The short-term response to Covid-19 for supply chains.
Covid-19 represents a very different supply chain challenge to that created by the Fukushima earthquake of 2012. The disruptions are more global, longer-lasting and, above all, felt on the demand side as well as the supply side. Lockdowns in many countries have all but dried up end-consumer demand for some products, while sending demand for others soaring.
Every company and every supply chain is unique, so it is hard to come up with a plan of action that will work for each, but in this white paper we will attempt to suggest a number of measures that should help whatever your situation. We will also try to highlight a few things to avoid.
In the short term, the imperative is survival. But the organisations that will come out of this situation the strongest will already be thinking about the longer term. While this white paper will focus just on the short-term response, look out for our other papers on the mid-term response, Back to normal, as well as the long-term response The new normal. Now is the perfect time to think about those longer time horizons too.
In the first instance, the priority of every organisation must be the health and safety of its employees, customers and suppliers.
Assuming this has been assured, most organisations have by now set up some kind of “war office” to deal with the situation. The role of such an office is to provide overall strategic direction to your response while staying abreast of major external developments, in terms of policy, available government support, market conditions, and so on. But how specifically should organisations adapt their supply chains?
The biggest concern for any organisation should be its cashflow. This is the life-blood of your business. Before the crisis, a major focus of working capital initiatives was too often squeezing suppliers by extending payment terms. We believe aggressive manipulation of payment terms to be one of the worst things you can do. Your whole supply chain is suffering similar pressures and potentially pushing your suppliers to the wall has both short-term and long-term repercussions. Even if you both survive, your reputation may take a hammering.
This is not to say that payment terms are not a valid lever to explore. Organisations with strong balance sheets can survive much longer than others and may also have a greater ability to borrow money at lower costs. Supply chain finance (where a bank or other financial institution allows both parties in a transaction to take advantage of the lower financing costs of the two) is a very useful solution to explore in this respect.
We are at least fortunate that interest rates are at historic lows in much of the world. While this is liable to change over time, it may still be possible to take advantage of low-cost borrowing. Several governments are pumping liquidity into the system themselves to support this.
The most important aspect of working capital to get right in such turbulent times, however, is inventory. Having too much cash tied up in inventory when demand crashes can be fatal to your organisation’s survival, while shortages risk haemorrhaging sales, market share and customer good will. Inventory optimization – in its true sense, not as a euphemism for inventory reduction – is never more valuable than in such uncertain times. The closer you can match supply to demand the better.
Some early commentary on Covid-19, when the main supply chain impact was on the supply side, particularly from China, suggested that lean, just-in-time inventories were to blame, implying that greater safety stocks were a suitable buffer to protect organisations against such major disruption. Avoid this way of thinking. Apart from tying up unnecessary capital in inventory, it will exacerbate bullwhips throughout your supply chain. It is right and judicious to raise inventory reserves for some items where demand is certain and supply at risk, but this is not the same as building buffers across all items. Companies applying inventory optimization techniques will find that they reduce shortages even as they reduce excesses.
So how does one optimize inventories in such volatile times? Inventory optimization is technically challenging at the best of times, so what hope is there at the moment? Well surprisingly, you might actually find opportunities to take advantage of the current crisis to achieve things that are normally more difficult.
In the short term, things are liable to remain fluid. Things can change rapidly. Look out also for knock-on effects as unemployment and bankruptcies increase and production facilities are shut due to disease or preventative measures.
How you brace your supply chain may well determine whether and how well you survive the Covid-19 outbreak. The short-term response is critical to this. But do not lose sight of the longer term either. The crisis will pass, and when it does you will need to be ready for that too. We will consider the medium-term response in our next white paper, Back to normal.
What comes next after Covid-19 and how to prepare your supply chain for it.
In our previous white paper on the Covid-19 outbreak, Survival of the Fittest, we looked at what supply chain organisations need to do to survive in the short term. While, at the time of writing, it is highly unclear when things will get back to normal, or even what normal might look like in the future, this is nevertheless an important time for organisations to also look to the future and prepare themselves for it.
Of course, it is possible to imagine that what we consider normal will change for ever. That is not the topic of this white paper. We will look at more futuristic scenarios in the third and final paper in this series, The new normal. In the present paper, we will look at the immediate aftermath of the current crisis, without dwelling too much on to what extent things will ever get back to what was considered normal only a month or two ago.
