Supply Chains are changing
Pierre Courtemanche
Sustainability & Supply Chain Strategist | 360platform | Mentor @MENTORCONNECT
Supply chains connect all of us for the better and the worst. And they are currently in full mutation which will significantly affect the world economy.
In this article, I explain the main factors causing these changes and try to predict the foremost consequences.
Global merchandise trade volume grows year after year. Only major crises succeed in slowing it down.
The COVID-19 pandemic has been a massive stress test of the world trading system, delivering unprecedented shocks to global supply chains and trade relations among countries. In 2020, the value of global trade in goods and services in nominal dollar terms fell by 9.6 per cent, while global GDP fell by 3.3 per cent, in the most severe recession since World War II.[i]
?Figure 1:???? World merchandise trade volume, 2015Q1-2022Q4[ii]
After the 2008 financial crisis, volumes started recovering the following year and growth resumed. In the case of COVID-19, the recovery was even faster.
For the World Trade Organization, globalization has created a world that is both more vulnerable and more resilient to crises. Is this true?
Supply chains are the backbone of global trade. By connecting companies, whether local, regional, or global, they affect the trade balance of countries, their GDP, and the value of their currency. They have direct and indirect impacts on all humans.
Supply chains’ complexity has grown in parallel with the expansion of global trade, reaching an unprecedent level of opacity.
Over the past 60 years, large companies have traveled the world in search of favorable conditions to either build new infrastructures or relocate their industrial production. Among the main reasons for offshoring manufacturing production, we can mention three goals and the following criteria:
1) Reduce production costs
2) Exploitation of raw materials
3) Access to markets
The need to constantly increase volumes of production has led to the development of massive infrastructure around the world to extract, produce, transform, store, transport and distribute unprecedented quantities of materials, parts, components, ingredients, and goods.
This wave of globalization has allowed the development of international supply chains with sophisticated logistics. For example, the ‘just-in-time management’ is an innovation that makes it possible to efficiently manage stocks and input materials throughout a long and decentralized chain of operations while meeting demands. Another example, the invention of the container in 1956 which enabled intermodal transportation and has revolutionized the entire world trade system; the container becoming the vector of globalization.
Considerable investments were necessary to set up all this infrastructure and facilities. These investments are referred as Foreign Direct Investment (FDI). They are carried out by companies but also supported by governments and international institutions such as the World Bank. The graph below shows FDI by country from 1990 to 2021.
Figure 2:???? Inward direct investment evolution (top 10 countries $US billions)[iii]
When we analyze global investments made over the last thirty years, we find that Asia has obtained a significant share (around 30%), Africa little (3%) and that Europe and the Americas have received the greater part. For some countries like China, foreign investment has propelled their economy and allowed them to move from underdeveloped to emerging economies.
During the 2020 pandemic global FDI dropped from $1.707 trillion the previous year to 961 billion. It then rebounded in 2021 to 1.478 trillion, before declining again in 2022 to 1.294 trillion.[iv]
When we look closer to the 2022 data, we see that FDI inflows in non-OECD G20 economies dropped by 38%, mainly reflecting decreases in China, and that FDI outflows from OECD and non-OECD G20 countries plunged by 14% and 28%, respectively. The FDI trajectory appears to be negative in 2023 as well.[v] We can think that the FDI will resume its growth in 2024 and over the coming years.
All these investments have had an economic impact in all regions of the world and have lifted billions of people out of poverty. New middle classes have emerged in many countries creating domestic demand for the consumption of goods and products.
We have witnessed legitimate aspirations of several governments not wanting to be limited to a blue-collar role but wishing to master modern technologies to produce value-added products. China is the best example.
Although the positive economic impact cannot be denied, the globalization of the economy and supply chains has had and continues to have equally irrefutable negative environmental and social impacts.
It is not only production that has been relocated, but jobs too. Millions of workers in the North have lost their jobs to workers in the South.? The most vulnerable sectors are those that were heavily dependent on low-skilled work, such as textiles, clothing, footwear and leather, basic metals, and fabricated metal products. These massive job displacements have had negative social impacts in many northern working-class communities such as increases in unemployment, crime, and structural inequalities.
Increased consumerism and growing demand for products and services has led to an exponential use of fossil energy which in return has dramatically increased the emission of greenhouse gas.
Figure 3:???? Annual CO2 emissions by world region[vi]
This measures fossil fuel and industry emissions1. Land use change is not included.
The year 2023 will remain the year when the effects of climate change have reached a new threshold. While some climate skeptics still refuse to admit that fossil emissions modify the climate, the majority look to the future with concern.
