There is a new buzzword in boardrooms. It’s not “margin”, or “efficiency”. Those are the mantras of yesterday, fuelled by their fellow fetishes, “outsourcing” and “just-in-time” supply chains. Today’s philosophy is “resilience”.
Rocked by a pandemic which has left many struggling to secure basic supplies such as facemasks and without manufacturing capacity for more advanced kit like tests or ventilators, Western governments and major companies are considering how to pad the shock-absorbers on global logistics operations that they have spent much of the last 30 years paring down.
“Post Covid-19 there will be an additional lens front and centre; resiliency,” noted Robert O’Sullivan, vice president of Finance at Kellogg’s Europe. “In industry generally, we were all taught over many years the best way to run a business was low inventory, [and] just in time manufacturing,” former BP chief executive Lord Browne told this paper recently. “That was defined as efficiency, [a good way to] cut costs. These things will change. People will think carefully about what they need to have onshore. There is a lot of discussion about critical resources.”
Disease alone has not prompted the rethink. The health crisis of the last few months has merely accelerated the “deglobalisation” trend of the last few years, itself exemplified by greater protectionism, the call to reshore jobs, and above all the US-China trade war.
“There is genuine pressure,” says Philip Dunne, managing partner of Roland Berger, the German consultancy, which has a strong presence in China. “At board level there is much more discussion of resilience, about covering risks if factories have to close, having two or more sources of supply for raw materials, adding to inventories to cover for potential delays on long shipping routes.”
The apparently inexorable streamlining of supply chains that has driven costs ever lower, even through previous catastrophes like Sars in 2003, or the 2011 Japan earthquake, is finally being reconsidered.
Data released in March by Resilinc, which maps supply chains, noted that the world’s 1,000 largest companies and their suppliers had more than 12,000 facilities in quarantined areas of China, Korea, and Italy.
What was once lauded as efficient is now lambasted as vulnerable. Hence resilience, and its own articles of faith: duplication and diversification.
“There has been an over-reliance on efficiency and cost,” says Marianne Schneider-Petsinger, a fellow on the Global Trade Policy Forum at think tank Chatham House. “And now there is a moment to build in more slack, which comes at a cost. But companies are increasingly willing to take on that cost.”
It is a movement which is additionally attractive for companies spurred by consumers and even their own staff to take climate change seriously. “Buy local” campaigns are having a genuine impact, says Marc Lhermitte, head of EY’s Geostrategic Business Group. And shipping is dirty – responsible for about 2.5pc of global greenhouse gas emissions.
For companies, the stakes couldn’t be higher. “Supply chain decisions from sourcing to manufacturing to logistics… influence up to 75pc of corporate costs,” says Lhermitte. “It is the one massive influencer of corporate costs.” No wonder then that “the derisking of the supply chain is on every board’s mind.”
Governments step in
Such corporate manoeuvres, however, will be influenced by, and have influence well beyond, simple profit considerations. Post-Covid, national security will play its part.
“We’re entering a new era where you see supply chains, industrial policy, and strategic competitiveness really being merged,” says Schneider-Petsinger. Multinationals’ boards, she says, must get used to the fact that their logistics decisions are “linked increasingly to questions of geopolitics.”
If overdependence on a single, distant, low-cost manufacturing nation – usually China – is the problem, then diversification and onshoring of supply chains is usually touted as the answer.
But “decoupling” from China is tough. In 2003, China’s share of global manufacturing exports was 8pc. Today it contributes 19pc of global manufacturing exports.
Roland Berger’s managing director in China, Denis Depoux says: “It’s not just labour costs, it is the productivity of the whole supply chain. China has high-performing industrial clusters quick response capacity, a well-trained workforce, being able to mass produce in very large scale facilities, quality control… You don’t recreate this elsewhere very easily.”
Still, some companies may be encouraged to try by governments which have recently grown used to extending financial largesse.
Lhermitte says that a defensive (and expensive) mindset – “the strategic production of essential goods, stockpiling, continuation plans with regards to inventories that used to apply [only] to the energy sector” – is now bleeding out into other industries now considered essential.
Some, like medical manufacturing and pharmaceuticals, are present-day government concerns. Others, like electric vehicles, are about securing the future.
But the bottom line is that cold-blooded executives will demand a substantial quid pro quo if they are to turn their backs on cheap Chinese manufacturing. “We listen to hundreds of plants, and the one thing they are paying attention to is the quality and quantity of the national stimulus packages or public incentives, huge support programmes and bailouts,” says Lhermitte.
Such government assistance is likely to come with the condition that newly reshored jobs are preserved down the line. A case of governments saying to the major companies “we’ll do this for you, if you do this for us, and be a good citizen.”
If you can’t beat ’em
If such government stimulus for newly-critical sectors is not always commercially driven, “deglobalisation” is helping other sectors become economically viable.
