Supply Chains and the COVID-19 Crisis: Current Problems and Potential Future Trends

Mohamed Fayez Farahat | 26 Apr 2020

Supply chains have constituted one of the main consequences and dimensions of economic globalization. On the one hand, they constitute one of the demonstrations of the globalization of the production process. On the other hand, they constitute one of the mechanisms resorted to by producers and major companies to benefit from globalization through benefiting from the comparative advantages available to every country to produce a specific component/components within the framework of the production process of an end product. This has resulted in the reliance by the end product – at the level of every company – on a group of suppliers to supply a group of primary or intermediate products that contribute to the production of that product. The size of the supplier chain varies from one case to another. While in some cases the chain may depend on only one supplier, in other cases, this may reach tens of suppliers. Besides, those suppliers may be distributed over more than one country.

A number of facts and factors have contributed to the expansion and complexity of supply chains, mainly the transformation of a large proportion of goods and services into tradeable goods due to the development experienced in means of transport and logistical services, or what is known as trade services. China has managed to take over a significant proportion of supply chains due to several factors, mainly low-cost labour force and logistical services associated with the processes of production, supply and transport, etc.

The concentration of the COVID-19 crisis in China, during the period from December 2019 till February 2020, has resulted in the disruption of many of those chains. This has resulted in the disruption of production in a number of major companies, both inside and outside China. This has then resulted in questions being raised about the feasibility of relying on Chinese supply chains. However, with the further spread of the virus and its extension to Europe, the US and most other regions, the supply chain problems have gained a global rather than a Chinese nature. Thus, the question of the feasibility of reliance on Chinese supply chains has shifted to the discussion of the supply chain problem in general.  

The COVID-19 crisis is not the first of its kind to affect the operation of supply chains. During the last decade, it was preceded by a group of crises, whether natural such as the Iceland volcano, the 2010 Japan earthquake and the subsequent tsunami and the floods in Thailand, or of an economic nature such as the decision by the Chinese government in 2011 to impose quota on its exports of rare earths (17 elements that contribute to some important industries such as mobile phones, car batteries, turbine blades and wireless guidance devices in weapons). This has led to an increase in the prices of those materials to record levels, particularly in view of China’s control of over 90 percent of the global production of those materials, in addition to the impact of the US-China trade war during 2018 and 2019 on the operation of those chains within China.

However, despite the importance of those crises, two remarks are worth noting: first, the crises did not have a wide geographical coverage since they were mostly limited to specific countries or regions. Thus, their impact was limited to the supply chains operating within those regions. On the other hand, neither of those crises was as severe and deep as the COVID-19 crisis. Those two factors did not drive the supply chains to seek to adapt to those crises. In contrast, the COVID-19 crisis was characterized by such severity and depth that it extended to all economic sectors and most, if not all, countries of the world, especially major economies in Asia, Europe and America, developed, emerging and developing alike. This has affected both demand and supply sides, in addition to the absence of a specific time prospect for the end of the crisis. Both this severity and geographical and sectoral coverage have revealed a number of shortcomings in the current structure of supply chains on the one hand, and have launched a wide discussion on the necessity of adaptation by this important phenomenon to this nontraditional pattern of crises.

Main problems of supply chains in light of the COVID-19 crisis

The COVID-19 crisis has revealed a number of shortcomings in supply chains. While some of those problems have been known before the current crisis, most companies have not attempted to solve them for different reasons. However, the severity of the current epidemic has rendered countering those problems extremely important.

1- Absence of adequate maps of the supply chain of every product

Due to the absence of severe crises of the type of the COVID-19 crisis, producers and major companies have not paid adequate attention to developing detailed maps of the supply chains that feed their production processes. Developing those maps seeks to provide three types of essential information: the first relates to building databases on the entire rings of the chain of suppliers associated with the product. Most companies and producers were satisfied with knowing the first ring of suppliers or the immediate frontline, while they have neglected the other successive rear rings. In other words, while producers were aware that they rely on a successive and interlinked chain of suppliers and that the said last immediate ring is only the penultimate ring in a successive process of supply chains , they overlooked the necessity of building complete databases of those suppliers, starting with the immediate ring and ending with the ring of special resource supply.

