OPERATIONS

Global Supply Chains in a Post-Pandemic

World
From the September–October 2020 Issue

When the Covid-19 pandemic subsides, the world is going to look markedly different. The
supply shock that started in China in February and the demand shock that followed as the
global economy shut down exposed vulnerabilities in the production strategies and supply
chains of firms just about everywhere. Temporary trade restrictions and shortages of
pharmaceuticals, critical medical supplies, and other products highlighted their weaknesses.
Those developments, combined with the U.S.-China trade war, have triggered a rise in
economic nationalism. As a consequence of all this, manufacturers worldwide are going to be
under greater political and competitive pressures to increase their domestic production, grow
employment in their home countries, reduce or even eliminate their dependence on sources that
are perceived as risky, and rethink their use of lean manufacturing strategies that involve
minimizing the amount of inventory held in their global supply chains.

Yet many things are not going to change. Consumers will continue to want low prices
(especially in a recession), and firms won’t be able to charge more just because they
manufacture in higher-cost home markets. Competition will ensure that. In addition, the
pressure to operate efficiently and use capital and manufacturing capacity frugally will remain
unrelenting.

The challenge for companies will be to make their supply chains more resilient without
weakening their competitiveness. To meet that challenge, managers should first understand
their vulnerabilities and then consider a number of steps—some of which they should have
taken long before the pandemic struck.

Uncover and Address the Hidden Risks

Modern products often incorporate critical components or sophisticated materials that require
specialized technological skills to make. It is very difficult for a single firm to possess the
breadth of capabilities necessary to produce everything by itself. Consider the growing
electronics content in modern vehicles. Automakers aren’t equipped to create the touchscreen
displays in the entertainment and navigation systems or the countless microprocessors that
control the engine, steering, and functions such as power windows and lighting. Another more
arcane example is a group of chemicals known as nucleoside phosphoramidites and the
associated reagents that are used for creating DNA and RNA sequences. These are essential for
all companies developing DNA- or mRNA-based Covid-19 vaccines and DNA-based drug
therapies, but many of the key precursor materials come from South Korea and China.
Manufacturers in most industries have turned to suppliers and subcontractors who narrowly
focus on just one area, and those specialists, in turn, usually have to rely on many others. Such
an arrangement offers benefits: You have a lot of flexibility in what goes into your product, and
you’re able to incorporate the latest technology. But you are left vulnerable when you depend
on a single supplier somewhere deep in your network for a crucial component or material. If
that supplier produces the item in only one plant or one country, your disruption risks are even
higher.

Identify your vulnerabilities.

Understanding where the risks lie so that your company can protect itself may require a lot of
digging. It entails going far beyond the first and second tiers and mapping your full supply
chain, including distribution facilities and transportation hubs. This is time-consuming and
expensive, which explains why most major firms have focused their attention only on strategic
direct suppliers that account for large amounts of their expenditures. But a surprise disruption
that brings your business to a halt can be much more costly than a deep look into your supply
chain is.

The goal of the mapping process should be to categorize suppliers as low-, medium-, or high-
risk. To do that, Tom Linton, who served as a supply chain executive at several major
companies, and MIT’s David Simchi-Levi suggest applying metrics such as the impact on
revenues if a certain source is lost, the time it would take a particular supplier’s factory to
recover from a disruption, and the availability of alternate sources. (Disclosure: I am on the
boards of directors of Flex, a large manufacturing and supply-chain services provider where
Linton is a senior adviser, and Veo Robotics, a company that has developed an advanced vision
and 3D sensing system for industrial robots.) It’s vital to ascertain how long your company
could ride out a supply shock without shutting down, and how quickly an incapacitated node
could recover or be replaced by alternate sites when an entire industry faces a disruption-related
shortage.

The answers to those questions depend, in part, on whether your manufacturing capacity is
flexible and can be reconfigured and redeployed as needs evolve (as is the case for many
manual or semiautomated assembly operations) or whether it consists of highly specialized and
difficult-to-replicate operations. Examples of the latter include production of the most advanced
smartphone chips, which is concentrated in three facilities in Taiwan owned by the Taiwan
Semiconductor Manufacturing Company; fabrication of exotic sensors and components, which
happens largely in highly specialized facilities in a handful of countries, including Japan,
Germany, and the United States; and refining of neodymium for the magnets in AirPods and
electric-vehicle motors, almost all of which is done in China.

