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There has been a lot of discussion as the coronavirus crisis progressed about the need to make drastic changes to the U.S. industrial supply chain. We’re going to decouple completely from China, dramatically cut back on sourcing from other countries, and bring manufacturing back to America, right?
Now that things seem slowly to be calming down, let’s take a look at what changes are actually a good idea, and at what’s really likely to happen.
“Even prior to the coronavirus crisis, there was beginning to be a reassessment in boardrooms and in Washington about our supply chain reliance on certain countries,” said Bob Hormats, former U.S. Undersecretary of State for Economic Growth, Energy and the Environment, and now Managing Director at Tiedemann Advisors. “American companies–in part because of higher production costs in key supplier countries such as China, lower energy costs in the U.S., and greater use of tariffs by the U.S. government in various trade disputes–were already reconsidering certain supplier relationships. And more broadly, some were beginning to question whether they had become too dependent on one of their decades-old supply models–Just in Time (JIT) deliveries of key components and products–that led to less need to keep large amounts of inventories, even in critical items, and a concentration of reliance on China and numerous other countries that had proved to be very efficient and quick suppliers for a multitude of items in the past.”
In 2019, some companies, for a very separate set of reasons, also were expressing increasing concerns about China and its long-term suitability as a business partner. Particularly troubling to a few in the US and Europe were its human rights record, especially its ongoing mistreatment of its Muslim Uyghur minorities in the western Xinjiang province, its poor environmental stewardship, its longtime underhandedness with respect to intellectual property (IP) and its increasing belligerence on the world stage. As we rolled into 2020, the pandemic hit, adding to those earlier concerns, particularly regarding China’s alleged lack of candor about the extent of the crisis and its failure to contain the outbreak.
Of course, as the virus spread across the world, the resulting lockdowns as countries tried to control their own caseloads caused severe strain to extended supply chains everywhere. The fallout from that has business and political leaders today questioning their assumptions not just about China, but about their sourcing philosophies in general.
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“As a starting point, we need to have an understanding that JIT is a broken model,” said Christian Lanng, co-founder and CEO of Tradeshift, a supply chain marketplace platform used by 1.5 million companies across 190 countries. He believes the economics of that model–at least in the way it’s been practiced by many companies, with a sole focus on unit costs that has driven a slash-and-burn management of inventory–have been fatally flawed. “You need to plug in a huge disruption every five years. Almost all modern supply chains are hyper-optimized for efficiency. Investment in resiliency and redundancy has been seen as waste.”
“The China-U.S. supply chain network is highly developed and has been very efficient for decades–we design here, make in China, and have no big stockpiles here at home,” explained Hormats. “Now the wisdom of that in some cases is upset. We’ll see some shifts toward other sources, including more production here at home in some product areas. It will likely include critical high-tech components, certain kinds of medical equipment, and pharmaceuticals, for example.” The April 2020 Thomas Industrial survey bears that out. Of those manufacturers surveyed, 64% say they’re likely to reshore, and 20% say they’re extremely likely to bring production back to the U.S.
But the idea of a wholesale decoupling from overseas supply is a pipe dream, says Dan Markovitz, author and President of Markovitz Consulting, a provider of Lean business coaching. “What I’m hearing in talking to clients and friends is a lot of talk about reshoring and shortening supply chains,” he said. “But we’re not equipped to do that in some cases. Footwear is a good example: good luck making a pair of shoes here in the U.S. for under $130. It takes a lot of manual labor and a lot of skilled expertise that we just don’t have.”
Hormats and Lanng agreed. “There are good reasons for close supply links on many products,” Hormats said. “A full rupture or decoupling between the U.S. and China would be mutually harmful.”
“I think complete reshoring is a fantasy, something we like our politicians to say,” Lanng added. “No major manufacturer will pull out of China. They might build secondary, tertiary plants here or elsewhere, but they can’t risk losing access to the China market.”
“Despite all the tensions with China, we’ll need to figure out how we interact better to deal with them and produce mutually beneficial outcomes,” said Hormats. “That will include better transparency, clearer rules on licensing and intellectual property, and greater coordination to enable our medical and research communities to work together on future global health challenges. Financial markets will need to feel confident about greater U.S.-China financial and trade relations to reassure people that these two enormous economic powers will not engage in mutually disruptive confrontations and will observe common, or at least non-confrontational, rules and standards. Big confrontations will make management of the global economy and our national economies all the harder.”
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One element of China’s behavior that America must deal with forcefully is theft of IP and trade secrets. For far too long this was swept under the rug and ignored. That has cost America sorely. But as Samuel Gregg, Director of Research at the Acton Institute, a free enterprise think tank, pointed out in a recent article at Law & Liberty, that’s changing. Huawei Technologies, a Chinese telecommunications giant, and four of its subsidiaries were recently indicted for conspiracy to defraud the United States, bank fraud, and theft of trade secrets, along with nearly two dozen other charges. “Many Americans, I suspect, would be surprised to learn that, until 2018, there were relatively few such prosecutions,” Gregg pointed out. “Now they have accelerated and, as Huawei’s reaction shows, China does not like it.”
What will also certainly happen is a close look at ways to reduce the risk of severe supply chain disruptions in the future. This will most likely drive a mix of changes: some reshoring as mentioned above, and some shifting of production to more hospitable countries; greater automation, including more adoption of advanced manufacturing technologies; and yes, the bugaboo of the Lean world, increases in stockpiles (a.k.a. inventory).
One big set of winners in the fallout of all this may be other offshore producers. “Vietnam, South Korea, and other Southeast Asia countries are going to be appealing,” said Hormats. “There’s also the lower-cost and very efficient workforce in Mexico. But in many products these will not displace China. And companies here will have to spend more money on domestic stockpiling in case of disruptions – as will the Federal Government, on critical items, as it did with the Strategic Petroleum reserve in the early 1970s.”
Companies will look at new models to chart the path forward. “Manufacturing can learn a lot from Cloud computing,” Lanng pointed out. “It’s organized around a few core principles that apply here, such as being distributed and resilient. Dynamic computer storage can lead the way for dynamic warehousing. A lot of Amazon’s success is because of their thinking this way. I think it’ll become a massive trend.”
It will all have to happen even as industry grapples with continuing shock waves of huge shifts in consumption patterns. Some of the changes we’ve seen will swing back, but not all. Working from home isn’t going away, so some commutes won’t be coming back. Our patronizing of restaurants and movie theaters will probably change for good. Schools will look very different come fall.
But we’ll have to get started regardless. “You may have heard the saying, ‘The best time to plant a tree is ten years ago,” said Markovitz. “The second best is today. We built incredibly long supply chains to bring unit costs down, but now we know they don’t give a good total cost. We have no shade today. We need to get to work providing for that down the road.”