The second type of information lies in building databases of parallel or alternative suppliers who could be relied upon in case some problem is faced by any of the supply chain rings, including information on the comparative advantages of every supplier, prices, technical specifications of the product and the duration of supply. The third type relates to building a database on the geographical distribution of supply chains. Given the reliance on electronic communication, producers have not paid adequate attention to building a database on this pattern of distribution.

Thus, the exposure by one of the rings of the supply chain to a problem, or its disruption of supply for some reason, has led to the disruption of the operation of the rest of the chain rings and the inability of the subsequent rings to provide timely alternatives to those suppliers because of the absence of adequate databases on alternative suppliers and the pattern of their geographical distribution. A survey conducted by the company Resilinc in late January and early February 2020 on a sample of 300 companies affected by the disruption of supply chains due to the COVID-19 crisis has revealed that 70 percent of those companies are still in data collection and assessment mode, trying to identify which of their suppliers operate in the crisis-stricken regions and the locked-down regions of China until the time of carrying out the survey.

Several factors have contributed to the failure of building those maps during the pre-crisis stage. Some of those factors relate to the absence of severe crises of the type of COVID-19. This has led to the non-exposure by supply chains to crises that reveal the gravity and costs of the absence of such maps. Other factors relate to the high cost of developing such detailed maps since the process requires substantial financial and human resources. A third group relates to the concentration of a portion of this information in the hands of staff in procurement departments who were either unaware of the importance of this information and of developing those maps, or are unstable because of their mobility among different companies. Some companies have also referred to another important factor, namely the non-cooperation by immediate suppliers in providing sufficient information regarding their preceding supply rings for fear of disclosing the real costs of the product which might affect their real competitiveness. Lastly, an important factor could be referred to relating to the centrality of the cost variable in the decisions of producers while specifying supply chains. This has led to their reliance on relatively fixed suppliers and overlooking the development of a list of alternative suppliers in cases of crises due to the high cost of those suppliers. Focus on the cost factor has produced another problem, namely overreliance on Chinese supply chains. This has led to the development of the problem of geographical concentration of supply chains, as will be discussed below.

2- Geographical concentration of supply chains

The problem of geographical concentration of some supply chains has developed as a result of a number of factors, some of which are associated with the comparative advantages enjoyed by some markets which allowed them to possess huge competitive advantages in the face of competing producers or suppliers. In this context, the Chinese case provides a striking example. Chinese suppliers have huge competitive advantages compared to competing suppliers from outside China due generally to the low costs of production factors, especially labour force and capital costs (tax incentives, investment incentives, etc.) in addition to advanced logistical services, mainly financial services and transport. This has provided Chinese suppliers with competitive advantages against competing suppliers from outside China and led to a tendency by companies producing numerous intermediate goods to build their own production lines inside China.

Thus, China has taken over the larger proportion of the world’s supply chains, especially those associated with the automotive industry, electronics, pharmaceuticals, minerals and medical products (especially masks and gloves). Likewise, reliance on a limited number of suppliers has led to benefitting by those suppliers from economies of scale and thus the reduction of unit production cost in a way that has contributed to the processes of production and supply in specific chains for some industries.

Yet despite the centrality of the Chinese market in this area, this has not prevented the concentration of some important qualitative supply chains in particular countries due to intellectual property rights. For instance, Taiwan has taken over 22 percent of global production capacity of semiconductor integrated circuits. Furthermore, 67 percent of this capacity is concentrated in the hands of one company in Taiwan, namely the Taiwan Semiconductor Manufacturing Company (TSMC) where Apple, for instance, relies entirely on this company to obtain the electronic chips needed to manufacture its products. The same applies to the Taiwanese company referred to above as it also relies entirely on a single company in the Netherlands to obtain lithography systems, namely the Advanced Semiconductor Materials International (ASMI). The latter in turn relies on a company in Germany to obtain optical engines, and so on.

