Supply Chains Optimizing for Resilience in a Post-COVID19 World

5.9.20 (2)

In the aftermath of WWII, Japan’s economy was in ruins. Its manufacturing industries found that they did not have the raw materials and resources to build enough items to keep any meaningful inventory. Compared to American car manufacturers who produced millions of cars a year upfront and then distributed them to dealerships, the Japanese could only produce thousands at a time at best.

Lean Manufacturing is Born

In 1948 at Toyota, Taiichi Ohno, turned this disadvantage into an advantage. Ohno created the Toyota Production System (TPS), a system that eliminated the need for inventory by integrating suppliers, manufacturers, and distribution for a “just in time” production. By building the cars “on-demand” and ordering the raw materials “on-demand”, Toyota only produced as many blue cars a year as was needed, as opposed to Ford and GM in the United States that estimated the demand for blue cars at the beginning of the year, built them, and then had to sell off the unused inventory at year end fire sales. By employing what is now commonly referred to as Lean Manufacturing, Toyota would eventually become the number one car manufacturer in the world.

Everyone Copies Toyota

Japanese auto manufacturers were the first to copy Toyota (most notably Honda with Scrum, their answer to TPS), however, after Japanese manufacturing companies started to dominate in several industries, just about everyone eventually followed suit. Fast forward to the 2000s and most manufacturing is optimized for efficiency. By optimizing for efficiency the next logical step is to optimize for margins by employing economies of scale.

Apple is the gold standard in optimizing for efficiency and margin at scale today. Before becoming the dominant consumer electronics manufacturer in the middle of the 2000s, Apple consolidated most of its manufacturing in Shenzhen, China. The massive operation has thousands of suppliers in its supply chain delivering the factories the components needed to assemble the iPhone, iPads, etc, that are so popular. Apple produces as much product a day that is needed to fit on the air freight that they have available, no more or no less. Apple will accept only the components from its supply chain suppliers needed each day to build what is scheduled with very little buffer. It runs a tight ship.

The First Cracks in the System: 2011

As the only way to compete in large scale manufacturing was to embrace the just in time manufacturing system, a lot of specialization occurred in order to maximize margin. Entire regions and their factories were optimized for one product line from one company. Certain components (think GPS receivers, hard drives, etc) are only produced in a handful of factories in certain regions.

Things were going well for the industry until two natural disasters in 2011: the Japanese earthquake, tsunami, and subsequent Fukushima nuclear power plant meltdown in March and massive flooding in Thailand in October.

The disaster in Japan shut down the supply chain for weeks in certain industries. Days after the disaster, a General Motors truck plant in Louisiana and a Peugeot plant in France had to temporarily shut down in order to wait for the parts suppliers in Japan to come back online. Similar problems occurred with silicon wafers (the basis of microchips), lithium-ion batteries, and flash memory, where Toshiba produces 35% of the world’s flash memory and had to temporarily shut down after the disaster.

The floods in Thailand caused similar problems. Thailand produces about 50% of the hard disk drives (HDD) for PCs and laptops. In addition a Japanese company that makes 80% of the motors for HDDs had all of its manufacturing for the motors in Thailand. Asian PC manufacturers experienced HDD shortages well into 2012 as Thailand was reeling from the floods. It was difficult to source hard drives from Korea, China, or other locations as other hard drive manufacturers could not get enough motors to complete their hard drives in time.

Trade War and COVID-19

After the disruptions to the consumer electronics and automotive supply chains in 2011–12, several manufacturers started to build in some redundancy into their supply chain and started to hold more inventory of components and products. Despite the redundancy being built into the system, most of the consumer electronics companies have very slim margins and doubled down on optimizing for efficiency and margin.

Several manufacturers were caught by surprise during the China-United States trade war in 2018–20 (and to a lesser extent by the Trump Administration’s tariffs on the EU, Canada, and Mexico.) While supply chains were not disrupted, the cost of doing business went up overnight by as much as 50%.

Just as the United States announced a new Trade Deal with China in early 2020, China was rocked by the COVID19 outbreak from January to April 2020. With over 80,000 cases of infection in China reported, China decided to shut down its economy for six to eight weeks. Factories were closed and entire supply chains were completely shut down. As opposed to 2011 where several important component vendors of the supply chain were taken out by natural disasters, in 2020 in China, individual component vendors as well as entire supply chains were taken offline at the same time. This was done at a massive scale since by 2020 China was the world’s largest manufacturer accounting for at least 28% of all goods produced worldwide. By this writing in mid-April 2020, three months after the shutdowns began, most factories are still not at 100% capacity.

The Post COVID19 Manufacturing World: Optimize for Resilience

After the world starts to recover from the COVID19 pandemic, the unprecedented global shut down, and the economic downturn that follows, companies will start to rethink their supply chain and manufacturing strategies. Instead of specialization and optimizing for efficiency and margins, manufacturers will start to optimize for resilience, durability, and redundancy. Companies will have mirrored supply chain and factory locations.

Consider a world where this is the case. A major consumer electronics manufacturer such as Apple, will have parallel supply chains in China, Mexico, and Ghana, supporting its customers in Asia Pacific, the Americas, and EMEA respectively. While redundancy would only help a little bit in a global pandemic (Mexico and Ghana would have been online from January to March when China was closed and China would come back online when Mexico and Ghana shut down), the risk of tariffs/anti-globalization regimes, geopolitical strife, war, pandemics, and natural disaster is mitigated by mirroring the supply chain and manufacturing in multiple locations.

Since the 2008 financial crisis, there has been a globalization backlash. Post COVID19, there will be a lot of demand to make things at home, and certain critical items such as pharmaceuticals, surgical masks, ventilators, etc, will be. The non-critical items will start to be made closer to home, if not at home through more durable supply chains.