Normality does not typically have a very positive ring to it. Normal, mediocre, boring. But after a few weeks of unprecedented measures to deal with the current coronavirus outbreak, the prospect of normality suddenly seems immensely attractive. And yet going from periods of extraordinary disruption to a period of relative normality is not always straightforward. This has implications for supply chains.
Before we turn fully to the topic of a return to normality, let us consider the potential elongation of the current crisis. In times of crisis we can get fixated by the day to day challenges. Yet it is far from certain that the current restrictions on movement and activity will be relaxed very soon. Organisations already need to start planning to deal with the next couple of quarters if the disruption continues at its current rate. Note that this is not some temporary stability. Indeed, the only certainty is probably uncertainty. Bullwhips will continue to ripple, new points of failure will emerge. The longer the crisis lasts, the more likely it is that more companies will go bust.
Some risks are hard or impossible to mitigate quickly. Yet necessity is the mother of invention. Look at how quickly a whole range of firms has designed and started producing ventilators. New records are being set for research and development (R&D) timelines. Sitting tight and hoping everything will be all right is a highly risky strategy. Work out effective mitigation strategies quickly and have the courage and conviction to overcome the normal inertia. Remember, these are not normal times.
As you plan for the next quarter or two, there are two critical activities to concentrate on. The first is your external risk assessment. What does your supply chain look like, where is it liable to fail and what would the impact of failure be on you? A system failure mode and effects analysis (system FMEA) can usefully be carried out on your supply base to identify and weight these impacts, helping define and prioritise actions to mitigate them.
The second critical activity is predictive analytics. Even when you have identified external supply issues or risks, understanding in detail the impact on your operations is vital. Extend your field of vision from the day to day to 3-6 months’ time. Model both a continuation of current business and major scenarios identified from your risk analysis. Most organisations have the data to do this if not necessarily the ability. Accept that as with any prediction it is going to be wrong in detail. What you are looking for is the impacts of the main risks so that you can take preventative action as soon as possible. The analysis needs refreshing on a regular basis.
Over and above these two critical activities, concentrate on all of the short-term levers we set out in the previous white paper: maximise transparency, stay nimble, look for alternatives, reduce complexity and bullwhips, avoid putting your faith in forecasts and prioritise relentlessly. These behaviours will all help you to ride out the storm however long it lasts.
At some point, some kind of normality will return. Depending on your circumstances, this could involve a surge in demand or a drop in demand. Those changes might happen quickly or slowly. Depending on how the pandemic develops, there may be a brief return to normality followed by further disruption before a more lasting return to normality. Normality is likely to return at different times in different places.
As with the short-term measures we recommend, agility is key to your ability to deal with whatever scenario your organisation is faced with. Long lead times and a lack of alternatives will be highly undesirable qualities in your supply chains. And there will be a whole new round of bullwhips to deal with, as your suppliers, customers and competitors react to the same developments at the same time.
Your ability to ramp up or ramp down quickly will have a major impact on your profitability, balance sheet and competitive position. Changes which in normal times can take years to accomplish or be considered too radical need not just to be considered but pushed through in record time. While you are considering whether buying a supplier might be the best option to shore up supply of a critical component, for instance, one of your competitors might already have done it.
This is not to advocate rash or ill-thought out actions, just to say that time is not a luxury most organisations have. Different risks need offsetting against each other. In many cases, governments are relaxing regulatory requirements to facilitate quicker responses and your organisation should do the same internally, even while continuing to maintain quality and protect health and safety. So now is the time to:
Now is also the time to model different ramp up and ramp down scenarios. If demand suddenly rises back to pre-crisis levels, how do you ramp up production as quickly as possible? And if there is then another drop in demand, how do you ramp down again? Thinking through all of the steps and challenges will make you much more able to do it successfully when the time comes. A RAID analysis (risks, assumptions, issues and dependencies), if carried out thoroughly, will be a very useful tool to help minimize “unforeseen” issues delaying roll out and specifically help with sequencing. You also need to model the cash flow implications of all the major scenarios you face.
What many companies already engaged in this kind of exercise are finding is that while it is not excessively difficult to do at a high level, modelling the full implications using data is much more of a challenge. Organisations with a connected digital infrastructure may have some advantages, but not necessarily the ability to run flexible analyses easily. This is an area where we at nVentic are specifically well-equipped to help our clients. Critical to success is the ability to combine essential supply chain knowledge and experience with advanced data analytical capabilities.
The top priority is the health and safety of workers, customers and suppliers and will continue to be so. But the supply chain has a critical role to play, both in directly supporting Covid-19 responses with the timely provision of critical supplies, as well as helping to minimize the medium-term impacts by helping the economy get back to some semblance of normality as soon as possible.
