Faced with a pandemic, we suddenly couldn’t find what we needed: Hospitals were running out of N95 and ventilators, automakers lacked essential components, and store shelves suddenly went empty, from sneakers to sofas.
Kostas Bimpikis, associate professor of operations, information and technology at the Stanford Graduate School of Business, explained how to keep our supply chains reliable, even when the world is in turmoil. His remarks have been edited for length and clarity.
Q: What has COVID-19 revealed about our supply chain?
A: It revealed two things. The first is how interconnected supply chains are. A disruption in Italy, Taiwan or Korea can be felt anywhere in the world. The second thing he revealed was the fragility of the supply chain. Any deviation from normal operations creates a huge shock all over the world.
Q: What got us into this mess?
A: One trend is “just in time” manufacturing. Typically, companies produce only the inventory they need to meet short-term sales. It keeps costs low. They don’t necessarily have excess inventory. The second reason is the specialization of product lines. For example, cars are manufactured which consist of thousands of components. An interruption at a supplier for a specific component – like a small screw somewhere in the car – can delay production of the entire car. And the third thing is the outsourcing and globalization of manufacturing. So a disruption in Taiwan, for example, also affects our national supply chain.
Q: What is driving these trends?
A: Typically, businesses aim to minimize costs, maximize speed, maximize efficiency, and maximize choice for consumers. Costs are minimized with very low “safety stocks”, as the storage of excess stock is very expensive. Maximizing speed and efficiency means lean operations and just-in-time manufacturing. Maximizing choice for customers indicates the specialization of the line. You can buy Nike sneakers in a million colors. These have big advantages, but they have drawbacks. At the start of the pandemic, shortages were mainly due to a sharp increase in demand for products. Now, most of the problems come from issues with the supply chain.
Q: Are some industries experiencing more disruption than others? And why ?
A: The industries that have experienced the most disruption are those with sustained demand and high geographic concentration. For example, the semiconductor industry is still experiencing quite a bit of disruption. The demand for semiconductors has increased as they are used in many consumer products, such as cars. And the semiconductor industry is highly concentrated in two geographic regions, Taiwan and South Korea. Manufacturing is carried out by only two companies. The last thing, especially for the semiconductor industry, is that the entry costs are very high. It is not easy to decide tomorrow that you will become a semiconductor manufacturer.
Q: Can we reduce the risk by producing more goods in the United States?
A: Products made in the USA do not experience as much disruption because they are not subject to shipping constraints. But to be realistic, outsourcing and globalization of trade cannot be easily reversed because of the benefits it brings. Outsourcing has led to much lower prices, due to much lower production costs. Domestic manufacturing must be boosted in industries that are of strategic concern to the United States. Semiconductors are a good example. The White House has some initiatives to invest heavily in the domestic semiconductor industry to increase capacity. It is unlikely that all of the manufacturing will be done on land. But maybe we’ll see more in strategic industries.
Q: Can supply chains be made more resilient?
A: There is a trend towards diversification of the supply chain called “dual sourcing”. It is “China plus one” – an alternative source of supply outside of China. But it takes time. Especially in China, there is a lot of investment, know-how and infrastructure which greatly facilitate the operation. Companies are trying to replicate the same infrastructure and the same efficiency in countries like India and Vietnam.
Q: Are there other strategies?
A: One way to avoid shortages might be to increase excess stocks of “safety stock”. Also, make the production more flexible. If you have a simple product line and there is disruption in one of your facilities, you can potentially increase production capacity in other facilities. This is called “reverse specialization”: if you make your components more common to all of your product lines, then it is easier to deal with disruption.
Q: What should the role of government be?
A: The government is already taking steps to increase the manufacturing capacity of strategically important industries. And the government can strengthen domestic production, through tariffs, subsidies, etc. Another action is to hold strategic reserves for important products, just as we do for oil. It can also provide greater transparency of complex international supply networks. It is currently not easy to identify risks, as companies do not have full visibility into where their suppliers are sourcing raw materials. One way to identify risk is to do a ‘stress test’, similar to what we’ve done with the financial industry: simulate the negative effects and see how it spreads throughout the supply chain.
Q: When might our current disturbance subside?
A: It will take a while, maybe three or six months, probably more. Companies generally underestimate the investment required to repair them. I guess it won’t be back to normal for another year.
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