Rising protectionism and a pandemic have highlighted the trade risks faced by companies with global value chains. Recognition of these risks is expected to spark a new way of doing business.
Carmakers in Germany have endured an anxious few years. Donald Trump has repeatedly talked about imposing a 25 per cent tariff on imported vehicles from VW, BMW and Daimler.
Such a move could halve the number of German cars shipped to the country, leaving a huge dent in their largest market, according to Munich-based research group the Ifo Institute.
Even the potential for tariffs has encouraged the German car industry to step up production at their giant US plants, which now employ close to 120,000 workers.
But the rise of protectionism is just one force that is causing companies worldwide to reconsider the security of their global value chains.
“We are seeing the end of an era,” says Ted Alden, a senior fellow and trade expert at US think tank the Council on Foreign Relations. “Companies had grown used to the idea that they could always access foreign markets, both to source supplies and export their products. So they built global value chains geared towards minimising cost and ensuring
just-in-time delivery,” he says. “Now they are being forced to consider the vulnerability of what they have built.”
A recent study by management consultancy McKinsey & Co, Risk, resilience, and rebalancing in global value chains, found that disruptions were becoming more frequent and more costly.
Companies can now expect supply chain disruptions lasting a month or longer to occur every 3.7 years. Adjusted for the probability and frequency of disruptions, they can expect to lose more than 40 per cent of a year’s profits every decade on average
“Averaging across industries, companies can now expect supply chain disruptions lasting a month or longer to occur every 3.7 years, and the most severe events take a major financial toll,” it argues. “Adjusted for the probability and frequency of disruptions, companies can expect to lose more than 40 per cent of a year’s profits every decade on average.”
Among these potential threats, protectionism has certainly been the most high-profile. The World Trade Organization has commented on a “dramatic spike” in protectionism, with nations imposing trade restrictions estimated at a record $747 billion last year. A 27 per cent increase on the previous high, hit just one year earlier, these restrictions included more than 100 new measures, ranging from tariff increases, quantitative restrictions and stricter customs procedures, to new import and export duties. In addition, the number of regional trade agreements, which had been a major driver for globalised supply chains, fell from more than 30 a year a decade ago to below 10 in both 2018 and 2019.
The trade conflict between the US and China lies at the heart of this rise in protectionism. The average US tariff on imports from China is more than six times higher than before the trade war started in 2018, according to Washington-based researcher the Peterson Institute. Aside from tariffs, the US has been imposing restrictions on Chinese technology firms, notably restricting the access of Huawei to US-made technology and pressuring allies to exclude the equipment maker from 5G wireless development.
“We are already starting to see the supply chains of communications equipment, semiconductor and component makers disrupted by this conflict,” says Simon Lester, a trade policy expert at the Cato Institute think tank in Washington. “What we are looking at is the development of two isolated tech domains, one built around Huawei in China and the other around the US and European tech giants.”
Companies had grown used to the idea that they could always access foreign markets, both to source supplies and export their products. Now they are being forced to consider the vulnerability of what they have built
With Huawei excluded from the expansion of the UK 5G network, European rivals Ericsson and Nokia look set to benefit. But as the tech sector finds itself in the eye of the trade storm, protectionist threats seem much lower for more labour-intensive industries, such as textiles, food and beverages. Instead, these sectors suffer from different vulnerabilities, many of which have come to the fore during the Covid-19 pandemic.
The clothing industry, for example, employs roughly 25 million people globally, according to the Geneva-based International Labour Organization. And the sector is regarded as particularly at risk from viral outbreaks, given the often-cramped conditions in which employees work.
The pandemic has also exposed the risk of over-reliance on a small number of suppliers. Within the pharmaceutical sector, for instance, many low-value or basic ingredients are produced in China and India, creating potential vulnerabilities. As McKinsey points out: “We find 180 products across value chains for which one country accounts for 70 per cent or more of exports.”
Former Japanese prime minister Shinzo Abe identified the same problem for his own nation: “Due to the coronavirus, fewer products are coming from China to Japan,” he confessed. In April, Japan offered $2.2 billion of assistance to companies moving production back home or diversifying their production bases into South-east Asia.
