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Global Supply Chain Disruption and Resilience

By Mari Sako

Communications of the ACM, Vol. 65 No. 4, Pages 18-21
10.1145/3517216

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More and more people are keenly aware of the disruption in global supply chains in recent months, as their daily lives are affected by supply shortage and longer lead times for receiving deliveries of a wide range of products, including new phones, game consoles, and cars. We are also told supply chain disruptions are not about to end but will exist for some time to come. It is therefore worth understanding what has thrown global supply chains into disarray, in what ways the COVID-19 pandemic has played a part, and what will become of global supply chains in the future. In short, the pandemic accentuated preexisting strains in global supply chains and the need to become more resilient to future disruptions.

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The Golden Era of Global Supply Chains

Looking back, the late 20th century was the golden era of global supply chains. Multilateral reduction in trade barriers and relative geopolitical stability led to the proliferation of geographically dispersed modes of production in many industries, including apparel, automobiles, and electronic equipment. Large suppliers such as Foxconn in electronics and Pou Chen in shoemaking thrived as "behind the scene champions" to engage in low-cost manufacturing for brand owners such as Apple and Nike.4 Improvements in container shipping and intermodal freight transport lowered the cost of moving cargo, facilitating the cross-border shipment of physical goods. Containerization also lowered information costs by removing the information burden from all but the consolidator and the breakdown operator. Offshoring of call centers, software development, and business services also spread in the 1990s, enabled by the rise of the Internet and low-cost telecommunication.

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What had Changed before COVID-19

By the 2010s, the geopolitical climate shifted to neo-nationalism and protectionism, causing disruptions in global supply chains. With respect to protectionism, the U.S. imposed 25% tariffs on semiconductor and capital equipment in June 2018, leading ironically to raising U.S. manufacturers' cost of production. With respect to neo-nationalism, U.S. companies faced a ban in 2019 on working with or sourcing telecommunication equipment from companies deemed a national security risk. The resulting reduction in demand for Huawei equipment had a rippling effect on its supply chain, with some component suppliers taking more than a few years to recover from a drastic reduction in their revenues.

At the same time, manufacturing revolution (called Industry 4.0) is accelerating the use of computer technology with flexible manufacturing, robotic automation, and additive manufacturing (including 3D printing). This technological revolution facilitates manufacturing locations to be closer to final customer markets. In other words, digital technology is making proximate sourcing more economical, undermining the relative advantage of exploiting international low-cost locations.

Thus, there has been a happy confluence of factors, both geopolitical and technological, that favor insourcing and the nearshoring of production.5 At the same time, the use of big data in artificial intelligence (AI) has heightened awareness of cybersecurity risks, rendering national borders important when deciding where to store data. The accompanying table gives a schematic summary of a shift from the golden era to the de-globalized era, identifying key factors that shifted the optimal paradigm away from outsourcing/offshoring toward insourcing/nearshoring in many industries.

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Table. Key factors affecting supply chain shift.

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What was Made Worse by COVID-19

Given there had been trends toward less global supply chains before the COVID-19 pandemic, we should not regard the pandemic as the sole reason for exposing supply chain risks. These risks had been present, resulting from decades of prioritizing efficiency (via just-in-time production) and low costs (via offshoring) over sustainability and resilience. The immediate impact of the pandemic-induced lockdown in 2020, however, was severe. Major demand shocks were first evident in the second quarter of 2020, and their effects down the supply chain were evident in a range of industries. Let's look at semiconductors and pharmaceuticals.

Semiconductors, as Communications readers know well, power virtually every sector of the economy, and are an integral part of our everyday life with usage in simple household items including refrigerators, mobile phones, computers, and automobiles. At the height of the pandemic, auto parts suppliers cancelled orders for chips due to a six-week industry shutdown to mitigate the spread of the virus in factories. At the same time, remote work arrangements dramatically increased demand for electronic devices such as computers and laptops and for the digital infrastructure to support videoconferencing and other online activity. As a result, semiconductor suppliers shifted production and foundry orders away from automotive-grade chips to electronics chips.

Adjusting to such demand shift, however, came with a lag. Planning semiconductor production volumes requires a six-month lead time because manufacturing computer chips from design, fabrication, and packaging can take up to 26 weeks.a Ramping up or down production volumes therefore takes time, particularly when suppliers practice low-inventory just-in-time supply and production. Moreover, before the pandemic, key suppliers in the chain were concentrated geographically in a few nations—for example, fabless chip companies rely heavily on foundries in East Asia (notably Taiwan) for the production of the most advanced (7nm or less) chips. The pandemic heightened awareness in industry and policy circles of vulnerabilities associated with such concentration, which could be exposed also by a natural disaster or a geopolitical event.

In pharmaceuticals, COVID-19 also exacerbated vulnerabilities in manufacturers' supply chains. As the pandemic unfolded, major countries including the U.S. and European Union nations faced a surge in the need for many generic medications used in hospitals, including intensive care drugs such as narcotic pain relievers, muscle relaxant ingredients, and anaesthetics. They came to realize many of the raw materials for those medications were manufactured overseas in emerging markets. For example, based on U.S. trade data, in 2020, the U.S. imported $1.8 billion in active pharmaceutical ingredients (APIs) from China and $582 million from India, the second and eighth highest sources, respectively. India, which supplies approximately 40% of generic pharmaceuticals used in the U.S., also imports nearly 70% of its APIs from China.6 Similarly, the European Union is highly dependent—90% according to one estimate—on APIs sourced from India and China for generic medicines.1,2

Additional vulnerabilities come from market consolidation in the production of APIs and finished dosage forms (FDFs) (for example, tablets or liquid) due to the need for highly specialized facilities that meet the required quality standards. The shift to generic medicine also contributed to market consolidation as low volumes and low margins have led to more exits than entry of manufacturers. Geographic and market concentration leave supply chains vulnerable to geopolitics and natural disasters. For example, in 2017, Hurricanes Maria and Irma adversely affected drug manufacturing facilities in Puerto Rico, which supplies 10% of drugs consumed in the U.S.6


We should not regard the pandemic as the sole reason for exposing supply chain risks.


