Right now, many CEOs are fighting for the survival of their firms, scrambling to shore up liquidity or try to get urgently needed raw materials wrung out of broken-down supply chains.
This is very much the short-term dimension of this COVID-19 crisis, which shouldn’t concern us with this article. Today we are instead contemplating the long-term measures, companies need to take, in order to deal with the fall-out from COVID-19 and to adapt to what is often called the ‘new normal’.
Very soon corporate managers will start to think hard about how they can make their supply-chains more resilient, less complex and less prone to risk.
To understand which options we have, it is maybe worth looking back for a moment. In the 1980s and 1990s many countries opened up their markets; transportation costs and tariffs came down and the labour-cost differential between developed and developing countries were still huge. Hence, it was attractive for firms to offshore their production. The mantras of those days were, “the world is flat” or “the death of distance”.
But are those factors, which led us to build these tightly inter-connected global supply chains, actually still true today? Looked at, in the cold light of day, many of the conditions that made this model such a success-story turn out of have softened (or even disappeared) in the last decade.
Even before COVID-19 exploded into our little private and professional worlds, the halcyon days of a flat, proximate world, with open borders and the un-hindered flow of goods were already drawing to a close. Protectionism, import restrictions, and a growing resistance to globalization were bubbling under the surface. With a number of FDI and M&A deals being blocked on account of “national security reasons”, or potential investors having to pass rigorous security-related screening processes, cross-border deals were already getting increasingly complex.
Increasingly more strident climate protests, start to make shipping goods (God forbid – even flying them in), from the other side of the globe, a reputational risk.
And with repeated wage-cost hikes of 10 – 15% in the coastal regions of China, as well as a tightening of labour-regulations, the wage cost differential that made off-shoring so lucrative, is rapidly dwindling away, while at the same time automation and robotization help to lower the wage-cost element in the West even further.
I am not talking the talk of those who propagate the death of globalization. Nor do I side with the grand – and often over-idealistic – rhetoric of ardent globalizers. But with the unfolding drama at our hands, we need to take stock of reality in order to assess the situation for future greenfield or M&A projects. If we look at two of the globally most integrated industries – the automotive as well as the electronics industry – we see two of the hardest hit sectors of the economy. Something which might serve a clue to the new realities.
So, how should companies respond to what many already term the “new normal”?
There obviously is no panacea, and measures that work for one firm might be useless for another. While tourism, airlines and export driven industries suffer, E-Commerce, medical suppliers and supermarkets couldn’t wish for a better time. In industry, the same holds true for physical, manufactured goods vs. product development and design services, (which can cross a border on the back of an e-Mail). So, no matter what some commentators suggest – there is no single best answer. I am afraid it is all rather messy. But the following thoughts might be worth a hard think
- How long is your supply chain? How many borders do the goods you need, have to cross? How many kilometres do they have to travel, to arrive at its point of destination?
Irrespective whether you produce in-house (i.e. own foreign subsidiary) or source from a third-party supplier – dual-sourcing of critical parts will be imperative. And that primarily means, dual sourcing from geographically different locations – there is no point in having say 2 Chinese suppliers. There might however be a point in having one supplier with plants in two countries (or several suppliers – although this probably negatively impacts standardization and work-flows). That however invariably means replicating manufacturing facilities (i.e. twice the CAPEX if you are thinking about your own plants), or looking after multiple suppliers. On the up-side you will still be in business when the next Fukushima or Covid-19 hits the business world. - Following from the above, it might make sense to think hard about re-shoring (or at the very least near-shoring) production. Producing close to your core markets will reduce complexity, allow you to side-step some of the growing trade tensions (e.g. US-Chinese trade war) or sudden export / import bans (e.g. protective equipment). In any case it will certainly get you out of the trouble with the rapidly rising levels of NTBs (non-tariff-barriers).
And with more robust transfer-pricing measures being put in place or highly volatile currencies, manufacturing out-of-area is adding a risk premium onto your calculation. If you sell in Europe it makes sense to produce within the EU, if your market is the NAFTA region – you will incur less uncertainty if you produce there as the plannability of your operations increases significantly - And the reason why this – for the first time in nearly half a century – starts to make sense, is automation, robotization and artificial intelligence. Suddenly the wage cost element isn’t the biggest cost block in your calculation any longer; production can run 24/7 without the risk of a health induced shut-downs. Although – a word of caution. While robots will not contract COVID-19, they still are threatened by a whole range of other viruses. So, do not aim for a fully automated, non-human high-tech facility. A healthy mix of men and machines tends to be the safest and most flexible option.
But that suddenly changes the equation. Firms might suddenly not look for the lowest labour-cost country, but instead for locations with a stable and reliable government, with decent infrastructure, and a superb educational system – particularly in technical professions.
There is no alternative to international co-operation and an open-trade system. But realistically speaking the question might be, how big the playground ought to be, to properly balance risks and benefits. On the grander political scene, it will therefore be imperative to stabilize regional blocs and ensure that they work closely together – again adding an element of plannability and stability for the investor.
It isn’t entirely clear what the future will bring, but that it will change the way we do business seems certain. Time to think about that. Time to start the debate.
