We are still in the midst of adapting to a world where limiting physical contact is changing our daily lives, both at home and at work. Businesses are facing a low touch economy that fundamentally and irreversibly changes the way they operate. Thanks to the resilience of global supply chains the world economy did not grind to a halt when most of the world went into lock-down. But, it has come at a price. Going forward supply chains need to be re-examined to keep operating cost-effectively while minimizing risk.
In this context many companies are considering making structural and permanent changes to where they produce and source products, parts and materials. It will take time for companies to come to a conclusion and adjust their supply chains.
In this article Kim MacGillavry, Strategy Director at UPS Europe, and Nick de Mey, co-founder of Board of Innovation, take stock of the situation and lay out the things that companies should be considering to be future proof.
Global trade throughout the ages
People have been trading goods across borders since the beginning of civilization. Silk and spices have traveled between empires along the silk road as far back as 2000 years ago. From that time on all sorts of commodities that were available in some countries have found their way to countries where they were not. The industrial revolution allowed companies to manufacture enough goods to satisfy local as well as foreign demand. Today even individuals can digitally trade products with anyone, anywhere in the world. By now every country across the globe participates in the world economy both through exports and imports. In the 2000s, global exports rose to about a quarter of global GDP and global trade (the sum of imports and exports) grew to over half of world GDP according to the Worldbank.
In recent years some parts of the global supply chain have been nearshoring, seemingly reversing the globalization trend. An example of this in Europe is the expanding production capacity in or around the EU and the growth of trade between Eastern and Western Europe in particular. Eastern Europe has become the manufacturing backyard for Western Europe where intermediary goods from especially automotive and high tech suppliers are produced and shipped mainly to Germany for final assembly.
There are a number of factors that are triggering the regionalization of supply chains in Europe.
- Increasing speed to market: Consumer expectations and the need to react to changes in demand quickly is reducing the time to market. Especially in industries where product life cycles are short and the cost of obsolescence or the need for discounting is high.
- Reducing labor arbitrage: With the low-cost countries especially in Asia becoming more expensive the salary cost differences with countries in and around Europe are becoming smaller too.
- Increasing automation: Accelerating automation across all business processes is probably the most obvious consequence of the low touch economy. New technology such as robotics is becoming cheaper and software such as data analytics, machine learning and IA is becoming more sophisticated and accessible. Automation is shifting cost structures to more capital intense production and warehousing where labor costs play a lesser role.
There may be some shifts in supply chains such as nearshoring, which play a role in certain industries and particular goods. However, the trend towards a more integrated global market place will likely continue as the benefits of labor arbitrage and outsourcing generally still outweigh the costs of complex supply chains and increasing working capital. Logistics continues to make the equation work by growing capacity, offering more choice, increasing speed, improving reliability, creating more visibility and increasing efficiencies throughout the entire global end-to-end supply chain.
The Corona test
What is often forgotten is that in an effort to reduce costs the risk of the supply chains has increased. When Covid19 struck it sent supply and demand shockwaves across the world. It put global supply chains to the ultimate test and exposed many risks that companies and governments around the world were previously not aware of. Companies have faced specific challenges in parts of their business before, such as during the Fukushima nuclear disaster in 2011. However, the scale and impact of the challenges caused by the Corona crisis were unprecedented.
Challenges caused by the Corona crisis
- Production closure: With Chinese manufacturers in locked-down areas having to close down production a shortage of parts and finished goods affected companies around the world. Many of them were Tier 2-5 suppliers that created issues with Tier 1 parts suppliers in countries that were not in lock-down.
- New sourcing: Abrupt shifts from affected suppliers to those not or less affected needed to be organized. Especially companies with single source suppliers faced big issues.
- Shift in product demand: Consumers in locked-down countries changed their purchasing behavior drastically. Discretionary spending on non-essential goods dropped dramatically while consumption of health & safety, hygiene and food & beverages increased a lot. Some companies saw a big drop in demand and others a big increase.
- Capacity: With passenger aircraft grounded the belly space used to carry freight also disappeared. This reduced the available capacity on important trade lanes dramatically. Assets needed to be re-allocated to get them out of the places where demand dwindled and into the places where demand spiked.
- Warehousing restrictions: Warehouses located in locked down areas became a big bottleneck for some companies. Especially single warehouse operations suffered, but also companies with multiple warehouses faced complications to boost other warehouses in an effort to compensate for those that were locked down.
- Sales channels: With brick-and-mortar stores closed ecommerce enabled people to still get the things they needed. As e-commerce supply chains are very different from sales to fulfillment to last mile that switch was a challenge for many companies. Logistics service providers had to make quick and radical changes to respect the social distancing requirements to continue operations.
