Is Regionalization the Answer to Supply Chain Risk Mitigation?
In his 1776 book, "The Wealth of Nations," economist Adam Smith introduced "absolute advantage" as the ability to produce goods and services more efficiently than competitors. Nineteenth century British economist David Ricardo built on this with what he called "comparative advantage": the ability to carry out a particular economic activity (such as making a specific product) more efficiently than another activity. Although these theories are more than 200 years old, they continue to influence our perspective of globalization.
After all, if a country can produce a certain product or service cheaper and more effectively than other countries can, it should focus on producing that good or service, and other countries should buy this good or service from them. Theoretically, this process fuels nations to be more competitive and efficient, which promotes innovation within an economy.
However, over the past 10 years or so, the globalization model has come under scrutiny and is being increasingly challenged by various geopolitical events, including tariff barriers between major trading blocks. Between October 2018 and 2019, the WTO recorded 102 new trade-restrictive measures, covering $747 billion of trade flows. The COVID-19 pandemic has further challenged the concept of economic globalization.
Is COVID-19 the Last Straw for Globalization?
According to Philippe Legrain, senior fellow at the London School of Economics, the COVID-19 pandemic may actually be the tipping point that pushes organizations to re-think and establish a supply chain closer to home (i.e. regionalization). For instance, U.S. companies are likely to shift some of the manufacturing production back to North America. The recently signed trade deal between the U.S., Mexico and Canada (the USMCA Agreement) is likely to accelerate this process. Concurrently, European companies are potentially relocating manufacturing to Eastern Europe, Turkey or North Africa.
Meanwhile, government interventions and attempts at regulating international supply chains are increasing. A Gartner report published in May 2020 pointed to Japan releasing a multi-billion-dollar stimulus package to help their companies bring manufacturing back to the country.
In the healthcare industry, which is critical to maintaining the health of nations during pandemics, a number of countries and regional trading areas (such as the U.S., European Union and India) have restricted exports to other countries to ensure local supply as well as insisting on a "Made in USA" or "Made in the European Union" label.
The notion of "true cost economics" may also increasingly play a part in the drive for governments to regionalize or localize manufacturing for sectors and products considered strategically important.
True cost economics consider the difference between the market price or cost of a product and the comprehensive cost and benefit of that product to society. In the case of healthcare equipment such as ventilators, the inability to meet rising demand during a pandemic has had a profound impact on the most severe COVID-19 cases. The personal protective equipment (PPE) shortage during the first few months of the pandemic was a factor in our inability to go back to some kind of normalcy, which has had a negative impact on the global economy, employment and the welfare of populations.
Can we expect a less global world with increasingly regionalized trading tendencies?
The recent agreements between the three major trading blocks (North America, the European Union and the Asia Pacific) seem to point this way. Within these areas, products and supply chains would benefit from relative freedom of movement, which may become increasingly restricted outside of those trading zones.
However, should organizations solely look at regionalization, macro-economic and political trends and risks associated with them to redesign their supply chain with a view to making them more resilient?
According to the recent Jabil-sponsored Special Report: Supply Chain Resilience in a Post-Pandemic World, the ability to respond quickly to business and supply disruption as well as resulting risk reduction are the guiding factors when trying to redefine supply chain needs.
Which of the following are important to your supply chain strategies in the next two years?
Some regionalization will almost certainly be a part of the overall strategy and the "toolbox" when it comes to addressing supply chain risk mitigation and resilience (whenever it makes financial sense), but not on its own.
As an example, a sudden, short-term move away from globalization and Chinese manufacturing is debatable because a lot of the raw materials required for production are still made in China, along with sophisticated supplier networks developed over decades. Furthermore, moving the whole manufacturing footprint and associated supply chain is risky and potentially costly. Finally, the "China for China" requirements (i.e., the increasing importance of the China internal market for international companies) means that China is still likely to be a destination of choice.
However, what COVID-19 has shown so far-such as when healthcare experienced a sudden increase in demand for test kits and ventilators-is that the ability to respond to sudden demand changes will be the determining factor for organizations to save lives as well as gain and retain market share. After all, if you are not able to respond quickly enough, customers will likely go somewhere else to source their products.
