COVID-19 is not a Black Swan

Or - Why Supply Chain Professionals Don't Have the Right to Use "Black Swans" as an Excuse for Lack of Preparation

With as much talk in Supply Chain circles lately about Black Swans as there is talk everywhere else about the novel coronavirus which at the time of writing has infected more than 100,000 people globally, it might be helpful to take a step back and understand where the idea of Black Swans came from. Nassim Taleb, the Lebanese-American essayist, statistician and - most consequentially - derivatives trader, popularized the term in 2007, but its roots go a lot further back. Indeed, it was the Roman poet Juvenal who in the second century CE wrote "rara avis in terris nigroque simillima cygno" ("a rare bird in the lands and very much like a black swan") in relation to something presumed not to exist. You see, it wasn't until the turn of the 18th century that Dutch explorers actually found black swans in Western Australia that anybody had ever seen one. We were certain, based upon the absolute certainty of all data that supported this conclusion, that swans were white. And so, after we'd seen black swans in 1697, thinkers began thinking - because that is what they do - about what this meant for the certainty of any facts.

Since I'm much better equipped to talk about Supply Chain than epistemology or philosophy, I'm going to skip ahead 300 years to Nassim Taleb's 2001 book Fooled by Randomness where he first begins digging into the idea of truly unpredictable events. Being a derivatives trader, his discussion was first centred on the application of Black Swan theory to financial markets, but his follow-up work in 2007, Black Swan, applies it to the world in general. The essential test dictated by the guy who literally conceived of Black Swan theory contains three parts (and this is directly quoted from Taleb):

1. … it is an outlier, as it lies outside the realm of regular expectations, because nothing in the past can convincingly point to its possibility.
2. It carries an extreme 'impact'.
3. In spite of its outlier status, human nature makes us concoct explanations for its occurrence after the fact, making it explainable and predictable.

That third test is of particular interest to me as it relates to the irrationality of human decision-making, but is not the focus of the present article. However, if you're interested in how Behavioral Economics can be used to address some of these cognitive faults, check out my article on this topic Using BE to Improve Demand Planning. No one can convincingly argue that COVID-19 does not effectively meet the second test, because in many ways, the scope and magnitude of its impact on global supply chains is unprecedented. However, my argument is that for the reasons above (and especially below), this new coronavirus doesn't come anywhere close to meeting the first and key test of a Black Swan event. We have far too many examples since the advent - and continued amplification - of globally-extended supply chains to plausibly argue that no one could have predicted something like this was possible.

The Last Twenty Years Are a Flock of Black Swans

I want to thank NorthFind Management Sr. Associate Y Nguyen for her research on this topic, and share with you only a very high-level extract of the MANY examples of supply chain disruptions we've had to endure and plan for in just the last two decades.