This latter pattern of the geographical concentration of supply chains makes it difficult to introduce a change into those chains or to replace those suppliers with other suppliers due to precise specialization and restrictions of intellectual property rights. This also explains the Chinese initiative “Made in China 2025” which aims to upgrade Chinese industry and its local technological content to reach 70 percent by 2025.

Potential shift trends in supply chains

In light of the above problems revealed by the COVID-19 crisis, a discussion is already underway regarding the future of supply chains. This future will be largely associated with the future of economic globalization in view of the strong relationship between the two. Yet, apart from the extreme trends advocating the end of globalization and increasing tendency to inward orientation and self-sufficiency, which would mean the end of globalized production and supply chains, the likely trend is to carry out some forms of rectification and adaptation of many phenomena to this nontraditional pattern of crises in a manner that would reduce economic losses and costs in case of their recurrence, which is true for supply chains.

In this context, the following different trends could be put forward for the adaptation of the supply chains phenomenon in light of the current crisis.

1- Developing detailed maps of supply chains

Despite the difficulties experienced in the process of developing those maps during the pre-crisis stage, the larger proportion of companies and producers are expected to seek to develop those maps with their aforementioned three dimensions and regardless of their cost. Some specialized companies in mapping may also emerge. Some have also suggested a number of mechanisms to overcome the problem of refrainment by some suppliers from sharing the data available to them about preceding supply rings, including the purchase of this data, and reliance on systems that ensure the prevention of sharing this information with a third party.

2- Wide geographical distribution of suppliers

Despite the wide coverage of the COVID-19 crisis and its expansion beyond Chinese borders, which means affecting production chains in all regions, this does not deny the fact revealed by the crisis that it is dangerous to rely on a group of suppliers or a supply chain that is characterized by geographical concentration in a specific country or geographical region and that it is necessary to tend to rely on a supply chain of a relatively wide geographical coverage. Within this framework, it is expected that the relative importance of the cost/price variable will be reduced in determining supply chains by producers while more weight will be attached to the factor of ensuring the flow of supply processes.

Yet this tendency will encounter several hardships, some related to the expected changes in the cost structure, especially in the case of the high costs of alternative suppliers. It will also depend on the extent of existence of alternative suppliers in alternative markets with the same required technical specifications. In other words, the matter will depend on the degree of flexibility of the demand and supply sides.

The main question will remain related to the future of China’s position within the supply chain markets. At its initial stage, the crisis has created a trend that advocates the necessity to ease reliance on Chinese supply chains in view of the prevailing Chinese nature of the crisis during the early months. However, with the widening coverage of the crisis to encompass almost all economies and regions, the Chinese identity of the crisis has receded. However, it is not expected to exclude the tendency to ease the heavy reliance on Chinese supply chains for several reasons, mainly:

a- The experience revealed by the COVID-19 generally with regard to the gravity of the geographical concentration of supply chains. Despite the uniqueness of this crisis, the geographical distribution of supply chains will remain one of its main lessons.

b- The gravity revealed by the crisis of the concentration of certain supply chains in China, especially those associated with the health sector. The corona epidemic crisis has revealed the state of exposure of this sector in Europe in particular due to its heavy reliance on Chinese supply chains as will be explained below.

c- The mounting political polarization between the US and China associated with the crisis and the ensuing controversy between China and some European countries regarding the extent of China’s responsibility for the wide coverage of the COVID-19 crisis globally due to its intentional concealment of some facts and information regarding the nature of the virus and the rates and ways of its spread, in addition to its impact, as argued by the US administration, on the performance of the World Health Organization (WHO). This polarization is expected to mark the resumption of the US-Chinese trade war. In that case, and taking into consideration all the previous facts, the supply chains are expected to constitute an important arena of this war.

Yet important as all those considerations are, the reduction in the extent of reliance on Chinese supply chains will not be easy. Even if political decisions are taken to ease reliance on those chains, in the final analysis, this will depend on the aforementioned variables and determinants. In addition, the Chinese supply chains have a number of important competitive advantages, whether related to the business climate in general or to China’s dominance of the rare earths market as indicated earlier. Apart from the Chinese case, it would be difficult to overcome monopolistic supply chains based on intellectual property rights.

