The infectious disease known as Covid-19 is wreaking havoc on the global economy, with the World Health Organization (WHO) having declared a global pandemic. The Wall Street stock tumble officially pushed stocks into a bear market, Italy was placed on a national lockdown, and sections of the United States—such as New Rochelle, New York—are on quarantine. Major companies, including Ikea, Starbucks, Apple, and Google, have closed or slowed operations. Many others, such as Amazon, Google, and Facebook, are asking workers to work from home.
While gatherings of every kind, from sports events to schools to Broadway shows, are being cancelled, product shortages are being felt from high-tech to pharmaceuticals. The ensuing economic and social disruptions are massive, and global supply chains are woefully unprepared to meet the challenges this poses.
The current pandemic has brought the criticality of supply-chain management to the forefront, as well as supply-chain vulnerabilities. The awareness of both should have been there long before. After all, the financial amounts tied up in the supply chain are staggering. The amount of corporate spend that is controlled by the procurement function averages 82 percent; the industry with the lowest average is the pharmaceutical sector, at 58 percent.
Further, for the typical company, 80 percent of total spend goes to roughly 6 percent of the organization’s suppliers. This means that, on average, an organization will spend 80 percent of its money with only 6 percent of its vendors. These are the “A”-list suppliers—the most important and critical. Suppliers categorized as “B” or “C” are of relatively small importance to the company’s operations.
CFOs and CEOs should be aware if their company has such a large financial number tied to only a few strategic suppliers. Executives may want to allocate more resources to managing, developing, and negotiating with these top suppliers.
A strategically designed supply chain is essential to support progress toward corporate goals, such as profitability and market growth. These goals are not achievable without the right portfolio of supply-chain partners. A company should consider its “A” suppliers—the top 6 percent, or so—to be partners. It should also design its supply chain to align with its business strategy, to ensure that it is prepared to satisfy the needs of customers, take advantage of the company’s strengths, and remain adaptive.
The supply-chain shocks that will continue to follow the Covid-19 outbreak, even after it is contained, will have a lasting impact on the global economy. This is why it is important for leaders to understand basic supply-chain functionality, what to do now, and how to mitigate future disruption.
Here is what corporate decision-makers need to know:
1. Global supply chains have become extremely complex. There is a lack of understanding among analysts, economists, and the general public of how global supply chains work. A supply chain is not a linear pipeline where a manufacturer—such as Foxconn, which manufactures iPhones for Apple—can suspend operations, then simply resume production and instantaneously begin delivering products again to the customer’s (in this case, Apple’s) stores.
Rather, a modern supply chain is a huge global web of entities involved in producing and delivering a product. Apple has suppliers in 43 countries, and its 200 top suppliers span the globe—from 3M in the U.S., Japan, China, and South Korea to Intel in the U.S., China, Israel, Malaysia, Vietnam, and Ireland. Then there is the fact that many tech companies have intertwined supply chains that share suppliers. For example, Intel supplies processors to manufacturers including Apple, Lenovo, HP, and Dell.
The supply chains of most other large multinationals are just as complex. Automotive supply chains include manufacturers, carriers, and shippers. Each vehicle contains more than 20,000 parts from thousands of different suppliers and assembly facilities. Even a simple product, such as ketchup produced in Sacramento Valley, is globally dependent—with bottle caps coming from China.
Further increasing the complexity, global supply chains are intertwined across industry sectors. The tech sector provides parts to the automotive industry. Carnival Corporation spends more than $1 billion a year on food and beverages. So a halt in demand across one industry, such as tourism, has a cascading effect on suppliers in other sectors, such as food and beverage.
Covid-19 has created a very complex combination of both supply and demand problems. The lockdown or quarantine of a factory in China will have visible impacts on manufacturing along that company’s supply chain. The business will not be placing orders for the widgets its Chinese factory usually requires, potentially creating a significant decline in demand for its suppliers. A factory closure may also impact production in the other direction, by limiting the ability of customer organizations along a range of other, interconnected supply chains to purchase inputs they need for their own manufacturing processes. Each event propagates to other industry sectors and then cascades down those supply chains.