Even beyond Covid-19 and the US-China trade conflict, the number of chronic risks to supply chains is increasing. These include threats arising from climate change, which has been associated with a rising instance of hurricanes, heat stress and floods. The clothing industry is highly exposed here, too, because so much activity in this sector takes place in regions that are susceptible to flooding.
Large-scale cyberattacks have also increased in frequency, with the number of ransomware variations doubling between 2018 and 2019 alone. Here, aerospace and semi-conductor companies are clearly at risk, given their high level of digitisation, capital intensity and exposure to digital data flows.
How can companies adjust to such diverse risks to their global value chains?
The first step, experts argue, is for them to gain a full understanding of their supply chains and where the points of vulnerability lie. This can be no easy task for large multinationals, which can have thousands of suppliers. Computer maker Dell, for example, has more than 4,500 tier-one and tier-two suppliers, while rival Lenovo has almost 4,000. But an increasing range of technological solutions can also help companies understand their value chains better, so they can identify and resolve fragilities.
“Technology is challenging old assumptions that resilience can be purchased only at the cost of efficiency. The latest advances offer new solutions for running scenarios, monitoring many layers of supplier networks, accelerating response times, and even changing the economics of production,” McKinsey suggests.
The first step, experts argue, is for firms to gain a full understanding of their supply chains and where the points of vulnerability lie. This can be no easy task for large multinationals, which can have thousands of suppliers
Bringing production home
This can be especially relevant where the potential shocks come from protectionism. Here, one option is to localise production in the target market, as German carmakers have begun to do in recent years.
Companies can also look more closely at where their suppliers are located. Worried about supply chain security, they may consider reshoring – bringing production back home.
“This can be an excellent way to curry favour with your home government,” says Simon Evenett, professor of international trade and economic development at the University of St.Gallen in Switzerland.
There have been a few notable examples, such as British vacuum cleaner maker Gtech, which has moved some production from China to Worcestershire, and shoemaker Clarks, which is now making desert boots in Somerset, rather than in Asia.
But the figures suggest that reshoring remains a relatively modest trend, despite the potential for automation and robotics to help offset higher wage costs in Europe and the US.
US manufacturing imports from China, for instance, fell by 17 per cent between 2018 and 2019, according to management consultancy Kearney’s US Reshoring Index. But the slack was not taken up by an increase in US production. Instead, there was a surge in manufacturing imports from other low-wage Asian nations and from Mexico.
US manufacturing imports from China fell by 17 per cent between 2018 and 2019. But the slack was not taken up by an increase in US production. Instead, there was a surge in manufacturing imports from other low-wage Asian nations and from Mexico
“The evidence for reshoring has been patchy beyond a few isolated examples,” argues Alden. “We were not seeing a huge rise in manufacturing jobs in Europe or US, even before the pandemic. Instead, this has mostly been diversification away from China’s sphere of influence or localisation – moving the supply chain nearer to the end-consumer.”
Even if reshoring has been modest so far, supply diversification and localisation could lead to significant changes in global value chains over the coming years.
Estimates suggest that between 16 per cent and 26 per cent of global goods exports – $2.9 trillion to $4.6 trillion – could move to new countries over the next five years.
Finally, companies can consider inventory levels. Keeping inventories low reduces costs, but it may increase risk.
“Where diversification of supply is not possible or sufficient, companies may need to hold higher levels of inventory,” argues Willy Shih, a management professor at Harvard Business School. Costly as it may seem, this can help to avert even more expensive disruptions to the supply chain, especially with regard to raw materials and intermediate goods. Danish drug maker Novo Nordisk, for example, is the largest supplier of insulin in the world and maintains a five-year base of critical goods to avoid disruptions to its output.
Global value chains have faced two of their biggest threats over the past few years: a protectionist US administration and a global pandemic. But even if US attitudes change and the pandemic is conquered, the global re-evaluation of supply chains is unlikely to stop. “This genie can’t be put back in the bottle,” says Alden. “Company executives have woken up to the fact that there is a large range of threats to global value chains. They will need to do some hard thinking to make sure their supply chains are fit for purpose in this new environment.” n