Once you’ve identified the risks in your supply chain, you can use that information to address
them by either diversifying your sources or stockpiling key materials or items.

Diversify your supply base.

The obvious way to address heavy dependence on one medium- or high-risk source (a single
factory, supplier, or region) is to add more sources in locations not vulnerable to the same risks.
The U.S.-China trade war has motivated some firms to shift to a “China plus one” strategy of
spreading production between China and a Southeast Asian country such as Vietnam,
Indonesia, or Thailand. But regionwide problems like the 1997 Asian financial crisis or the
2004 tsunami argue for broader geographic diversification.

Managers should consider a regional strategy of producing a substantial proportion of key

goods within the region where they are consumed. North America might be served by shifting
labor-intensive work from China to Mexico and Central America. To supply Western Europe
with items used there, companies could increase their reliance on eastern EU countries, Turkey,
and Ukraine. Chinese firms that want to protect their global market share are already looking to
Egypt, Ethiopia, Kenya, Myanmar, and Sri Lanka for low-tech, labor-intensive production.

Reducing dependency on China will be easier for some products than others. Things like
furniture, clothing, and household goods will be relatively easy to obtain elsewhere because the
inputs—lumber, fabrics, plastics, and so forth—are basic materials. It will be harder to find
alternative sources for sophisticated machinery, electronics, and other goods that incorporate
components such as high-density interconnect circuit boards, electronic displays, and precision
castings.

Building a new supplier infrastructure in a different country or region will take considerable
time and money, as China’s experience illustrates. When China first opened its special
economic zones in the 1980s, it had almost no indigenous suppliers and had to rely on far-flung
global supply chains and on logistics specialists who procured materials from around the world
and kitted them for assembly in Chinese factories. Even with the support of government
incentives, it took 20 years for the country to build a local base capable of supplying the vast
majority of electronic components, auto parts, chemicals, and drug ingredients needed for
domestic manufacturing.

Shifting production from China to Southeast Asian countries will necessitate different logistics
strategies as well. Unlike China, those locations often do not have the efficient, high-capacity
ports that can handle the largest container ships or the direct marine liner services to major
markets. That will mean more transshipment through Singapore, Hong Kong, or other hubs and
longer transit times to reach markets.

In the long run, though, it would be a mistake to cut China completely out of your supply
picture. The country’s deep supplier networks, its flexible and able workforce, and its large and
efficient ports and transportation infrastructure mean that it will remain a highly competitive
source for years to come. And because China has the second-largest economy in the world, it is
important that firms maintain a presence to sell in its markets and obtain competitive
intelligence.

Hold intermediate inventory or safety stock.

If alternate suppliers are not immediately available, a company should determine how much
extra stock to hold in the interim, in what form, and where along the value chain. Of course,
safety stock, like any inventory, carries with it the risk of obsolescence and also ties up cash. It
runs counter to the popular practice of just-in-time replenishment and lean inventories. But the
savings from those practices have to be weighed against all the costs of a disruption, including
lost revenues, the higher prices that would have to be paid for materials that are suddenly in
short supply, and the time and effort that would be required to secure them.

Take Advantage of Process Innovations

As firms relocate parts of their supply chain, some might ask their suppliers to move with them,
or they might bring some production back in-house. Either course—transplanting a production
line or setting up a new one—is an opportunity to make major process improvements. This is
because as part of the change, you can unfreeze your organizational routines and revisit design
assumptions underpinning the original process. (One challenge for companies with existing
production lines is that when those assets are fully depreciated, executives may be tempted to
retain them rather than invest in newer, more competitive plants and equipment: Since the
depreciation expense is no longer factored into the calculated cost of production, the marginal
cost of boosting production at a plant with idle capacity is lower.)

