much longer than planned.
With so many staff locked down in houses or slowly venturing back to offices, it makes sense to seize the opportunity to re-examine supply chains and determine whether and how the existing footprint can be adjusted to cope with new stresses.
This is unlikely to result in wholly new operations. It is particularly unlikely to result in dual supply chains, no matter how much companies might like the idea of designing extremely robust operations.
With trade and economic growth in a free fall for an extended period, this is probably not the time for companies to spend a lot of money on extremely expensive dual supply chains, even if the idea sounds desirable. Nor, to the chagrin of many sustainability advocates, are firms likely to spend limited capital on creating green outcomes.
At a time of cash crisis and major disruptions to business operations, firms will be understandably cautious about making heavy investments. Every dollar of spending will be carefully scrutinized.
Companies will also need to seek out any source of competitiveness that sets their products and services apart from potential competitors.
It is perhaps not surprising that Talking Trade strongly recommends that companies look carefully at trade agreements during this challenging time. Not every agreement is the same. Some provide almost no practical benefits to companies.
But many can deliver two things in extremely short supply at the moment: improved market access and lowered risk of regulatory changes. Both will create bottom-line impacts for firms that effectively think about how to leverage trade rules to their advantage.
Many companies think they already use trade agreements. But the reality is that most do not—whoever is “supposed” to be in charge of figuring this out doesn’t actually do the job, doesn't review the system very often, or assumes that someone else does more of the job than they actually deliver.
The benefits can be substantial. It’s not just tariff cuts, although clearly companies that are paying MFN rates of 6.5% or 45% are at a strong disadvantage compared to firms that harness FTAs to pay no duty at all.
FTAs also can provide more certainty about services delivery and investment conditions. They can help companies compete for lucrative government contracts. They help protect the ideas and innovations that sets firms apart from competitors. They may facilitate the movement of goods at customs or limit the mischief that governments can impose though various standards and product regulations.
As companies restructure supply chains to grapple with disruption and changing patterns of supply and demand, FTAs and other trade tools ought to be a critical part of the analysis. Firms simply cannot afford to drift or to rely on whatever methods worked in the past.
It is unclear at the moment where global and regional trade is headed, but it is certainly obvious that the new normal will require supply chains better fit for purpose. Companies can seize this opportunity to design structures that harness benefits from all sorts of trade arrangements, lower costs and improve bottom line performance.
© The Hinrich Foundation. See our website Terms and conditions for our copyright and reprint policy. All statements of fact and the views, conclusions and recommendations expressed in this publication are the sole responsibility of the author(s).