By: ProcurementIQ Analyst, Sean Windle
In the natural world, biodiversity is the hallmark of a stable ecosystem—the greater the variety of plant and animal species there are, the lower the impact of the loss of any one species on the environment will be. Supply chains work in a similar fashion. Businesses that diversify their upstream suppliers are less likely to experience supply disruptions and price spikes, while companies overly reliant on one or a few suppliers are exposed to higher supply chain risk.
Globalization provides many opportunities for supply chain diversification, giving procurement professionals access to an expansive network of new customers and suppliers around the world. Moreover, telecommunications, cloud computing and other internet technologies have helped level the playing field for small companies looking to compete with large vendors by expanding the range of suppliers from which they can source. However, while globalization opens the door for effective supply chain diversification, it has a multiplying effect on risk. Hazards such as economic and political instability and natural disasters, previously managed on a national level, must now be monitored globally.
Economic and Political Instability
Labor strikes, government shutdowns, recession, civil strife and war are just a few of the many economic and political events that can disrupt supply chains. Many of the world’s largest exporters of goods, particularly countries in the Asia-Pacific region, regularly experience these destabilizing occurrences. Even developed countries are not immune, as demonstrated by the shutdown of the US federal government in 2013.
When it comes to supply chain risk and economic and political instability, no country is scrutinized in the United States more closely than China, and for good reason. China is by far our largest trading partner, accounting for about $480 billion (22%) of US imports and $116 billion (8%) of US exports, according to the US Census Bureau. The United States and China comprise the largest trade relationship in the world.
China’s popularity as a source of goods is due to its manufacturing prowess—Chinese manufacturers enjoy lower labor costs and lax regulations, and they receive substantial government assistance, enabling them to undercut competitors around the world. Recent economic signs, though, suggest that China’s manufacturing price advantage may be eroding. Chief among these signs is China’s shrinking labor force, which has pushed wages upward and spurred Chinese leaders to end a decades-old one-child policy in 2015. Moreover, an increase in strikes from factory workers protesting low wages, as well as international pressure on foreign multinationals to divest from sweatshops, has driven up wages.
For now, sourcing from China remains a comparatively cheaper option; however, this paradigm is gradually changing. Rising wages in China and lower energy costs in the United States are whittling away at Chinese manufacturers’ price advantage. Moreover, as China’s economy slows and the Beijing regime moves toward more privatization to stimulate economic growth, tension surrounding widening inequality and social unrest is rising. Frustration over China’s perceived unfair trade practices is also boiling over in the United States, spurring many political leaders to call for a crackdown on Chinese imports. Given these factors, US companies looking to maintain low costs and stability in the long run should consider deemphasizing China in their supply chain.
Natural disasters wreak havoc on supply chains by severing communication lines, destroying transportation infrastructure and causing power outages, which can bring factory production to a standstill. As supply chains become longer and more complex, the economic threat posed by natural disasters will only increase in scale.
The magnitude-9.0 earthquake and subsequent tsunami that struck Japan in 2011 not only killed thousands of people, but also resulted in hundreds of billions of dollars in economic losses. When factoring in the environmental damage and long-term economic impact of the meltdown of the Fukushima nuclear power plant, Japan’s triple disaster represents one of the most expensive catastrophes in human history.
The economic fallout from the earthquake and tsunami was far-reaching. Japan is the world’s third-largest economy and a major supplier of parts for automobiles, computers and electronics; however, widespread earthquake and flooding damage brought much of the country’s industrial production to a screeching halt. One of the many supply disruptions that followed involved a pigment called Xirallic, which is used in automobile paints. At the time of the disaster, Xirallic, which gives cars a shiny appearance, was produced in only one plant in a coastal town in Japan that was damaged by the earthquake and exposed to nuclear radiation. The shortage of Xirallic left major automakers such as Ford, Volkswagen and General Motors scrambling to find last-minute alternatives, with many having to halt the production of certain vehicles in colors reliant on the pigment. Had there been an additional plant or supplier outside of Japan that offered Xirallic, this costly headache could have been avoided.
While environmental destruction of this scale is relatively rare, global climate change is causing natural disasters to increase in frequency and severity. Even relatively localized natural disasters, such as wildfires, flooding and storms, can have devastating consequences on global supply chains if they hit the right area. For example, the Gulf Coast of the United States is a major oil-producing region and a highly trafficked supply route. These factors, combined with the region’s frequent hurricanes and tropical storms, make it especially important for businesses economically tied to the area to have good supply chain risk management, including diversification.
As supply chains become more globalized, they become harder to effectively manage. ProcurementIQ recommends that procurement officials take advantage of tools such as supply chain management software, which helps businesses execute transactions, manage inventory and track shipments. Cutting edge software can even track news sites and government data to deliver minute-by-minute intelligence on earthquakes, social unrest, port strikes and other issues that could potentially disrupt supply chains. Another tool ProcurementIQ recommends to minimize risk is business interruption insurance (BII), which provides coverage to a company if a supplier’s factory or warehouse is damaged in a fire or other disaster.
While supply chain management software and BII provide additional management and protection solutions, they are not without limitations. Software can track the aftermath of an earthquake, but it cannot as easily monitor subtler risk factors like quality and productivity issues. Similarly, BII’s coverage is limited to very specific incidents of property damage and does not include industrial accidents, regulatory changes, public health emergencies and other risks. The best way to minimize supply chain risk is to use these tools as part of a more comprehensive approach that involves diversifying and organizing supply chains to allow for a quick response if one or more parts of the chain experience problems.