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Breaking the Chains: COVID-19’s Impact on Global Supply Chains

Ian Alberts, CPA and Christopher Taglianetti, CPA

6.17.20 | COVID-19 Industry Insights

In mid-March, as the severity of the COVID-19 pandemic was becoming more and more evident with each passing hour, Lawrence Summers, a former U.S. treasury secretary took to Twitter and asked: “Why can’t the greatest economy in the history of the world produce swabs, face masks and ventilators in adequate supply?”

It is a valid question, after all, some 95% of surgical masks and 70% of ventilators are produced overseas. Yet ironically, the answer to Summers’ question lies in the very policies — including, prominently, China’s accession to the World Trade Organization (“WTO”) — Summers himself had championed over the course of his career as an economist and high government official. Summers was hardly alone. In 2003, the McKinsey Global Institute issued a report which concluded that “Offshoring is as beneficial to the United States as it is to the destination country.” Yet the benefits, as we have seen, have proved illusory; due to offshoring, valuable engineering and production skills and capabilities have perhaps forever been lost. Meanwhile, jobs lost on account of Chinese WTO entry are estimated at 3.7 million.

The lack of domestic production capacity which now bedevils the U.S. is the result of specific policy choices that were made over the course of the last thirty years and pursed with equal vigor by both political parties. A question among many that arises from the current crisis is whether an industrialized country is truly industrialized if it cannot produce the things it needs — like swabs, face masks and ventilators  — during a crisis? The hollowing out of the American manufacturing base, overseen by erstwhile devotees of globalization, has left the U.S. underprepared for ‘black swan’ events, such as the one we now find ourselves having to overcome.

The trend toward offshoring manufacturing jobs that began in earnest in the 1990s has left the country vulnerable to natural, medical, and political crises as never before. And alarmingly, the problem of offshoring supply chains extends to the military. In September 2018, the Department of Defense (DoD) reported that “China is the single or sole supplier for a number of specialty chemicals used in munitions and missiles…. A sudden and catastrophic loss of supply would disrupt DoD missile, satellite, space launch, and other defense manufacturing programs. In many cases, there are no substitutes readily available.”

However, as a result of the COVID-19 pandemic, the past two months have seen a plethora of proposals on to how to ‘re-domicile’ supply chains that relate to the production of everything from food and medical supplies to military and telecommunications equipment.

Among these are proposals deigned to make the awarding of federal contracts contingent on there being a ‘made in America’ component; an executive order for medical equipment to that effect was proposed — but subsequently shelved — in March. Another proposal requires companies that receive COVID-19 relief from federal aid re-shore a percentage of their operations back to the United States. Meanwhile, the pending Small Business Administration reauthorization act would expand avenues for government funding for research and development (R&D) to domestic manufacturers. The bill would, among other things, replace “outdated export programs with more effective policies to promote the success of innovative, high-growth small businesses in advanced manufacturing.”

Yet significant obstacles to re-shoring remain not least because valuable manufacturing and management skills have been lost in the ensuing decades, and the fact that the county lacks supplier networks that make domestic production possible. Adding to this, investor and managerial incentives remain skewed toward short-term gains rather than toward long-term investment.

Meanwhile, the global ramifications of the crisis have been severe. The shock up and down the supply chain caused by the pandemic have rattled the automobile industry in Germany as well as suppliers of copper in Peru. In the U.S., Apple, Inc.—which relies on assemblers and component makers in South Korea, China, Germany, and Malaysia—has also had to navigate a recent spate of supply chain disruptions.

Additionally, the decision to temporarily suspend production by Detroit automotive makers Ford Motors, General Motors and Fiat Chrysler, had knock-on effects for their suppliers down the supply chain. By March, an Institute for Supply Chain Management survey showed that 75% of companies reported interruptions in their supply chains. The fact that many of these companies are reliant on China, where the pandemic first hit, only makes matters worse since China accounts for between 17 and 20% of the world’s GDP.

Nevertheless, current challenges will give rise to new approaches in order to mitigate future risks. Over the long term, we may see a trend toward re-shoring in the U.S., while in Europe and Asia, particularly Japan, governments may begin to move toward policies which promote national investment strategies aimed at supporting domestic production.

But right now, the challenge facing businesses is how to mitigate and minimize the potential damage from the disruption caused by the COVID-19 pandemic. To give a sense of where we are today: prior to the outbreak, the Purchasing Managers Index (PMI), which measures the activity level of purchasing managers in the manufacturing sector, registered dramatic changes in recent months, coming in at 49.1 at end of March, then, a month later, at the end of April, hit 41.5, a level not seen since the Great Recession.

In order for manufacturers to successful comeback from the COVID-19 crisis, they will have to begin exploring ways to insulate themselves from supply chain risk. Achieving this will likely be essential for long-term survival, especially as new, and potentially worse, crises arise in the future. Two options that can help and should be explored by businesses, now, as they prepare for the brave new post-COVID-19 world include:

Dual Sourcing. Some companies are hedging their risk by employing a dual-source strategy. The Agriscience giant Corteva produces key ingredients for its products in both China and Europe. This allowed it to weather the recent storm when China went into COVID-19 lockdown early this year. In fact, the strategy was such a success that the company went on to beat first quarter earnings expectations by more than 10%.

Multi-Carrier. The production/manufacturing end is only one part of the supply chain equation. The other part, of course, is delivery. Companies are now realizing the need to build-in additional flexibility and capacity into their delivery systems. One way to do this is to make the switch to “multi-carrier shipping software” that enables businesses to cut down on transportation costs while improving customer service. A move toward a “cloud based” system will build added resiliency into the supply chain, allowing companies to navigate future shocks with greater confidence.

Companies will need to continue to explore these options, among others, as they look to successfully navigate current and future seismic changes in the domestic and global economy and their impact on the makeup and structure of global supply chains.

If you have any questions regarding this article, contact Ian Alberts at 516.806.3479 | ialberts@berdonllp.com or reach out to your Berdon Advisor.

Berdon LLP New York Accountants