How to respond to global supply chain disruptions caused by Covid-19?

The corona pandemic illustrates the fragility of global supply chains and the risks of supply chain disruption. In the future, many companies will pay more attention to planning their supply of inputs not only in terms of efficiency but also in terms of increased risk management. This results in a conflict of objectives between efficiency and resilience. The boost in the use of digital technologies could at least partly resolve this conflict of objectives.

International division of labor before the corona pandemic

The international division of labor is currently characterized by three central features: just-in-time production, the expansion of supplier relationships to the entire world (global outsourcing), and often the cooperation with only one supplier (single sourcing) (see Fig. 1).

This form of production enables efficiency gains. Consumers can consume a larger quantity of goods and services for which they pay lower prices.

The disadvantage is an extreme dependence on exact adherence to all agreed details of the supply relationship. The fact that this condition is by no means guaranteed has been illustrated by the abrupt severing of global supply chains by the coronavirus pandemic.

Short-term reactions of the companies

In the short-term, most companies have few alternatives for action. Cancellation of ordered inputs that are no longer needed due to an epidemic-related plant closure can lead to contractual penalties. Moreover, the buyers of intermediate inputs could increase their storage capacities in the short-term. In addition to renting appropriate storage space, consideration is given to choosing slower means of transport, e.g., by replacing air freight with container ships and thus shifting storage to ships.

Customers who have to reduce or even stop their production activities due to lack of inputs have even fewer alternatives for action. If they are dependent on a specific supplier, production must be stopped until the supplier can deliver again.

Medium-term reactions of the companies

Companies suffer less from supply chain disruptions when they reduce the level of just-in-time production, global outsourcing, and single-sourcing. But this results in higher costs.

• A lower level of just-in-time production means that companies operate with larger inventories. However, this increases storage costs and capital requirements.
• Relocating individual production steps back to the company’s operations (insourcing) or at least to the domestic market (reshoring) reduces dependence on production locations that are far away. However, this results in higher production costs.
• Switching to a larger number of suppliers reduces the risk of default on advance payments. However, if the entire input requirement is no longer produced by one supplier, economies of scale are reduced.

Efficiency or resilience – what will prevail?

It is questionable whether companies will make use of these opportunities. Rather, it is to be feared that efficiency considerations will again predominate after the corona pandemic.

• Company closures will lead to losses. To compensate for these losses after the economy has recovered, profits must be made. The compulsion to generate profits can lead companies to forego measures of increasing the resilience of their supply and value chains.
• Even if a company accepts efficiency losses, competitive pressure can prevent this: if competitors forego cost-increasing measures to avoid interruptions of production, this forces all companies in the concerned market to give priority to cost minimization.
• The provision of additional storage or production capacity is often combined with credit financing. If companies have had to take out loans during the lock-down phase, their debts will increase. If banks are no longer willing to provide further loans, the financial means to adjust the input relationships are not available.

3D printing technology as a catalyst for insourcing

In recent years, advancing digitization has already led companies in highly developed economies to bring production steps from low-wage countries back into their own country. The corona pandemic is likely to reinforce this trend of reshoring.

3D printing technology could play a particularly important role in this. 3D printers are used to fuse plastics, metals, and other basic materials into new objects. This technology leads to a significant reduction in material waste, which leads to an increase in productivity. In the future, it is plausible that technological advances will make 3D printers attractive for mass production.

This makes insourcing more attractive. Individual parts will then no longer be produced by suppliers from abroad, but with the help of 3D printing technology at the place of production. This is cheaper (material consumption is lower, and transport costs are eliminated), faster (transport routes are saved), and more flexible (product-specific features can be addressed immediately).

Efficiency and resilience in terms of required inputs are then no longer a contradiction (see Fig. 2). However, even this strategy is not entirely risk-free: companies in countries with few raw materials such as Germany are no longer dependent on imported inputs, but they do need to import the raw materials required for production with 3D printers.

Supply Chain Disruption: Outlook

Numerous causes can interrupt global supply chains. A pandemic is an extreme case because it stops production activities worldwide. In the event of an exogenous shock of this magnitude, even reshoring or insourcing may not help if the plant in question has to be temporarily closed.

Nevertheless, the coronavirus pandemic should prompt most companies to rethink their supply chain dependencies. It remains to be seen whether resilience considerations will prevail over efficiency efforts. Instead, supply chains may only be shortened if this does not come at a high expense of efficiency. The increased use of digital production technologies – especially 3D printing technology – could be a way to resolve the contradiction between efficiency and resilience.

Note: This article is a highly abbreviated version of the German-language article “Globale Lieferketten zwischen Effizienz und Resilienz”, which was published in the journal ifo Schnelldienst 05/2020.