Effects of COVID-19 on The International Supply Chain
March 30, 2020
The global pandemic began due to the initial outbreak of the coronavirus epidemic in Wuhan, China. With no new deaths in the Hubei province for several days, one might assume that manufacturing in China will soon return to business-as-usual, ending the disruptions to the global supply chain that have affected companies in the U.S. and around the world.
However, to the contrary, much of China remains on lockdown. Open factories must contend with logistical bottlenecks and labor shortages as travel restrictions prevent employees from returning to work after the Lunar New Year. That’s all worrisome news for multinational companies that have grown to depend on China for raw materials.
The companies that are best positioned to deal with the impact of disruptions caused by the new coronavirus are those that have diversified their supply chains out of China, i.e., started manufacturing in Mexico or other nations. Here, we’ll explain the shift of manufacturing out of China and introduce strategies for reducing the risk of supply chain disruption in the face of our current and future challenges.
The Need to Diversify Supply Chains
For months before the current crisis, U.S. and multinational companies have been moving their supply chains out of China and into other nations, including Mexico, for other reasons. These include:
- Costly tariffs on goods imported from China
- Decreased freight and transportation costs on goods sourced closer to the market they are sold in
- Reduced lead time for items sourced closer to their eventual market
In particular, the recent trade war with China has added costly tariffs of up to 25% on goods from China, leading to losses for companies with supply chains that are heavily dependent on China.
The effects of these tariffs have been pervasive. CNBC reports that “20% of all U.S. retailers’ supply chains are exposed to China.” Industries that are particularly reliant on Chinese manufacturing include:
- The Clothing and Footwear industry
- The Electronics industry
- The Active Pharmaceutical Ingredient (API) sector
As a case in point, CNBC notes that electronic goods retailer Best Buy sources 60% of its goods from China.
It stands to reason that for companies and retailers that significantly rely on China for products, parts, and assembly, events that affect the flow of business in China will have an outsized effect. Some U.S. companies have been paying increased tariffs since the beginning of 2018, up to six times more than the cost of those tariffs before the trade war.
Worries Beyond Financial Cost
For a long time, U.S. companies have operated on the assumption that the best supplier is the most cost-effective supplier. However, it’s increasingly evident that when companies source a significant percentage of their parts or products from a single nation, tariffs are not the only worry. Any of the following disruptions in the supply chain could affect a multinational company’s bottom line:
- Natural disasters that affect production and shipping
- Shifting political tides that affect their industry
- Disruptions to a trade partner’s economy and the cost of doing business
In some cases, a company- or industry-wide reliance on a single nation could pose not just a fiscal threat, but also a public health threat. In a February 2020 article, the Economist points out that China’s dominance of the Active Pharmaceutical Ingredient sector might pose problems not just for the U.S. medical industry, but also for the safety of troops and citizens.
Currently, many medicines sold and distributed in the U.S. rely on China for their active ingredients. The Economist details a congressional oversight panel:
“Christopher Priest [a pentagon official] declared that ‘the national-security risks of increased Chinese dominance of the global API market cannot be overstated.’ He invited the hearing to imagine China interrupting supplies of irreplaceable drugs, such as those that protect troops against anthrax.”
When companies are reliant on a single supplier for crucial parts of their products, anything from political manipulation to a pandemic can affect their ability to maintain production and get their product to consumers. In the API sector, successful production and delivery of products is essential not just to the health of the pharmaceutical industry, but to public health.
The need to diversify supply chains has been brought into even greater relief by the new COVID manufacturing challenges many sectors are facing.
COVID-19’s Effect on the Supply Chain
While U.S. and multinational companies have already begun to see the wisdom in diversifying their supply chains, the urge to move production out of China has increased in recent days. Michael Dunne, director of a Chinese-based automotive consulting group, is quoted in the Washington Examiner:
“Now, with the coronavirus, the urgency surrounding [diversification] has been amplified. Manufacturers and suppliers find themselves really hostage to events inside China and that, without sources outside of China, they are vulnerable.”
