Coronavirus and the impact on global supply chains

February 20, 2020
Mark Essle, Suketu Gandhi, John Song, Jian Xu.

Global emergencies such as the recent coronavirus outbreak in China and its massive impact on the economy show the need to immediately rethink existing supply chain thinking. The popular and established strategies work, but only when they are not disrupted—and we live in a world where disruption is the only constant. Conventional supply chain thinking needs to be revisited with an eye toward increasing customer satisfaction and long-term financial return. “Plan and pray,” it turns out, is pretty bad business advice.

Disruptive events can take the form of natural phenomena such as epidemics, hurricanes, and earthquakes. They can be manmade “crises” such as tariffs, trade wars, military wars, or elections. Or, as in the case of the coronavirus, they can be governmental responses to a domestic emergency with broad international impacts. In these various forms, disruptive events are ironically becoming the norm. Furthermore, digital connectivity gives businesses, their customers, and end users alike near-real-time awareness of disruptive events across the planet, causing markets to immediately react, often before the events fully develop.

We rightly view situations like the coronavirus outbreak first in human terms, tracking the rate and degree of infection and focusing on the human cost, the often-tragic effects on individual lives and communities. The toll on the Chinese people in this case has been horrific and may well continue to be so, but beyond the human face of a disruption lies a compelling business story. In the face of disruption, corporations fight to keep their operations as “normal” as possible. Although a less popular story, it’s nevertheless important, because the goods and services they provide touch millions of lives as well.

The toll on the Chinese people in this case has been horrific and may well continue to be so, but beyond the human face of a disruption lies a compelling business story.

The amount of disruption characterizing today’s global markets—especially at critical links for multiple industries such as China—makes conventional supply chain strategy no longer tenable. Companies will do better to rethink logistics strategies, reconfiguring their global supply chains to deliver maximum customer satisfaction and financial outcomes by anticipating disruptions rather than being cornered into reactive, knee-jerk responses.

The effects of the coronavirus are being felt in three areas of commercial activity: manufacturing, distribution of goods and transportation. But the situation on the ground is fluid across the globe, and that fluidity is a large part of the problem.

Who, what, and where?

One way to begin rethinking supply chain strategy is to ask the old journalist’s questions: who, what, where, when, and how? The first three questions are straightforward: Who is being impacted; what do their primary, secondary, and even tertiary supply chains look like; and where is the crisis located?

Let’s start with where. The virus’ impact differs by industry and Chinese province. Hubei, for example, contains an automotive industry cluster. Henan has a high concentration of food and agricultural activities. Zhejiang is home to a cluster of apparel producers. Guangdong is home to a number of machinery producers. And Zhejiang, Guangdong, and Hubei all have concentrated productions of electronics goods.

Now, let’s look at the who. As a rule, more labor-intensive industries face greater impacts from a quarantine policy, due to the lower level of work resumption. As a consequence, declining output has hit the globally-sourced automotive components, electronics, and apparel industries especially hard.

For example, at this writing, the automotive industry is still at less than 50% of its pre-virus production rates. While some Chinese parts suppliers have partially resumed operations, all major automotive suppliers, especially in Wuhan, have postponed resumption. These delays have created a ripple effect on domestic and overseas OEMs, which are postponing or interrupting production. Because of higher Chinese content, North American OEMs are more vulnerable than their European and Asian competitors. Then again, it only takes being out of stock on one part to shut down an assembly line.

The epidemic is dealing a heavy blow to an already falling market, causing an additional 2%–5% volume decline this year. Abrupt Q1 sales declines of up to 20% are expected.

Believed to be at the epicenter of the coronavirus outbreak, the food and beverage sectors have been hit hard, particularly livestock and fresh goods. Although China doesn’t adopt extensive quarantine measures against export, foreign nations are enforcing quarantines on certain product categories, including food.

The epidemic is dealing a heavy blow to an already falling market, causing an additional 2%–5% volume decline this year.

Consumer goods also face significant hurdles, depending on how they are shipped. Ocean-going products face only minor impacts, most of which are demand driven and/or concerned with surplus and idle capacity. However, products shipped by air face more severe impacts, with price surges and capacity drops for both belly cargo and freighters. Geographical quarantine has for all intents and purposes paralyzed land transport in China. This has significantly extended or interrupted line haul transit times. Consumer goods producers are still at only 10%–20% of their pre-coronavirus levels.

Multiple labor-intensive segments in the apparel supply chain have been critically hurt, especially in Zhejiang. The slowdown there will have a domino effect throughout the supply chain, creating pressure on stock and logistics systems and ultimately affecting retailers’ stocks. Currently, global retailers purchase about 20% of their goods value from China, a percentage that rises substantially in seasonal categories.