The Corona crisis has shown that although global supply chains have become extremely efficient and cost effective, they have also become precarious and sensitive to shocks. It is still too early to say how global supply chains will structurally change. However, many companies are looking into their current design and how technology can be leveraged more.
Supply chain design
- Accelerating near-shoring: Producing closer to market.
- Alternate sourcing: Reduce dependency on single source suppliers.
- Adjusting warehouse footprint: Finding a new balance between centralization and decentralization of stock.
- Business transparency and control: Measuring, reporting, forecasting and predicting changes in demand and monitoring suppliers across the entire supply chain (not just Tier 1 suppliers).
- Integration: Increasing the collaboration and data exchanges between different companies across the end to end supply chain.
- Digitization of processes: Digital interactions to speed up transactions and provide more insights that can be used to respond and predict demand.
- Automation: Smart warehousing, autonomous transportation and delivery solutions that improve productivity and efficiency.
It is not a surprise that most of the companies that did well during the crisis are technology driven businesses. Check out the low-touch winners.
Companies across all industries will lean heavily on technology also as a result of the crisis and in order to continue to grow profitably as the low-touch economy sets in.
Managing both costs and risks: finding a new balance
So, what is the optimal supply chain? One thing that the Covid19 outbreak has taught us is that cost considerations alone are not enough. There is a need to find a new balance between the cost and risk of supply chains.
The trade-off that companies need to make between cost vs risk are:
- fewer suppliers to leverage scale and get better purchase prices and payment terms vs buy from multiple suppliers and avoid sole suppliers
- produce and store at lowest cost locations vs produce and store goods closer to where you sell
- build bigger and more automated warehouse with high SKU concentration vs store SKU’s in multiple locations
- minimize inventory and working capital vs maintain safety and buffer stock
- cut overheads needed to manage fewer suppliers and logistics service providers vs more people needed to manage the complexity of a dispersed supply chain network
Companies will need to make more effort to manage risk better and ensure their supply chains are resilient to respond to sudden and drastic changes. A few simple steps to take in that process are:
Supply Chain risk assessment
- Map your end-to-end supply chain beyond Tier 1 suppliers and understand the associated risks (where and what they buy, produce and store).
- Model different risk scenarios to know where the critical bottlenecks are and size the implication.
Business continuity planning
- Prepare actions in case a risk scenario occurs.
- Work with suppliers to create alternate sources, production and storage sites to reduce the risk of the scenarios with the highest risk.
- Consider insurance to cover the residual risks that can’t be economically mitigated.
Supply chain monitoring control tower
- Use technology to monitor suppliers and the supply chain 24×7 and flag issues in real-time
- Share information with your partners along the Supply Chain such as demand and production plans, sales forecasts and purchase orders to better understand capacity needs, create efficiencies and predict and respond to disruptions.
Depending on the industry you operate in you will be exposed to different risks and will be affected by disruptions in different ways.
The automotive, aerospace and electronics industries have complex, global supply chains. A large number of suppliers and even larger number of tier 2-5 suppliers produce parts all over the world. Sophisticated inbound logistics ensure that all these parts arrive at the right production facility at just the right time to ensure production is not interrupted.
For fast-moving goods such as apparel and fashion speed is paramount due to short product life cycles and the high cost of promotions and obsolence. It is increasingly e-commerce driven which comes with costly and complex returns processes.
Supply chains in the life sciences industry are highly regulated with very specific requirements on account of temperature sensitivity and the need to avoid contamination. The supply of critical goods is likely get increasing governmental scrutiny in the aftermath of the Corona crisis.
So, each company will need to make its own risk assessment and come up with a different approach to manage risk.
A stable world economy depends on supply chain resilience
There is little doubt that globalization will continue to be a prominent component of the world’s economy despite occasional setbacks and even efforts to curb it. While logistics innovations have enabled companies to build global supply chains that allow them to operate wherever and however they want, the Covid19 outbreak has exposed risks that most companies were neither aware of nor prepared for. A better trade-off between costs and risks is needed to ensure the resilience of global supply chains and with it the stability of the world economy. Companies need to understand their end-to-end supply chains better and collaborate more closely with all stakeholders along it. That will be key to avoid the high cost of failure in the light of inevitable future disruptions.
About Kim MacGillavry.
During the last 25 years Kim was responsible for product and service innovation in various multinational companies. By designing, developing, and launching a multitude of products and services, he gained a lot of experience in dealing with the complexities of innovation in large enterprises. Kim has a Master in Applied Economics from the University Faculty Saint-Ignatius Antwerp in Belgium.
About Nick De Mey.
Founding Partner and Insights lead at Board of Innovation. Nick has a strong passion for new business models, future trends and overall changes in human behaviour.