Lithium for batteries, and rare earths, transformation of which into critical electronic components is dominated by China, are likely to become increasingly important. “People used to talk about oil as a critical national resource. But what about lithium? What about rare earths?,” says Lord Browne.
And there are, says Schneider-Petsinger, “massive supplies of rare earths in the US that haven’t really been mined because it’s not cost effective – but that is starting to change.”
Brine pools from a lithium mine in Chile – Ivan Alvarado /Reuters
Those massive supplies sit in sites like Round Top Mountain in Texas. And for those minerals where there is no domestic supply, new international alliances are being formed.
“Working with other countries and setting up trusted partnerships is going to be critical,” says Schneider-Petsinger. The model is in some ways a modern day equivalent of the strategic petroleum reserves set up in the 1960s and 70s – national stockpiles which could be shared with friendly nations in a pinch.
As for rare earths – a core ingredient of a low-carbon future, “there’s an alliance building here between the US, UK, Australia and Canada,” Pini Althaus, chief executive of USA Rare Earth, told Forbes in April. “The EU has its own initiatives to source independently of China as well.”
There is an irony here, though. For years, Western countries and companies have complained of China’s “one economy, two systems” model, in which outwardly its economy seems subject to increased market forces and modern regulations, all while critical areas of national industrial importance are made “stronger, better, bigger” by state-ownership or support.
“Stronger, better, bigger” is the mantra of vice-premier Liu He, China’s top trade negotiator. He made his view clear last year in an article: “We will promote state-owned economy reforms and structural adjustments, and invest more in industries related to national security, serving the national strategic goals.”
The irony is that, post-Covid, western countries now seem to want to do the same. “In the past, the United States and Europe had really legitimate concerns about subsidies in China… but now there may be concerns about the very same sort of practises in the West,” says Schneider-Petsinger.
Too big to say goodbye
Western dreams of repatriating industries will prove expensive. Costs in the West can be 10 times those in Asia; already stretched health systems, say, are in no way ready to bear resulting price hikes passed on by a reshored pharma industry.
“It’s not just the cost of producing the drug, there’s pill coatings, blister packs, polyurethane film on top,” says Depoux. “To bring all that back… the devil is in the detail with supply chains. So while there are discussions, we will see what the reality turns out to be, especially when they see what it means for the paying consumer.”
The likelihood is that manufacturing may be “nearshored” – relocated to closer low-cost destinations, like Eastern Europe or Africa. In an EY survey this May, 83pc of companies said they expected to focus on “regionalisation” of supply chains. For a global company, this could provide the agility to weather trade wars or supply interruptions. “We’re looking at diversification, not decoupling [from China],” says Depoux.
How will you change your supply chain model in response to COVID-19?
Towards the Industrial Revolution 4.0
Genuine onshoring is likely to take a different form. If manufacturing is to be brought home it will not be a replica of the low-cost model in a high-cost economy. Rather, multinationals are looking at huge inward investment in technology – automated production lines, stocked with 3D printers.
“And it doesn’t take a lot of imagination to see a product going from there to a driverless truck and delivered to your door by drone,” says Mike Vrontamitis, head of trade for Europe and the Americas at Standard Chartered.
It’s a vision which doesn’t foresee many jobs. But automated production will save money. It is the most significant post-Covid “megatrend”, says Lhermitte, with 82pc of executives expecting to automate processes that will replace manual labour. Many spare parts for old airline engines, for example, are already produced by 3D printers, because it is not economic to ramp up old-fashioned production lines.
Ultimately, automated production lines, close to the consumer, will allow “mass customisation”, says Vrontamitis. “It’s the shoe factory able to take orders directly off the website. You customise your shoe and that feeds into the automated production line.”
The value, increasingly, will reside with the owners of intellectual property, like the blueprints of those aircraft parts. “We are going to see more trade in services and intellectual capital and away from the physical,” says Vrontamitis.
Moving on up
That is a move up the value chain that much of the planet is attempting simultaneously. China certainly is, having already happily shunted much of its low value-added manufacturing to neighbouring countries. As it gets richer, its internal market becomes more attractive to Western companies.
Long-term access is another deterrent to uprooting plants now, despite the enforced tech-transfer or IP theft that many companies report as a cost of doing business. “Ultimately the intention is to use China less for manufacturing, and serve the Chinese domestic market more,” says Depoux.
Who will the winners be, in this new industrial revolution?
“Everybody starts again on a level playing field,” says Depoux. “It’s a great reshuffling.”
Germany and America and Japan remain leaders of value-added manufacturing. But India, Indonesia, Thailand are rushing forward, and France, Spain or Italy “can again become great manufacturing countries”.
Faced with such upheaval, meanwhile, nations heavily invested in traditional manufacturing like South Korea, “have a lot to lose”. He says: “We are seeing a great reset.”