2. Just-in-time inventory replenishment is exacerbating the coronavirus situation. “Just-in-time,” or Lean, manufacturing instructs a company to maintain only enough stock on hand for a short duration, in order to control costs. The idea is that inventory will be replenished only as needed.
Many companies have implemented Lean management, which means that many no longer have the inventory or excess capacity to absorb the impact of a supply-chain disruption. As a result, these businesses are highly vulnerable to even a short material-flow problem. When an earthquake shook Taiwan on September 21, 1999, it created a huge disruption for the computer-chip industry. A low volume of products in the pipeline created delays of four to eight days, which adversely affected the performance of companies such as Apple, IBM, and Compaq.
Similarly, because Lean systems have removed most excess inventory in medical supply chains, many companies were unable to adequately respond to disruptions during the emergence of avian influenza, or the bird flu. Extra inventory creates buffers for a business, enabling it to cope with disruption. Supply chains that are too “lean” are unable to respond when things break down.
The challenges multiply for companies that have reduced the number of sources of their inputs—for example, businesses that rely primarily on a smaller number of suppliers which are concentrated in a specific geographic area, such as China. In fact, prior to the current pandemic, China comprised significantly greater impact on the global economy than it did during earlier disruptions, such as the SARS epidemic.
3. When the outbreak is contained, ramping up manufacturing will take time. Supply chains cannot just repopulate with products overnight. Even water takes a few moments to flow from one end of a garden hose to the other.
Consider what happens when there’s a shortage of flu vaccines at hospitals and clinics. Producing a vaccine takes months of lead time, including the time needed to source the materials, grow the virus, and coordinate packaging and distribution. And each step is handled by multiple companies—from labs to packaging manufacturers, to testing facilities, to distributors—often going through several countries. As medical staff wait for replenishment of their vaccine supplies, the flu will spread, thereby increasing the demand for additional vaccines, exacerbating the inventory problem.
Lead-time issues can damage any business. In the context of infectious disease, they can be fatal. During the Ebola epidemic of 2014, front-line healthcare workers lacked sufficient personal protective equipment such as rubber gloves. Epicenter communities in Africa were surrounded by rubber tree plants, but rubber gloves are made through a globally distributed supply chain, which could not move products quickly enough.
Demand might not rebound quickly, either. A lasting quarantine or travel ban would mean a loss of disposable income for workers in certain areas or industries and a drop in consumer spending—from consumables and retail to food and rent, not to mention luxuries such as entertainment and tourism. Both supply and demand might take a long time to recover from the economic damage of the Covid-19 pandemic.
What Can a Company Do Now?
The short term is volatile and requires triage. Immediate measures require careful segmentation of the entire product and customer portfolio based on margins, lead times, and criticality.
- Create a matrix sorting customers, products, and suppliers based on importance and vulnerability. Set priorities: Which customers get served first? Which suppliers are most critical? Which components have the longest lead times?
- Identify all risks to sources of supply, production capacity, delivery, and demand. Consider all options and outcomes, so as not to lose critical customers and market position. How this part is handled can make a huge difference for a company’s future position.
- Identify possible substitutes and alternative sources of supply. For example, the Polish fashion retailer LPP is talking with factories in Turkey, Bangladesh, and Vietnam as a backup plan if Chinese production delays continue.
- Consider slight product modifications where you may have local access, or other sources, to substitute components.
- Evaluate the feasibility of gearing up capacity or switching production processes to similar products that might be experiencing increased demand because of the coronavirus. When the SARS epidemic broke in 2003, a Toronto-based lotion manufacturer quickly switched production from lotion to hand sanitizer. Currently, DuPont has revved up production of protective suits, such as hazmat suits, at its Richmond facility. The factory is working at full capacity to meet this surge in demand. This requires just a little flexibility in operations.
