The coronavirus outbreak — coming on the heels of last year’s Chinese tariffs — has thrown yet another monkey wrench into the already delicate relationship between U.S. companies and their Chinese supply chain networks.
Glenn Richey, the Raymond J. Harbert Eminent Scholar and Professor in Supply Chain Management in Auburn University’s Harbert College of Business, discusses what this latest development might mean for the strategic readjustment of supply chains across the global business landscape.
Auburn University: What are some of the biggest concerns facing U.S. businesses as a result of the coronavirus outbreak — in particular, the potential impact on critical supply chains?
Glenn Richey: To begin with, I find it interesting that some business leaders are floating out statements that attempt to minimize their exposure. Claims of “no disruptions” can’t possibly be true. Perhaps they can’t quantify those inevitable disruptions yet, but they exist, and will soon become material — if they haven’t already.
The impacts are inevitable for any company sourcing either goods or services out of China, although they will vary from company to company. The underlying, inescapable factor is that these companies incorporate China into their supply chains for a reason, and that reason is typically cost. Chinese manufacturers succeed primarily because of their extraordinary efficiencies, which translates into lower costs. The value of their operations — be they product manufacturing, assembly or services — are high efficiency-based. Processes are very tightly cost-optimized, and margins are thin.
AU: Haven’t we encountered these same supply chain issues with China before, when U.S. companies had to adjust their sourcing networks last summer because of the tariffs? Does that experience make these new concerns easier to deal with?
Richey: One might think, and to a certain extent that may be true for those companies who learned the lessons presented to them — hopefully they found multiple sourcing options. But to a certain extent, these issues are different.
AU: How so? What makes the current coronavirus different from the tariff considerations U.S. companies have already been forced to deal with?
Richey: Companies can pay a tariff — they can’t simply pay away a virus. So, the biggest difference is the level of uncertainty — the ability to gauge the possible outcomes. With the tariffs, there were fairly clear-cut options — the level and scope of the trade issues were primarily political decisions. This is different in that there are many more factors at play beyond politics — how wide the infection will spread, how long the disruptions will last, the impact on in-country manufacturing operations, the practical viability of securing alternative sources of products and services to take up the slack. There are a whole host of both short- and longer-term impacts in play this time around.
AU: We assume these short- and long-term impacts require different remedies, different decisions — how can companies decide which way to go?
Richey: They need to do both, and there are only so many options in the short term. As the tariff issue showed us, it isn’t that easy to simply turn to other sources for many products and services. Even if you could, these kinds of pivots wreak havoc on critical supply chains, adding costs and time delays to the equation. But the bigger issue is availability — there isn’t a ton of plant capacity just sitting out there ready to be turned on. In the case of the tariffs, many U.S. companies turned to suppliers in Vietnam, for example. But many suppliers in Vietnam said, “We’re full. We don’t have the capacity to fill new orders right now.”
AU: What about the long-term decisions — what can companies do to ensure their exposure to China is minimized going forward?
Richey: Savvy business leaders are weighing their options — particularly regarding products and services that are sole-sourced from China. There’s an analogy with what Amazon is doing with its distribution centers — building product distribution facilities closer to where their demand is to fulfill their next-day and same-day delivery promises. But in this case, it isn’t time they are seeking; it’s local and regional availability of manufacturing and assembly operations. This move to “near-sourcing” requires an initial capital outlay, but the payback can be significant in terms of reducing supply chain risk over the longer term.
AU: What countries or regions are being considered — are they all in the Far East or are there other areas?
Richey: Certainly, some of these are in the Far East — China isn’t the only country in the region known for high-efficiency, low-cost manufacturing. But not all decisions are based on cost alone. Quality is also a key concern, and with higher quality comes added costs. South Korea, for example, has a vast array of high-efficiency manufacturers, but costs are significantly higher there, primarily due to the cost of high-skilled labor required to produce that higher quality.
Over the longer term, companies are looking to parts of Africa and South America for alternative sources as companies on these two continents ramp up manufacturing operations of their own. But this takes time, and the capacity simply isn’t there yet.
AU: What can business leaders do, if anything, to expand manufacturing and sourcing operations into these areas more quickly?
Richey: The most important thing they can do is to commit resources to training employees in these areas. Without a skilled workforce, these areas can’t become reliable sources of supply. It is a huge, long-term commitment, but it has the potential to pay off over time.
AU: What about North America — in particular, the U.S.? Commerce Secretary Wilbur Ross was recently quoted as saying that the coronavirus outbreak could be positive for U.S. manufacturing. Do you see that happening?
Richey: There could be some of that on a small scale, but I think Mexico would be a more likely beneficiary — if that’s even the right word. The new United States-Mexico-Canada Agreement will remove a significant number of economic and strategic risks of shifting sourcing to Mexico. They also have the skilled workforce necessary for many of the products built in China, and costs are much lower there than they would be in the U.S. Plus, there’s already a robust, efficient transportation system in place between the two countries.
AU: What about the transportation sector itself? What impacts do you see there from the coronavirus outbreak?
Richey: One of the impacts of the suspension of passenger flights in and out of China is the corresponding reduction in the freight that typically goes with those flights. These planes don’t just carry people and their luggage. Delta, for example, doesn’t have any dedicated cargo aircraft, yet it carries tons of cargo in the holds of its passenger jets. The vast cargo capacity of today’s large jets — the Boeing 777-300ER can carry more than 20 metric tons in addition to a full load of 400 passengers — means this freight will now need to be shipped via dedicated cargo flights.
But the impact of the coronavirus on freight transport doesn’t stop there. To maximize efficiency and costs, freight carriers work hard to make sure their holds — be they in airliners or ships, for that matter — are full in each direction. With factories shuttered and shipments out of China down, we can expect imbalances in that equation that can have a significant impact on the bottom line of some freight carriers.
AU: Looking forward, once the outbreak subsides to the point where commerce begins to resume in and out of China, what other issues do you foresee?
Richey: One impact for China relates to business lost to alternative suppliers — that business doesn’t simply go back to China. In order to secure capacity in a tight supply scenario, companies need to commit to these new suppliers, often under long-term contracts. Once that investment in resources and supply chain shifts is made, there might not be compelling reasons to return to China based on previous cost benefits, which might no longer exist.
And then there’s the impact on ports and customs operations — both those going out of China as well as those on the receiving end here in the U.S. and elsewhere. Backlogs of deliveries will likely push those operations beyond their ability to accommodate a surge in product flow, resulting in further product delivery delays.
Bottom line is — nobody knows how this will all pan out. But one thing is certain: These changes will have lasting impacts on existing supply-chain strategies. And that’s a good thing.
This story originally appeared on Auburn University’s website.
