Supply chains: Become less lean or step up risk management

We interview Patrik Zekkar, Global Head of Trade Finance & Working Capital Management at Nordea, about how the COVID-19 outbreak will disrupt global supply chains, as occurred during the SARS outbreak in 2003-04 and the Fukushima accident in 2011. He elaborates on how China plays a greater role today and will aggravate the impact, how corporates should think about their supply chains, and how Nordea can offer short-term help with handling trade documentation and the interpretation of rights and responsibilities to avoid extra costs. 

Measures to contain the global COVID-19 outbreak will disrupt trade flows and constrain supply and demand, by keeping people away from work in production, shopping and travelling. How do you expect supply chains to be affected for corporates?

Patrik: Systemic supply chain shocks are not a new phenomenon. Earlier incidents include the SARS virus outbreak in 2003-04, the Fukushima nuclear plant accident in Japan after an earthquake in March 2011, and the volcano eruption on Iceland in April 2010, which created an enormous ash cloud and grounded all flights in northern Europe. All of these events stretched supply-chain resilience. It took Toyota three months to get back to pre-earthquake production rates in 2011, and the European land and sea transport network was under enormous pressure for six days to keep supplies flowing.

What has changed over time is the reliance on China in the global economy. Back in 2003 during the SARS outbreak, China accounted for only 4% of global GDP. Today it is 16%. Furthermore, the increased shift towards China in the global supply chain has been driven by cost and competence factors.

Another fundamental change is that China has climbed the value-chain ladder from manufacturing components to also assembling products, and it has become an important trade partner for developing countries. Hence, the ripple-effect from a disruption in China can be sudden and unexpected, such as General Motors' Louisiana plant closing down owing to a lack of Japanese-made parts after the Fukushima accident. Such disruption will be felt not only in developed countries, but also among manufacturing hubs in developing countries where much needed raw materials are trapped. For example, the vast majority of factories in Bangladesh source raw materials from China.

At present, an additional concern is that the regions in China hardest hit by the COVID-19 outbreak to date are those focused on electronics and the automotive industry. We have seen indications that global shipments of smart phones could be impacted by up to 10% this year, and that there could be an impact on upcoming Christmas orders. Major releases of next-generation gaming consoles planned for the 2020 Christmas holiday season could also be at risk. When South Korea and Japan are added to the picture, their large automotive sectors also become a clear area for concern.

What can corporates do to manage their supply chains in the short term? What should be their key considerations? Are there any tools they can use to minimise the impact of the disruption? 

Patrik: Each supply chain has its own specific circumstances. Production levels vary from factory to factory, and where capacities are insufficient, prioritisations are made for which customers to supply first. Production and freight capacity may change rapidly, and should be monitored closely.

There may be a risk of infection recurring, especially in plants and factories with company dormitories. In terms of supply-chain disruption, even a single infected person can cause an entire factory to halt production, as was the case with Motorola in Singapore during the SARS outbreak of 2003. While ports have traditionally been kept open during previous outbreaks such as the SARS epidemic, disinfection operations and labour shortages may still reduce productivity beyond normal levels for maritime trade. Logistical challenges across China will continue for some time, with truck drivers needing to report back to work, continued road blocks and travel restrictions, and the prioritisation of food and medical goods transports. International ocean freight rates are likely to surge when goods start moving, and then there is the transit time to Europe and the US of around three weeks to contend with.

It is important to be fully up to date on your responsibilities and rights under existing contracts and outstanding trade finance instruments, in order to mitigate and prevent additional costs. This may include international commerce terms, obligations to present valid and accurate documentation within required time frames, an understanding of what alternatives may be permissible in an exceptional situation as we face today, as well as initiating work to allow extensions for various timelines in the supply chain. As much as possible, you should also avoid getting trapped with goods in the cost-intensive part of your supply chain, such as goods in transit.

Do you think large corporate supply chains will have to change in the longer term? Can corporates live with the cost of reducing their current vulnerability to disruption through greater buffers such as more inventory or more local (and hence more expensive) production?

Patrik: After every systemic incident, corporates are quick to re-evaluate their supply chain, shifting from reducing inventories and cost (ie the lean and just-in time approaches) to put more emphasis on buffering risk by building up inventory and backing up suppliers, as a way to enhance resilience and increase redundancy.

Such measures can, however, be costly, and may not be commercially viable in fiercely competitive industries. We believe an advancement in risk management is required for more complex global supply chains. Corporates generally monitor strategic suppliers and high cost components with adequate risk management strategies, split sourcing etc. It is the second tier of suppliers and smaller, cheaper, and less-critical components where the greatest risk is found. Lacking specific parts, even if they only cost a few cents, can mean shutting down a whole factory.

Corporates also need to assess their specific supply-chain risk in relation to their position in the chain. The logic is that each company in the supply chain must make a quick decision and cut its production in line with its projected decline in sales. As sales are projected to decline, this would leave each company with more inventory than forecast, and hence the company does not need to order more and can instead use up existing stocks. This increases risks further up the supply chain, where the effect is amplified the most, and where corporates tend to be the most leveraged.

What can Nordea do to support large corporates with working capital management in this challenging environment?

Patrik: We can help with short-term advice and support in the “here-and-now” situation, such as securing proper interpretation of rights and responsibilities, supporting and securing proper handling of trade documentation, sharing information and updates for corporates, thus allowing them to plan and take action. Nordea can also support with working capital bridge solutions in various ways.

In the long term, Nordea is working to increase transparency and simplify the fragmented physical supply chain in trade, by participating in the evolving trade echo system we.trade and by utilising new technology.

Nordea can also support with a required risk and working capital analysis of your supplier and buyer universe, which is a basis for your supply chain risk and working capital management.

Finally, together with a partner, Nordea is currently piloting a supply-chain financing solution that includes sourcing and procurement services, with the purpose of acting as a supplier aggregator for our customers to reach a large supplier universe via only one supplier relationship. With indirect access to a large supplier universe through Nordea's financing solution, there is a reduced risk of dependency on single suppliers, while still reducing sourcing, procurement, and supplier management costs.