Indeed, the Institute for Supply Management has found that, amidst the current coronavirus pandemic, 75% of U.S. companies have experienced supply chain disruptions. Perhaps even more worryingly, 53% have little information about what is happening with their overseas vendors.
And although China is partially returning to business, that is a small cause for comfort for U.S. companies already suffering delays and disruptions in their supply chains. In the Harvard Business Review, Pierre Haren and David Simchi-Levi warn that U.S. businesses have only seen the beginning of the delays—and their costs. CNBC agrees, noting that, “Losses for U.S. retailers — from production and transportation shortages due to coronavirus — could amount to $700 million.”
As the coronavirus slows its initial spread through mainland China, continued localized quarantines, transportation checkpoints, and port restrictions and more will likely continue to prevent a second wave of cases. This could lead to several continuing challenges for U.S. companies, detailed below.
Lowered Production Capacity
With much of the workforce still in their home provinces after travel for the Lunar New Year in February, Chinese manufacturing plants may struggle to find sufficient staff to meet their production quotas, or to find available drivers to transport the goods they can to produce.
Edward Hertzman, president of Sourcing Journal, notes that this lowered production capacity may hit small businesses the hardest:
“It’s going to affect the mom and pops that are relying on wholesalers getting seasonal products into the country from China…If I am a brand, and I’m prioritizing my list of retailers, I’m going to go down the list, starting with the larger retailers. Some of the mom and pops may get left out.”
However, businesses of all sizes may have to find new vendors to meet consumer demand for their products and remain profitable.
Delays Due to Closed Borders and Factories
U.S. ports are taking in fewer shipments than a year ago. According to CNBC, there are, in fact, 18% fewer shipments as of March. However, the problems extend beyond goods bound directly for the U.S. Market Watch details two examples in the automotive industry of how Chinese delays can disrupt a company’s entire international supply chain:
- Fiat Chrysler Automotives has suspended the production of cars in Serbia due to the unavailability of parts from China.
- Hyundai has halted production in Korea for similar reasons.
Missed shipments and service windows can make it costly and even impractical to continue production outside of China.
It’s worth noting that even in the best of circumstances, goods from China take 30 days to reach the U.S. and Europe. Due to this lag, products needed for the busy summer wedding season are already being affected. Beyond that, retailers rely on back-to-school season and holiday shopping to remain profitable. Should this situation persist, goods may arrive late—or not at all.
Finally, even as production ramps up, this might cause issues, too. As shipments go out en masse, it could cause a “huge bottleneck” at the ports, as well as massive delays.
Legal Issues
Beyond the logistical issues of getting goods from China, the U.S. government may soon implement measures to make it even more expensive—or even impossible. Forbes reports that President Trump might soon issue an executive order mandating that federal agencies buy American-made goods to fight the pandemic in the U.S., from pharmaceuticals to masks and beyond.
As the federal government institutes further measures to boost the U.S. economy in the face of a possible downturn, there’s no telling which industries will ultimately be affected by new federal regulations in the months to come.
Changing Your Supply Chain & Saving Your Business
The current pandemic has made it clear that businesses need robust strategies for mitigating supply chain disruptions. Beneficial supply chain pandemic strategies include:
- Diversifying your supply chain to avoid over-reliance on vendor or nation
- Taking advantage of legislation that facilitates the entry of goods from the supplier nation
- Looking for partners staffed with skilled workers who can still produce goods at a low cost
For example, the new USMCA treaty continues to make trade between the U.S. and Mexico advantageous and is likely to continue boosting Mexico’s already robust export sector. While China and Mexico have similar labor rates, importing goods from Mexico is considerably faster and less expensive. Learn more about manufacturing in Mexico.
Here at NAPS, we work to help shift companies’ manufacturing processes from offshore to onshore. Given the climate of our current situation, should you want to learn more about how we can help, we’re here for you.
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