Several years ago I spent a week at a new Chinese factory of a major American industrial-
equipment company. When creating it, the company had started with the designs of its U.S. and
Japanese factories and then improved on them by introducing newer equipment and ways of
working. The result was a streamlined operation that was much more efficient than those in the
United States and Japan. When the company built its next new factory—in the United States—
it repeated the process, using the Chinese factory as the starting point. Another example is the
Flex factory complex in Guadalajara, Mexico. When increases in productivity plateaued, the
company often moved smaller assembly lines to another building (or part of the same building).
During each move, workers redesigned steps to use less space and less labor, boosting
productivity.
New technologies already or soon will allow companies to lower their costs or switch more
flexibly among the products they manufacture, rendering obsolete the installed bases of
incumbent competitors or suppliers. Many of these advances also present an opportunity to
make factories more environmentally sustainable. Examples include the following:

 Automation: As the cost of automation declines and people see that robots can operate
safely alongside humans, more kinds of work are being automated. The pandemic has
made automation even more attractive, because social distancing in factories is now a
necessity. As a result of these developments, it’s becoming more practical to return off-
shored production to higher-cost countries. Robotic palletizers, which can sharply
reduce the need for labor in preparing products for shipping, will pay for themselves
quickly, as will automated optical inspection systems for quality control.
 New processing technologies: The latest chemical manufacturing equipment uses less
energy and solvents, produces less waste, is less capital-intensive, and is less expensive
to operate. Similarly, a new generation of compact bioreactors could allow makers of
biopharmaceuticals and vaccines to produce smaller batch sizes economically.
 Continuous-flow manufacturing: This innovation could significantly increase the
resilience of the supply chain for small-molecule generic drugs by making producers
less dependent on imported active pharmaceutical ingredients (APIs). The U.S. Defense
Advanced Research Projects Agency (DARPA) has funded one initiative in this area:
the development of flexible miniaturized manufacturing platforms and methods for
producing multiple APIs from shelf-stable precursors as specific medical needs arise.
 Additive manufacturing: This production method, also known as 3D printing, can
dramatically reduce the number of steps required to make complex metal shapes; it can
also lessen dependence on distant suppliers of the machinery and tools needed for, say,
the injection molding of plastics. Rapid advances in 3D printing are making it possible
to economically produce an ever-expanding array of items in much higher quantities.

In many industries, technologies such as these promise to upend the traditional strategy of
seeking economies of scale by concentrating production in a few large facilities. They will
allow companies to replace large plants that serve global markets with a network of smaller,
geographically distributed factories that is more resistant to disruption.

Revisit the Trade-Off Between Product Variety and

Capacity Flexibility
During the pandemic, when demand surged in many product categories, manufacturers
struggled to shift from supplying one market segment to supplying another, or from making
one kind of product to making another. A case in point is the U.S. groceries market, where
companies had difficulty adjusting to the plunge in demand from restaurants and cafeterias and
the rise in consumer demand. SKU proliferation—the addition of different forms of the same
product to serve different market segments—was partly responsible. For example, one obstacle
to meeting heightened demand for toilet paper at supermarkets was that manufacturers had to
change over their production lines, because consumers prefer soft multi-ply rolls rather than the
thinner toilet paper that many hotels and offices purchased in much larger rolls. Adding to the
complexity, different retail chains wanted their own packaging and assortments.

Researchers such as Barry Schwartz of Swarthmore College and Patrick Spenner, a consultant
who was formerly at CEB (now part of Gartner), have long argued that more choice isn’t
always better. Separating demand into many different SKUs makes forecasting more difficult,
and trying to fill needs by substituting products during periods of shortage causes a real
scramble. The lesson: Companies should reconsider the pros and cons of producing numerous
product variations.

CONCLUSION

The economic turmoil caused by the pandemic has exposed many vulnerabilities in supply
chains and raised doubts about globalization. Managers everywhere should use this crisis to
take a fresh look at their supply networks, take steps to understand their vulnerabilities, and
then take actions to improve robustness. They can’t and shouldn’t totally back away from
globalization; doing so will leave a void that others—companies that don’t abandon
globalization—will gladly and quickly fill. Instead, leaders should find ways to make their
businesses work better and give themselves an advantage. It’s time to adopt a new vision
suitable to the realities of the new era—one that still leverages the capabilities that reside
around the world but also improves resilience and reduces the risks from future disruptions that
are certain to occur.

Willy C. Shih is the Robert and Jane Cizik Professor of Management Practice in Business
Administration at Harvard Business School.