What that normality might look like is the subject of our third white paper in this series: The new normal.
Will Covid-19 herald fundamental changes in how global supply chains function?
The 2020 Coronavirus outbreak has led to an almost unimaginable change in how a large percentage of the planet lives its life in the short term. At the time of writing, schools and businesses are shut, many people required to stay at home, all but essential travel banned in many countries. People have found ways to adapt, with home working now the rule rather than the exception, video conferencing widespread and e-commerce boosted.
So fundamental are some of the changes, that it is reasonable to ask whether things will ever fully go back to the way they were before. A quick survey of the press in the middle of April 2020 provides a full range of opinion, from everything going back to normal, to nothing ever being the same again.
An early spoiler for this paper: we don’t know what the future will hold.
So why write a paper on the future of global supply chains? Well, we are going to indulge in what other commentators are doing and write about what we think should happen, rather than necessarily what will happen.
Confirmation bias is a powerful thing. If you have a strong nationalistic bent and believe that everything you consume should be made in your own country, Covid-19 seems to be proving everything that you ever believed. That the initial outbreak occurred in China seems clear. That Chinese supply chains were amongst the earliest affected is certainly the case. Which only goes to prove, some argue, that we should not rely on China for anything.
But wait a minute. The underlying problem is surely concentration risk, not an origin risk. Bringing all production “home” is just displacing a concentration risk, not eliminating it. It may have a stronger emotional appeal to some people, but it is a political argument, not a logistical one. Besides which, only time will tell if Chinese supply chains actually bounce back quicker than others.
Goods are produced in different places for a variety of reasons: proximity to customers and sources of raw materials, conversion costs like labour and energy, tax efficiency and other government incentives, access to talent and technical know-how, plus, ideally, risk mitigation. These considerations, plus an era of reasonably borderless commerce, have led to the evolution of supply chains that see parts cross and sometimes re-cross borders in the journey from raw material extraction to final product assembly.
Note that these criteria are in a state of flux. Labour arbitrage is a prime example, with wages in the developing world catching up on those in the developed world. It is only a matter of time before there is no labour arbitrage to be had between, say, China and the US. This will happen anyway, and will drive changes in production strategy much more surely than any lessons learnt from the Covid-19 crisis. For a country like China, proximity to its numerous and increasingly wealthy population will supplant labour arbitrage as a prime reason for locating production there.
Will some organisations bring some operations closer to home, prioritising local sourcing? No doubt, and in many cases it will be the right thing to do for them. They just need to make sure they are targeting the systemic risk in their supply chain in the right way and not just swapping one risk for a different, equal one. If you have all your eggs in one basket, switching them all to a different basket won’t help. The next completely unexpected but massively disruptive event is unlikely to be exactly like this one.
Another example of confirmation bias evident in recent weeks concerns mistrust of lean manufacturing. Coronavirus-related shortages prove, if that is what you want to believe, that inventories have been kept too small.
But wait a minute. Large parts of the economy are currently crashing for lack of demand. How would additional inventory help? Having too much of your current assets tied up in inventory that you can’t sell is the last thing you want in such a situation. And how do you know what inventory to buffer? Holding inventory is a valid strategy for dealing with normal variability and some particular scenarios (for instance, if you know that a given supplier is liable to be unreliable and you have no reasonable alternative sources), but is hardly a feasible protection against any possible disruption that might last for any length of time. How much inventory do you need? 6 months? 12 months? Of everything?
On the contrary, we think that the new normal for leading companies will be inventories that are closer to optimized. Large inventories built to forecast are the opposite of agile. To make supply chains resilient, carefully thought out redundancy and a relentless focus on shortening lead times is necessary. Meanwhile, there is enormous potential to better apply optimization techniques.
It is perhaps easy to pick holes in other people’s predictions, more difficult to improve on them. We are not in the business of divining the future. And yet in this humanitarian crisis, and the extraordinary disruption it has brought to everyone’s lives, there is an opportunity to genuinely change supply chains for the better. Perhaps the most likely outcome is that some things will go back to how they were before, but some organisations will take this opportunity to improve a number of things in how their supply chains function. We expect leading organisations to do the following:
Whether or not what we describe in this paper become the new normal in supply chain management only time will tell. But our belief is that these behaviours will improve supply chains regardless of what the future holds. They would have been good things to do before the Covid-19 crisis and we believe that they will make your supply chains successful whatever the future holds.