1. 2000 - Y2K made the years leading up to 2000 a fantastic time for ERP and other software vendors safeguarding against the electronic end of the world. In the end what people remember is that nothing happened, but that's only because a ton of work (and money) were invested making sure nothing would happen. Above all, Y2K shone a light on the frailty of an infrastructure increasingly dependant on software to function.
2. 2001, 2002, 2003, 2005 - Anthrax, West Nile, SARS, Avian Flu (H5N1) - Collectively, they don't come close to the scale that we're seeing with COVID-19 (though COVID, in contrast, doesn't come anywhere close to the number of deaths we see annually from the measles, either) however at the time they dominated news cycles and people spoke of them in similarly-apocalyptic terms. Supply chains were not disrupted to the same extent because a) global supply was not as dependent on one country (China) as it now is; b) none of them grew to the scale of COVID-19 (though the potential was clearly recognized); and c) media was talking about other things as well. Which brings us to...
3. 2001 - 9/11. This is one of the true Black Swan events identified and discussed by Taleb in his book.
4. 2002 - LA and Long Beach Port Strike. $1 billion dollars a day of impact for the 10 days of the lockout, and more than 6 months to recover to normal shipment patterns. The strike shook people's perceptions of what elements of their supply chain were unassailable, and importers, exporters and manufacturers all had to recognize the need for having alternate distribution strategies in place.
5. 2005, 2012 - Hurricanes Katrina and Isaac. Multi-billion dollar impact on the economy, not to mention 30% of American oil production (and 20% of natural gas) takes place in the Gulf region. Additionally, some of the nation's most heavily-trafficked supply routes and the Mississippi River converge here. In some respects, there are areas that have still not fully recovered.
6. 2008. Financial Market Crash. At least $1.5 Trillion in impact between write-offs, bankruptcies, bail-outs, etc. Another key pillar of business - the basic premise of access to liquidity and credit - was called into question again. This wasn't by any means the first time, though.
7. 2009 - Swine Flu (H1N1). According to the CDC, over 60 million people in the United States were infected, and over 12,000 died. Globally, deaths reached between 150,000 and 575,000. Interesting fact: I caught it.
8. 2011 - Earthquake and Tsunami in Japan. At least $360 billion in impact. Because of bullet 6 (the financial crisis) many companies were pushing JIT (Just in Time) inventory management in order to keep risk off their books. Unfortunately, especially in the automotive industry (which I was working in at the time) though also computers and electronics, there was a concentration of supply in Japan which, because of inventory risk aversion, had nearly no strategic buffers in place and was immediately impacted by the manufacturing disruption. JIT makes a company's ROIC (Return on Invested Capital) look better, but leaves it increasingly dependant upon its suppliers, and exposed to risks that they have not safeguarded against.
9. 2011 - Thailand Floods. Anyone in supply chain talking about the Sendai Tsunami like a Black Swan and convincing themselves it was a one-off event, needed only to wait until July of the same year to witness the monsoon flooding that a) devastated Thailand, and b) wiped out Western Digital's offices and with them, a full quarter of the world's supply of hard-drives. It took more than a year to recover to pre-flood production levels.
10. 2014, 2015, 2016 - Ebola, Disney Measles, Zika.
11. 2010, 2014 - Iceland Volcanic Eruptions. Widespread disruption of air travel over Europe. I wanted to write the name of the volcanos, but to be honest I couldn't find the appropriate characters on my keyboard.
12. 2016 - Hanjin Bankruptcy. Hanjin is the world’s 5th largest ocean carrier or shipping line. Many shippers affected - some furniture companies were on the verge of bankruptcy as a result of the supply chain interruption.
13. 2019 - Hong Kong political unrest. Anti-government demonstrations in Hong Kong have at times involved violent clashes between protesters and the police. Hong Kong International Airport is the busiest air cargo hub in the world. Last year it handled 5.1 million metric tons of cargo. The hub serves as a major transit point for intra-Asia flights, as well as Transpacific travel between Asia and North America - everything flies through HK. Road closures around the airport are affecting cargo carriers ability to get freight to and from the airport, increased transport costs and delays. The protests, along with uncertainties such as the U.S.-China trade war, sent the Hong Kong economy into a recession for the first time in a decade. Hong Kong’s annual gross domestic product to fall by 2.25% in 2019 and 5.8% in 2020.
14. 2019 - Chile political unrest. Port Disruption - Unionized workers strike across 24 ports. On 25 October, over a million people took to the streets throughout Chile to protest against President Pi?era, demanding his resignation. Chile is the world's largest copper producer.
15. 2019 - Brexit. This has been years in the making, but it finally happened. The EU is the UK’s largest trading partner, accounting for approximately half of both imports and exports of goods. Uncertainty around Brexit and impact on trade could last more than a decade. A large proportion of the UK’s imports from and exports to the EU are in the form of intermediary products—an indicator of the high degree of interconnectedness between UK and EU supply chains. Trading ties with the EU are of particular importance to UK-based firms in the food and drink, chemicals, and automotive sectors. The EU accounts for the great majority of the UK’s trade in the crucial commodities in these sectors’ supply chains. Trade in these inputs is vulnerable to disruption from Brexit, as they would all face relatively high duties. Dyson, Panasonic and Sony, P&O and Schaeffler, and undoubtedly more, are all moving their offices out of the UK.
16. 2019 - US/China Relations. Prior to the outbreak of the novel coronavirus, China - US relations were predicted to be the number one geopolitical instability to affect Supply Chain in 2020 and forward (decoupling, rising tensions, trade wars). US manufacturing has shipped away from China (Mexico has hugely benefitted), and "reshoring" discussions have started trending. Others have ramped up shipments of imported goods, and stockpiling in advance.
17. 2020 - COVID-19. Axios estimates that up to 75% of American companies have had their supply chains disrupted by the impact of COVID-19 on China alone. We are only starting to see what the impact will be on other global suppliers.

Black Swans are not an Excuse for Unpreparedness

Global health organizations have been warning for years that increasing population levels combined with skyrocketing global travel make a pandemic like the 1918 Flu more a question of "when" rather that "if". And moreover, there have been too many substantial global supply chain interruptions in the last five years alone for Supply Chain leaders to be leaving their networks exposed to these risks and being surprised when something happens. Conversely, it is in these times that companies who recognize the value of risk assessments and robust business continuity planning; and who bake risk mitigation into their supply, inventory and manufacture strategies; see their greatest opportunity to leverage supply chain agility. Supply chains have been extended globally and transmitting far-off risks to local sites for too long to excuse being unprepared for the certainty of something like COVID-19 impacting consumer demand and raw material supply.

The balance-sheet benefit of a JIT inventory policy needs to be balanced against the risk it carries with it. The volume-driven discounts on single-sourcing of raw material should at the very least only be pursued when eligible secondary and tertiary suppliers have been vetted and kept available. The risk of unique raw materials or components on a Bill of Materials is for companies with advanced risk mitigation capabilities a known issue that their R&D and Strategic Sourcing teams actively work to eliminate. Risk mitigation extends to logistics and distribution as well, where there have been far too many issues to pretend it won't happen again. It takes effort, discipline and money to mitigate risk, but the cost of not doing so in an environment where supply chain interruptions are far too common to invoke a Black Swan defence are far greater.

We'd love to hear how your supply chain is dealing with COVID-19, or better still, how you already had mitigation plans in place. For more information on what you can be doing to assess risk in your supply chain or organization, email me at [email protected] or our Practice Lead on Internal Audit and Risk Y Nguyen at [email protected]