The COVID-19 economic downturn is coming – and global supply chains are unprepared
The coronavirus disease 2019, known as COVID-19, is rapidly disrupting global supply chains. Ikea, Starbucks, Amazon, Microsoft, Google and Tesla, for example, have closed or slowed operations around the epicenter of the outbreak in China. Mattel expects product delays due to factory closures, while Apple expects to ship 5%-10% fewer iPhones this quarter. Some analysts are predicting a temporary blip, comparing this to large flu outbreaks or the SARS epidemic in 2003. They state, for example, that it is just a matter of time before Foxconn, which makes most of Apple’s iPhones in China, will return to full capacity. Supply will quickly be restored, we are told, and everything will return to normal.
A Global COVID-19 Economic Downturn
Unfortunately, this may be over-optimistic. The supply chain shocks that will follow the COVID-19 outbreak, even after it is contained, are not well understood by Wall Street and economists. This outbreak will likely have a long lasting impact leading to a global COVID-19 economic downturn.
Here’s why. There is a lack of understanding of how global supply chains work and their complexity. A supply chain is not a linear relationship where a manufacturer, such as Foxconn, can simply resume production and product supply is immediately restored to Apple. Rather, a supply chain is a huge global web of all entities involved in producing and delivering a product. Apple, for example, has suppliers in 43 countries that receive components from Apple’s contract manufacturers in China. Similarly, in the automotive supply chain, each vehicle contains more than twenty thousand parts from thousands of different suppliers across the globe. Even something as simple as ketchup produced in Sacramento Valley depends on bottle caps from China.
China on lockdown
Supply chain networks are essentially global webs of entities that produce and move products — but also labor, customers, and money. Adding to the complexity is that global supply chains are intertwined across industry sectors. High tech provides parts to the automotive industry, not to mention that industry sectors like tourism are also linked to a range of other supply chains, as well as to global labor sources and flows of money. Consider that Carnival Corporation (the cruise lines) spends well over $1 billion on food and beverages alone. A halt in demand means a cascading effect on a range of suppliers in the food and beverage industry.
Facilities on lockdown and quarantines of factories, as in China, not only impact production along that supply chain, but also the loss of purchasing along a range of other supply chains. This is both a supply and demand problem — and a very complex one at that. Lastly, supply chains cannot just repopulate with products over night. It takes time to ramp up production and supply. Even water in a garden hose takes a few moments to flow from one end to the other.
Global Supply Chains Implemented Lean Strategy
The situation is exacerbated by corporate global supply chain strategies that have relied heavily on “just in time” inventory replenishment, also known as “lean.” This strategy, designed to reduce costs, keeps only enough stock on hand for a short duration with the idea that inventory will be replenished as needed. As companies have increasingly implemented “lean,” they no longer have the inventory or excess capacity to make up for production losses caused by a disruption. As a result, they are highly vulnerable to even a short material-flow problem. Further, these companies have reduced the number of sources of supply, relying primarily on a smaller number of sources from areas such as China.
China, where COVID-19 originated, has a significantly greater impact on the global economy today than say in 2003 during the SARS epidemic. But China is not the only source of supply and demand being affected. While companies are looking for alternative sources of supply, for instance in countries like Vietnam and Turkey, the coronavirus is quickly spreading across continents. It’s already in countries such as South Korea, Australia, and Iran. The high interconnectivity of global supply chains coupled with a lean inventory pipeline spells trouble given the rapid COVID-19 spread.
Companies should have learned from past disruptions that it is imperative to be highly judicious in “leaning out” their supply chains. There are numerous strategies for managing risk, including having access to backup suppliers, building excess capacity into the system, monitoring suppliers for risks, and requiring suppliers of critical items to develop detailed disruption plans. Unfortunately, many multinationals have not done this, focusing primarily on cost. As a result, their companies are extremely exposed. Companies that will be most impacted are those with highly innovative products and lean inventories (e.g. high tech), limited alternative sources of supply, and long lead times (e.g. pharma). Indeed, many companies are now in crisis mode and already implementing rapid response strategies, but it may be a little late. The impact of COVID-19 on the global economy will be vast. The “coronavirus downturn” is coming.