Will Supply Chains diversify away from China post COVID-19?

In 2003, during the SARS epidemic, China accounted for 4% of global output, but today China accounts for 16%, four times as much. Globalisation has increased since then and so has our dependence on China. Post COVID-19 I looked at how likely it is for this dependence to continue.

As businesses reassess their supply chain strategies, I discussed the key objectives of future supply chains with senior supply chain executives. The consensus was that the experiences of doing business the Covid-19 have shown that supply chains need to:

  • Increase resilience while reducing risk and vulnerability
  • Increase diversification providing more responsiveness and agility
  • Increase value although not necessarily reducing cost
  • Ensure continuity of supply in the face of future global events

So, how do businesses achieve these improvements to their supply chains? UK business has four key decisions regarding supply chains;

1. Maintain the status quo

In short, keeping current supply chain structures and reliance on China is unlikely. Changes are certainly afoot with US companies expected to feel the political pressure to leave China due to the so-called ‘new Cold War’ trade tensions. Added to this is the rising the cost of production in China due to growing wages and stricter environmental regulations. It’s a perfect storm of elements that make it evident that companies need to diversify their manufacturing locations and supply chains away from a traditional reliance on China.

Frederico Duarte, Director Supply Chain Operations for Baker Hughes argues businesses cannot afford to avoid making changes:

“Whether it is a war, a tsunami, another pandemic, or even snow that closes airports, an event similar to COVID-19 that affects global business will certainly happen again. Businesses must invest, diversify and build greater resilience into their supply chains more than they currently are if they are to mitigate the risks. We must have not only a Plan B, but also Plans C and D ready to roll.”

2. Diversify away from China but still produce in East Asia

The exodus of companies leaving China had been underway for years – even before Trump’s trade war and the COVID-19 pandemic – but it now costs manufacturers $6.50 per labour hour in China, which is $1.50 higher than in 2016 and over twice that of Vietnam [1]. With countries such as Thailand, Cambodia, Indonesia and Vietnam investing in infrastructure and developing economic incentive zones there are now more cost effective alternative ways of accessing the ASEAN free trade area without relying on a Chinese manufacturing base. It seems the diversification into East Asia will continue and the pace will quicken.

3. Near-shore to Europe or Africa

Businesses are re-evaluating the long lead times for shipping by sea from China to UK which takes, on average, 30 days. With shipping fuel costs set to double due to International Maritime Organisation (IMO2020) Low Sulphur Regulations coming in to effect on 1 January 2020 [2], UK businesses are considering whether now is the time to shorten supply chains.

German car manufacturers have increased their production of components in countries such as Rwanda and some British companies are actively developing manufacturing sites in north and eastern African countries like Egypt, Tunisia, Morocco, Ethiopia, Ghana, Senegal and Ivory Coast. Africa certainly stands to benefit from this pandemic as European businesses seek to near-shore.

4. Re-shore to UK

During the COVID-19 crisis, we have seen various critical medical-supply shortages, perhaps not surprising when 80–90% of generic medicines used in the NHS are imported and China and India are in the top five providers of UK medicines outside of the EU[4]. There is certainly a feeling that UK is over-dependent on China and other nations for manufacturing. There is an expectation of a shift towards re-shoring, even if it is more expensive, in part to support the UK economy and jobs, but principally to reduce risk and guarantee supply.

The UK Government has invested £93 million[5] to open the UK’s first dedicated Vaccine Manufacturing and Innovation Centre where it expects to produce Coronavirus vaccines from 2021. In the meantime, the Government has guaranteed a further £38 million to establish a rapid deployment facility based in the UK this summer. This shows an overt pledge to support UK manufacturing and a shift away from the reliance on other countries – especially with pharmaceuticals and healthcare.

Supplier Relationship Management

Another theme of change is an increased need for better supplier relationship management (SRM).

David Wylie, Commercial and Procurement Director at Thames Water notes how the closure of Chinese manufacturing plants has led to the short supply of components and raw materials for some products globally and how this will change procurement behaviour;

“Supplier relationship management will become more important post-COVID-19. Previously SRM has sometimes struggled to always make its business case. In future it will become an essential part of corporate risk management. Behavioural change was already happening prior to the pandemic, but this is a catalyst and will really accelerate the change. Building long-term trusting relationships with suppliers, understanding and helping mitigate where their risks are – down to second and third tier suppliers – is even more important today. Visibility of the supply chain is going to become key.”

Many businesses do not know what their risk exposure is because very few actually have the complete knowledge of all the companies that provide the component parts to their suppliers. A robust supplier-monitoring system which maps tier 2 and 3 suppliers is arguably considered more essential in today’s environment if businesses are to understand their risks and maintain continuity of supply.

But will anything actually change?

There is no lack of discussion around the benefits and reasons who supply chains should change, but when it comes to the crunch can businesses actually afford to re-shore or near shore? Do companies have the time, resources and capital, especially in these times, to multi-source when their revenues have been reduced as a result of the pandemic?

Martin Calland, Chief Procurement Officer and Consultant in Procurement Transformation, says it rests with CPOs to make the case for change:

“It is for CPOs/Chief Supply Chain Officers to create the compelling value propositions to justify investment in supply chain diversification. It is not all about the bottom line. Supply chain resilience is about business continuity and risk reduction/management. The decision to invest in, and change supply chains is a business-wide decision and it is up to the management board to choose what risks they are willing to accept. COVID-19 is a universally lived experience and it has certainly heightened the motivation to make supply chains more resilient.”

Diversification of supply chains, and a movement away from China, has been happening for many years before COVID-19, although the pace of this change has been rapidly accelerated by the pandemic. Supply chains are in the spotlight and businesses are forming strategies around how to build-in greater resilience ahead of whenever the next disruptive global event occurs. The degree to which UK business changes and how much manufacturing is ‘re-shored’ very much depends on the what level of risk each company is willing to accept. What is clear, is that change is happening, but it remains to be seen just how much of an opportunity for UK manufacturing this will be.

Sources:

1. House of Commons Business, Energy and Industrial Strategy Committee. The impact of Brexit on the pharmaceutical sector. 2018. Available at: https://publications.parliament.uk/pa/cm201719/cmselect/cmbeis/382/382.pdf(accessed August 2019)

2. PWC Supply Chain and Risk Management, 2013 at: https://www.pwc.com/gx/en/operations-consulting-services/pdf/pwc-supply-chain-and-risk-management.pdf

3. How Coronavirus could Impact the Global Supply Chain, 2020 at: https://hbr.org/2020/02/how-coronavirus-could-impact-the-global-supply-chain-by-mid-march

4. Forbes: COVID-19 undermines China’s Run as the World’s Factory at: https://www.forbes.com/sites/wadeshepard/2020/03/26/covid-19-undermines-chinas-run-as-the-worlds-factory-but-beijing-has-a-plan/#e51333c459a9

5. https://www.gov.uk/government/news/vaccines-manufacturing-and-innovation-centre-to-open-12-months-ahead-of-schedule