In other words, despite the importance revealed by the COVID-19 of dismantling the problem of the geographical concentration of supply chains, achieving that target requires quite a long time and will depend on a number of variables.

3- Tendency to achieve self-sufficiency in some products

Apart from economic motives and calculations, some governments may resort to taking strategic decisions by refraining from reliance on Chinese, and generally external, supply chains in some sectors that are classified as “strategic”, mainly health and medical products. This trend was expressed by French Minister of the Economy and Finance Bruno Le Maire who explicitly referred on 21 February to the gravity of reliance on China and Asia in providing a lot of goods (90 percent of batteries and 80 percent of active materials needed for the manufacture of pharmaceuticals). He called for carrying out a detailed study of the strategic shortcomings of the various French industrial sectors as a result of heavy reliance on external supply chains in China and Asia and working to repair those problems. However, reaching this target or the required or safe rates of reliance will certainly take time.

4- Building a strategic stock of intermediate goods

The current crisis has revealed the importance of building a larger safe stock of intermediate and end goods sufficient for the continuation of the production process or the presence of the product in the market pending overcoming the crisis or shifting to alternative suppliers and in a way that would allow easing the pressures on producers during the management of future expected crises. This trend will be followed by the construction of those huge stocks and distributing them to different geographical regions.

Lastly, reference could be made to the increasing possibilities of “digitalizing” supply chains. This digitalization will have several dimensions, from building digital databases for those chains to increasing the scale of reliance on 3D printing and robots in the execution of production processes to ease reliance on humans at times of crises.

Thus, it is clear that the main trends for adapting supply chains focus mainly on the manner they are managed rather than reconsidering them as a mechanism or pattern for managing the “globalized” production.

Conclusions and expectations

In light of the above analysis, the upcoming period will witness further controversy over the future of supply chains as part of the expected controversy over the future of economic globalization. Apart from extreme views within this framework, a number of remarks could be put forward regarding the future of those supply chains, as follows:

  • The COVID-19 crisis has revealed a number of demonstrations of weakness in supply chains and their processes and ways of management. While those chains have been subject to a number of crises during the last decade, their managers and beneficiaries have not drawn from those crises sufficient lessons to deal with future more severe crises such as the coronavirus epidemic crisis.
  • Despite the emergence of a trend calling for a review of economic globalization and a return to building national economies that prioritize the principle of self-sufficiency, the prevailing trend considers that globalization and the phenomena and processes structurally associated with it, including supply chains, will not be affected. Yet this does not prevent reviewing this issue and dealing with its main shortcomings, especially the problems of the absence of detailed maps on supply chains and geographical concentration.
  • Among the main reform demonstrations expected after the COVID-19 crisis are the tendency to deploy supply chains with a wider geographical coverage, the reduction of the relative importance of the cost/price criterion as the only criterion in the choice by companies and producers of their supply chains, and the possibility of giving up some Chinese supply chains, which would mean the presence of an important opportunity for emerging economies to benefit from this shift. However, the size of this benefit will depend on multiple factors, mainly the competitiveness of the supply chains in those economies and the weight of central decisions by producers to shift away from Chinese markets, which are hard decisions.
  • China’s share of the volume of supply chains globally will certainly be affected. Yet the extent of this effect remains controversial. Numerous factors still benefit the Chinese market in this area. Despite the severity of the current crisis, the ultimate assessment of the size of its impact on global supply chains and the size of decisions to shift away from Chinese supply chains will be governed by several factors which have been discussed in detail. Furthermore, the Chinese government itself takes this challenge into account, which may require it to enhance the competitiveness of supply chains at the stage following the current crisis.
  • Reliance on Chinese, and generally external, supply chains will decline more clearly in some industries, especially pharmaceuticals and medical products and sectors that will subsequently be classified as “strategic”. Yet this shift will take time in view of the heavy reliance on Chinese supply chains in some of those sectors.

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