In summary, in both semiconductors and pharmaceuticals, COVID-19 exposed some underlying structural issues that led to supply chain risks including: market concentration in certain components and materials, just-in-time inventory management and full capacity utilization that reduce the capacity to respond to demand surges, and geographic concentration of manufacturing that puts production at risk from natural disasters and geopolitics.

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Balancing Multiple Objectives in Global Supply Chains

We should use COVID-19 as an occasion to review how changing circumstances require a different trade-off among various stakeholders' objectives in designing geographically dispersed supply chains. For example, geographic concentration of manufacturers has the cluster advantages of sharing infrastructure and know-how in a region, but puts production at risk from natural disasters, geopolitical events, and the pandemic.

Each stakeholder group should also review their own trade-off to be better prepared for the future. National governments are interested in "supply chain security" for both economic and national security. The aim here is to be able to access enough essentials to feed the nation, to create and secure jobs, and to prepare for national defense. Much of this aim would be fulfilled by creating incentives for industry to relocate production within national borders. In devising policies, governments would need to review whether the country's reliance on foreign production capacity is too high.6 For example, is the EU's 90% reliance on APIs for drugs from India and China too high?

Global corporations and smaller enterprises should consider investing more in "supply chain resilience," which is about introducing some redundancies and flexibility. Thus, resilience may come from balancing efficiency (reducing cost, minimizing inventories, and maximizing capacity utilization) against building flexibility and buffers to absorb disruptions in supply chains. Flexibility may be built in by conducting scenario planning for possible sources of supply disruption, and diversifying sources to include multiple regions. There are also technological solutions to enhance the transparency of supply chains by using track-and-trace sensors for real-time monitoring of shipments, and by using blockchain to trace the provenance of materials, thus preventing fraud.3

For individual consumers, supply chains are of increasing importance as we care more about sustainability and the provenance of goods and services we consume. To meet this expectation, we can enhance sourcing transparency in goods ranging from apparel, food, and pharmaceutical products. In addition, consumers may care about labor and environmental standards adhered to by firms that produce the goods they consume. And of course, some of the consumers are workers to whom such standards apply directly at their workplace.

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Data-Driven Technology for Resilient Supply Chains

This column argued the golden era of global supply chains had ended before the COVID-19 pandemic, with geopolitical drivers and technological enablers. The pandemic exposed preexisting vulnerabilities, which are being addressed by implementing an optimal trade-off between different objectives, in particular firms' need to trade off low-cost efficiency against building redundancies to mitigate risks, and consumers' need to purchase affordable goods against their wish to consume sustainably produced goods.

Although this column focused largely on non-technological factors shaping global supply chains, there is much that technology can do to enhance their resilience. The COVID-19 experience has made companies realize the importance of agility. Their focus therefore should be on creating flexible supply chains, with real-time visibility to better manage supply chains. This may involve the use of external data (weather patterns, port delays, and supplier issues) to make real-time corrective decisions, and to improve supply forecasting. A modular ERP architecture, with a narrower core of functionalities and loosely coupled functional applications hosted in the cloud, would deliver valuable insights and predictability in managing global supply chains.b


The pandemic exposed preexisting vulnerabilities, which are being addressed by implementing an optimal trade-off between different objectives.


Lastly, optimal supply chains may be more easily crafted for emergent products with emergent technologies, such as electric vehicles. While many components will be based on existing technology (for example, semiconductors are key to computationally intensive electric vehicles), many things are new here, including the energy source (batteries rather than powertrain) and an infrastructure for power charging stations. These provide opportunities for new entrants and new supply chain configuration. The climate change imperative—phasing out gasoline and diesel-powered car sales by 2040—adds to the momentum of these changes. This is good news for shifting toward optimally globalized supply chains of the future.

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References

1. Brunsden, J. and Peel, M. 'Covid-19 exposes EU's reliance on drug imports' Financial Times (Apr. 20, 2020).

2. McDonnell, A. et al. A path to resiliency: Mitigating the impacts of COVID-19 on essential medicines supply chains. CGD Policy Paper 213. Washington, D.C., 2021.

3. McGrath, P. Tools and technologies of transparency in sustainable global supply chains. California Management Review (2021).

4. Sako, M. Driving power in global supply chains. Commun. ACM 54, 7 (July 2011), 23–25.

5. Sako, M. Free trade in a digital world. Commun. ACM 62, 4 (Apr. 2019), 18–21.

6. The White House. Building Resilient Supply Chains, Revitalizing American Manufacturing, and Fostering Broad-based Growth: 100-Day Reviews under Executive Order 14017, 2021.

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Author

Mari Sako ([email protected]) is Professor of Management Studies at Saïd Business School, University of Oxford, U.K.

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Footnotes

a. See https://bit.ly/3Ln3rN3

b. See https://on.bcg.com/3Bd44Eb


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