Best Practices Moving Forward
Once Covid-19 has been effectively contained, companies should consider revamping their supply chain with four important points in mind:
1. Ensure that the company’s portfolio of suppliers is diversified. The number of different suppliers is not the only issue; a company should also look to diversify across geographic distribution and other risk elements. Immediate actions will be to find alternative sources of supply, including partnering with competitors in a relationship called co-opetition.
2. Monitor risks so that the supply chain is not too heavily “Leaned out.” A heavily Leaned supply chain is one in which companies have removed too much inventory from the pipeline—it is simply too “lean.”
A Lean approach to operations is good for a business when it removes excess and waste. However, it is bad when it results in too little inventory throughout the system, so that there are no reserves left. This is especially true when dealing with critical components. Companies should have learned from past disruptions that it is imperative to be highly judicious in Leaning out their supply chains.
A good strategy is to carry more inventory for items that are critical, that have few alternative sources of supply, or that have long lead times. Like suppliers, inventory items can be classified according to criticality, using what’s called the “ABC analysis.” Class “A” inventory items are most critical, and companies should maintain extra supplies of these products—unlike “B” and “C” inventory items, which are less important.
There are many metrics that can be used to monitor appropriate inventory levels; the most common is “weeks of supply.” This metric tells a business how many weeks it can function with the inventory levels it currently has on hand. The right level for this metric depends on the industry and product, and numbers can vary dramatically. The key is for each business to develop established values for its different material inputs, then monitor actual levels over time. If the numbers become low, the company may have moved too far toward Leaning its supply chain. If the numbers grow much larger than the targets, it may have too much cash tied up in inventory. The key is to strike a balance and track the values over time.
3. Create visibility into the supply chain. Simply put, supply-chain visibility is the ability to see from one end of the pipeline to the other. Visibility implies a clear view of upstream and downstream inventories, demand and supply conditions, and production and purchasing schedules. This is where using analytics becomes important, as well as creating dashboards and control towers to provide visibility up and down the supply chain.
A business needs to know where demand is—by product and location—and adjust supply accordingly. Consider Lennox, a provider of climate-control products for heating, cooling, and ventilation. The company used sophisticated analytics to identify more than 200 “micro-climates” within the United States, detailing their seasonal timing variations. This enabled Lennox to have more of the right inventory at the right locations, matching supply with demand. The result was a 16 percent improvement in customer service levels and a simultaneous 25 percent improvement in inventory levels.
The lesson is for companies to rely on analytics to assist in these types of decision-making processes, in order to better “see” both demand and supply, and to bring them in sync.
4. Prepare for the next black swan. Black swan events are considered low probability but highly disruptive. Although individual black swan events rarely happen, taken together, we have had quite a few. Companies should have learned from past disruptions that it is imperative to be highly judicious in managing supply-chain risks.
There are numerous strategies for managing these risks, including having access to backup suppliers, building excess capacity into the supply chain, monitoring suppliers for risks, and requiring suppliers of critical items to develop detailed business continuity plans. Unfortunately, many multinationals have not done this, instead focusing primarily on cost when choosing suppliers. As a result, their supply chain is extremely vulnerable.
The global economy is quickly moving into a crisis of a global pandemic—a “coronavirus downturn.” This will be a painful time for the business community overall, but it may be an opportunity for some companies to actually improve their standing, depending on how they handle the challenge.
There is still time for businesses that act immediately. The companies that will be most impacted are those with highly innovative products and Lean inventories (such as tech firms), limited alternative sources of supply, and long lead times (such as pharmaceuticals). Indeed, many companies are now in crisis mode and already implementing rapid response strategies, but it may be a little late.
- Thinking Outside the Working Capital Box
- Supply-Chain Disruption Is Widespread
- The Finance Leader’s Guide to Preparing for an Economic Downturn
- Emerging Risks: Get Ahead of the Unexpected
Nada R. Sanders is the Distinguished Professor in Supply Chain Management at the D’Amore-McKim School of Business at Northeastern University, the 2019 president of the Production and Operations Management Society, and a Fellow of the Decision Sciences Institute. She is co-author of the new book The Humachine: Humankind, Machines, and the Future of Enterprise.