Global Supply Chains Under Huge Pressure as COVID-19 Creates ‘Manufacturing Deserts’
According to a new report from Baker McKenzie and Oxford Economics, Beyond COVID 19: Supply Chain Resilience Holds Key to Recovery, the pandemic has produced an unprecedented global supply chain crisis, stemming from a lack of mapping and flexibility around the multiple layers of global supply chains and a lack of diversification in sourcing strategies.
On the upside the report forecasts that the hardest-hit manufacturing sectors across the world will be also the first to recover by H1 2021 as a release in pent-up demand is driven by a recovery in sentiment, and production ramps up to make-up for previously lost output.
The current global supply chain crisis is due primarily to the pandemic creating temporary ‘manufacturing deserts’, whereby a city, region or whole country’s output dries up so substantially due to lockdown conditions, they become a no-go zone to source anything apart from essential items such as food stuffs and pharmaceuticals.
The report highlights that the immediate impacts of a failing global supply chain are already being felt, from auto plants in Korea shutting down because of a lack of parts from China to smart phone manufacturers running dangerously low of components. As a result, global trade is expected to have fallen by more than 4% in Q1 2020, and decline even further in Q2
As Mattias Hedwall, Global Chair, International Commercial & Trade at Baker McKenzie explains this has serious implications for global supply chains: “It is clear that the extended shutdown of parts of the world’s economy is now feeding through to impact supply chains as existing stocks are depleted. Businesses need to focus on how to minimize supply chain disruption and to adjust rapidly to a changing landscape. This includes among others, infrastructure, tax and employment implications of changes and the option of quickly reversing changes if the situation stabilizes quickly.”
Borys Dackiw, EMEA Co-Chair, Compliance & Investigations, and Gulf Head of Compliance at Baker McKenzie adds: “During this period of uncertainty, it is particularly important for companies to be alive to the risks arising from trade restrictions and supply chain issues, particularly when seeking out new sources of supply or dealing with new third party business partners. Sufficient compliance due diligence on new parties, jurisdictions, products and transaction structures will play an integral part in effective supply chain risk management.”
Impact on manufacturing sector globally
While there remain a number of scenarios for the global economy over the next 24 months, Oxford Economics’ baseline forecast is that global manufacturing will take a 5% hit in the first six months of this year compared to 2019, recover much of that drop in H2 2020 and finally exceed the 2019 position by early 2021.
As the table below shows the pace and extent of decline and then subsequent recovery varies by manufacturing sub sector. The automotive sector is set to see the biggest output falls globally in H1 2020 of 13%, followed by textiles (8%) and electronics (7%) although the forecast also shows the auto and other transport equipment sector is likely to see the swiftest recovery, along with textiles.
All four key manufacturing sectors analysed for this report are predicted to start recovering in the second half of 2020 with the strongest recovery from the automotive and textiles sector growing at 10% and 8% respectively (relative to their levels in the first half of the 2020), and then all sectors will see at least some output growth on 2019 levels by 2021.
Impact on China
Because of China’s unique role in the global supply chain, and its sensitivity to drops in global demand as a leading export nations, the forecast sees a significantly deeper drop in output this year than the global decline as the table below shows, with sectors such as automotive and electronics not actually climbing back to 2019 levels until 2022. China’s automotive sector will see a 19% drop in output for H1 2020 while electronics will see a 17% drop in output, all relative to Q4 2019 data. Textiles sees a 14% drop in H1 2020 as well as headline manufacturing (11%) and aerospace (6%).
The Chinese economy being largely out of action for several weeks has also left many multinational companies with limited contingency plans to deal with supply chain disruptions. It has also rapidly exposed supply chain concentration issues for global companies that have relied heavily on China.
This has been further compounded for companies that are reliant on just-in-time manufacturing processes — particularly important in sectors such as automotive — and/or with thin inventory levels.
As the epicentre of the pandemic has moved away from East to West, these same issues have become acute for those sourcing highly specialist goods and services in key markets such as Germany, Northern Italy and now the US. In coming months, there may even be challenges in securing some categories of commodities if the epicentre shifts again, to emerging markets.
New York-based Debra A. Dandeneau, Chair of the Global Restructuring & Insolvency Practice, Baker McKenzie, said there was also a growing risk of supplier insolvency around the world.
Dandeneau comments that some companies may have to support their supplier at least for the short-term, but understanding the source of the distress faced by the supplier is critical. Other suppliers may commence, or be placed into, some kind of formal restructuring or insolvency proceeding, which is likely to add delay to operations. Knowing how the law will work in each possible jurisdiction will help companies develop an advance strategy for dealing with that situation.
Long term transformation
The report highlights that supply chain risk management has jumped to the top of many companies’ agendas because of the current supply chain crisis, and is likely to stay there well after the immediate threat of COVID-19 begins to recede.
While the cost of such risk management processes can be high, it is often more than offset by the savings it can generate through helping to inform decisions around product pricing to shift the balance of demand towards less affected lines, inventory purchasing, and management and relocation of production processes across sites. There has clearly been in increase in this activity as a matter of urgency, in order to mitigate some of the immediate impacts of COVID-19, including the huge fall in output in some sectors.
Longer term, digitalization of supply chain will increasingly be the way companies begin to strategize and achieve business resilience against supply chain disruption. In this context, big data analytics can assist firms in streamlining their supplier selection process, while cloud-computing is increasingly being used to facilitate and manage supplier relationships.
Anne Petterd, Technology, Communications and Commercial Partner, Baker McKenzie based in Sydney, said: “Enhanced supply-chain management and adoption of digitalization has never been more important. Companies with well-considered supply-chain risk management processes will be better-placed to identify the impact of disruptive events on their supply-chain and product-offering, providing them with an opportunity to assess how to best respond in tough circumstances.”
The way forward
The report concludes that to take advantage of the policy boosts around the world, businesses need to be agile, nimble and ready to tackle operational, labor and demand/supply constraints, re-address strategic and tax planning and re-consider business models post-COVID-19. This means structuring their supply chains, ramping up on digital transformations, which could lead to an even stronger commitment to sustainability goals alongside building resilient businesses.
As we begin discussions about what the new normal will entail it is clear companies can help shape it through robust planning and more holistic risk management scenarios.
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