How to Mitigate Supply Chain Risk
Besides a potential selective regionalization approach, organizations will need to consider the following risk mitigation strategies to develop a more resilient supply chain going forward:
1. Keep Your Products Up to Date with Technology Trends
Some industries, such as healthcare, typically have product lifecycles of up to 20 years, whereas most consumer products are refreshed every few years with the latest technology. This allows them to not only adopt the latest features-such as connectivity and user interface-thereby attracting more potential customers and resulting market share, but it also positions them to ramp up their products quickly by minimizing the amount of legacy technology (i.e., End of Life (EOL)) within their products with likely capacity constraints at suppliers.
Today, the market is telling us that companies need to adopt more agile product management strategies. They need to upgrade their products every two to three years-not once a decade-or risk losing market share to their competition with more up-to-date products serving the needs of their customers better.
2. Invest to Maximize Profit, Not Minimize Costs
A traditional supply chain way of thinking loathes inventory and applauds "lean" supply chains. Inventory is undesirable because it ties up precious cash. However, this isn't always true. This philosophy should be applied to holding too much of the wrong inventory.
In fact, holding buffer stock of the right inventory (such as components that are difficult to source because of technology, lead-times, quality issues or other associated risks) can actually reduce inventory and increase revenue. What if a $1 part delays the shipment of a $10K product, thereby losing revenue and profitability and reducing cash flow?
Look at your whole supply chain holistically and identify key risks that are best served through buffer inventory because of the limited investment it requires. Think about profit maximization, not only cost minimization.
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Complexity and the number of nodes will play a big part in determining the right approach. The complexity of your decision of where and what to invest is directly correlated with the number of supply chain nodes (which is determined by how large the Bill of Materials (BoM) and the geographical spread of where components are coming from). Know your critical products driving most of your revenue and profit and focus on developing a coherent strategy on those.
3. Spread Your Risks Selectively...and Diversify Sourcing
One of the key lessons of the pandemic is that not all geographies were impacted the same way and at the same time, nor did all geographies recover the same way and at the same time. For instance, having a diversified, multi-sourced supply chain in different geographies would allow organizations to seamlessly switch from China, which was impacted first, to other parts of the world, and then revert back to China when other geographies became increasingly impacted, whilst China recovered.
Multi-sourcing may imply additional costs (duplicate CAPEX investment and the cost of managing two suppliers as opposed to one, to name a few). Focus on your most critical products as per the "true costs" vs. "total landed costs" concept. Diversified sourcing is increasingly likely to be viewed as a normal facet of doing business and a key requirement for customers as part of their business continuity plan.
4. Develop Your Digital Supply Chain
Over the last decade, a number of events have severely tested global supply chains: the eruption of a volcano in Iceland, a Japanese earthquake and tsunami, floods in Thailand, various hurricanes and more. Yet, despite all those warnings, many organizations still found themselves relatively unprepared for the unexpected, such as a pandemic.
Out of 300 respondents to a survey conducted by Resilinc in early 2020, 70% revealed that organizations did not have a clear picture of which suppliers were at risks due to their geographic location at that time. Conversely, manufacturers with a digital supply chain were able to map out their true risks more quickly and effectively, which allowed them to draw contingency plans ahead of their non-digital competitors.
What makes a digital supply chain effective? Visibility is the first stepping stone, but it's more than that. Supply chain managers need to be able to model scenarios based on "what if" and create a risk mitigation strategy that includes a mix of balance sheet investment, diversified sourcing and regionalization at products level, depending on their criticality.
For about a decade, financial institutions across the world have "stress tested" their resilience by ensuring they could withstand another economic downturn, like the one experienced in 2008. However, whereas the financial crash of 2008 was mainly created by demand disappearing, COVID-19 has impacted both demand-whether rising to unprecedented levels, as in the case of ventilators, or suddenly dropping (i.e. products associated with elective surgeries)-as well as supply, with factories shut down and disrupted logistics.
The recent disruptions created by the COVID-19 pandemic have highlighted the need for contingency plans and a risk mitigation strategy, including supply chain diversification and regionalization as one (but not the only) solution to develop better supply chain resilience. Fundamentally, COVID-19 has accelerated the need for something that already existed prior to the pandemic: the necessity to develop a more adaptable and nimble supply chain network.
Special Report: Supply Chain Resilience in a Post-Pandemic World
Insights from over 700 supply chain decision-makers at OEMs with more than $500 million in revenue on how they are managing their supply chains in light of COVID-19 and other market dynamics.