Electronics companies are operating at 40%–60% of pre-outbreak levels. This impact varies significantly from category to category: wafer fabrication and PCB and LCD panels are less impacted, due to continuous production; assembly-related processes are affected the most. Apple’s recent announcement about the coronavirus’ role in forcing a downward revision of its previous March quarterly revenue guidance may be the tip of a much larger iceberg about to hit the electronics industry.

What configuration supply chains take on is critical: think of your product allocation based on your supply constraints and focus on customer satisfaction as a critical element of your financial payoff calculations.

Many global companies are suffering not only from issues with their Chinese suppliers, but also from a paralyzed logistics network. The network has high logistic elasticity closely related to demand by producers’ output—and that presents tremendous challenges.

So far, ocean freight capacity hasn’t been affected. There is container availability lay-up in major Chinese ports and increased idle capacity in global shipping—a direct byproduct of huge capacity surpluses tied to demand-side plunges. Long distance liners are the least affected, while short distance liners such as those to ports in Southeast Asia are experiencing minor impacts. The coronavirus crisis most affects trips of under 14 days from China to Southeast Asian destinations.

Ninety percent of passenger flight capacity to and from Greater China has been withdrawn, with suspensions predicted to continue through the end of April. The result has been slashed air transport capacity and mild surges in air freight costs. Belly cargo capacity, accounting for approximately 50% of total air cargo capacity, has dropped off.

Local manpower restrictions in China also contributed to mild increases in air freight rates. Due to quarantines, staffers of Chinese freight forwarders are required to work from home; meanwhile, ground handlers—truckers, warehouse staff, and manufacturing staff—have been unable to return to work for longer than expected. Reduced belly capacity might trigger some demand shift toward freighters to expedite delivery, but only for limited volumes, since freighter operators have also been pulling capacity out of Hong Kong and China.

Not surprisingly, ground logistics are significantly impacted due to road shutdowns and stricter inbound traffic control. Compared to last year, inbound transportation to Wuhan is down 87% and ground logistics within Hubei province have been reduced by 65%.

More difficult: When and how

The last two questions, when and how, have more complicated answers. Indeed, the when question, of how long the crisis will last, is one we don’t even pretend to have an answer for. But we do have definite perspectives about how you address it.

The first step is to develop visibility to your entire supply chain—primary, secondary, and even tertiary players and steps. For instance, a shortage of bolts can ultimately stop production of any number of products, so it is critical to understand where your appliance suppliers are getting their bolts.

Next, recognize that events like the coronavirus outbreak are going to happen again and again—and determine what plans work best to mitigate the damage. For companies facing a supply chain crisis, these plans begin with understanding the exact nature of the threat and getting an accurate assessment of the situation on the ground. It only makes sense to war-game or scenario-plan against the most probable threats before they happen, not after.

Once you feel confident that you understand what is going on, immediately make a list of things that could or should be done. Again, a series of what-if models can help you plan in advance. For example, assuming your primary supplier shuts down, do you have a network of alternate suppliers? If shipping is constrained, is air freight a viable option in terms of both cost and volume to be moved?

Recognize that events like the coronavirus outbreak are going to happen again and again—and determine what plans work best to mitigate the damage.

Discussions of just-in-time inventory, on-demand production, and eliminating warehousing are so popular they have become part of the conventional wisdom that we warned about earlier. As many companies have found out the hard way, those models don’t sufficiently indemnify you against a major supply chain disruption. Maintaining higher inventory levels may cost 0.3%–0.7% more, but in a crisis, the higher inventory levels pay dividends in terms of customer satisfaction and competitive positioning. It’s better to have enough buffer stock and not need it than to need it and not have it.

So, conventional models may be fine for about 80% of your supply chain—as long as you get the maximum flexibility available out of that remaining 20%. That means you may have to learn how to live with higher inventories than conventional supply chain strategists suggest. Cutting inventories to the bone in the name of efficiency may turn out to be a high-risk maneuver even within one country.

The same is true of single sourcing. Sure, you can save some money and maximize economies of scale and control by buying in quantity from one supplier, but what do you do when that supplier is located at the epicenter of a pandemic? Ask yourself: do single sourcing’s advantages outweigh the higher risks that accompany it?

The current coronavirus crisis reminds us all that is it is always better to manage with disruption in mind than it is to assume the worst can’t and won’t happen.

Mark Essle, Suketu Gandhi, John Song, and Jian Xu are partners at management consulting company Kearney.