This increases the pressure on governments and the private sector to reduce carbon emissions. Several countries and companies have already made commitments to reduce their level of emissions and a carbon tax covering upstream supply chains operations has started this year in Europe with the initial phase of the Carbon Border Adjustment Mechanism. It imposes CO2 emissions tariffs on imported steel, cement, and other goods as it tries to stop more polluting foreign products from undermining EU’s green transition. Some are even committing to net-zero emissions which entails decarbonizing companies’ operations and their supply chains as well as offsetting and carbon removing programs.
?Figure 4:???????? Countries’ net zero target pledges[vii]
Even if several experts doubt the realism of the targets announced[viii], decarbonization is a key factor of supply chain transformation.
This year we witnessed unprecedented weather phenomena ranging from gigantic forest fires to flash and heavy floods and to extreme heatwaves. In addition to their destructive effect, these unpredictable events are disrupting supply chains. For procurement managers, it's like going back to the days of COVID-19 when it was impossible to keep the inventory needed to ensure production and meet demand. More and more, we see companies suspending their manufacturing activities while waiting to receive the required input materials.
Disruption is another key factor of supply chain transformation questioning the just-in-time procurement process.
Violent conflict has spiked dramatically since 2010 in several regions, and the fragile landscape is becoming more complex. Since the start of the COVID-19 pandemic, the world has seen a series of massive setbacks to stability in regions across the world: from Asia and Africa to Latin America and the Caribbean, and more recently in Eastern Europe. The war in Ukraine affects energy and commodity markets, and places further stresses on areas that were already fragile, such as Yemen and the Sahel.[ix]
Figure 5:???????? Humanitarian crisis in 2023[x]
As if this list of conflicts wasn't long enough, on October 7, the new episode of the Israeli-Palestinian conflict plunged the world into atrocity with a risk of regional escalation.
In addition to the human tragedies and precariousness that these conflicts create, they put governments on the defensive or in deterrence mode. Very often sanctions and embargoes are imposed which disrupt, among other things, trade and increase geopolitical tensions.
These tensions also translate into a race to monopolize or secure access to critical raw materials.
We only need to look at the measures taken by China, the United States, and the European Union to help their industries source critical minerals such as nickel, cobalt, lithium, graphite, and silicates and to benefit from the energy transition current.
Currently China dominates global critical mineral supply chains, accounting for approximately 60% of world-wide production and 85% of processing capacity. But the U.S., Canada and several European countries are taking steps to build out their own ability to mine, process, and manufacture critical minerals.[xi]
Let us look at two pieces of legislation adopted in the U.S. on August 2022, the Inflation Reduction Act, and the CHIPS and Science Act.
For these two bills, the intention is clear: increase national autonomy, promote the development of domestic supply chains, and foster private investments.
In the 12 months since the Inflation Reduction Act was signed into law the private sector has announced more than $110 billion in new clean energy manufacturing investments, including more than $70 billion in the electric vehicle supply chain and more than $10 billion in solar manufacturing.
The CHIPS and Science Act releases US$280 billion to support domestic technology industry in America (with US$76 billion earmarked for domestic semiconductor support). American semiconductor companies have already announced more than 40 new projects resulting in nearly $200 billion in private investments to increase domestic production.[xii]
领英推荐
In response to this massive injection of money south of the Canadian border, the Canadian government as well as that of Ontario and Quebec are attracting foreign investments by offering subsidies and other unprecedented forms of financial assistance.
Canada’s federal and Ontario governments have pledged subsidies of close to $C30 billion to entice Volkswagen and Stellantis to build electric-vehicle battery production facilities in St. Thomas and Windsor, Ontario.
Last May, GM and its Korean partner announced the construction of a factory in Quebec to manufacture lithium-ion cathodes for electric vehicles. This project will receive loans of $C300 million from the provincial and federal governments.
Last month Northvolt, a young Swedish company, announced the construction of a mega lithium battery factory in Quebec. Northvolt will be able to count on an investment of $C1.34 billion dollars from Ottawa and $C1.37 billion from Quebec.
To compete with the US Inflation Reduction Act “production incentives” will be available to Northvolt once it is in operation. These incentives represent another sum of $C4.6 billion — a third of which would be paid by the Quebec government.
It is not only governments that are participating in this race which is increasingly becoming a struggle. There are also some carmakers and billionaires. Bill Gates and Jeff Bezos are investing in mining in Greenland for graphite and in Zambia for cobalt. GM, Volkswagen, Tesla, and Mercedes-Benz are bypassing traditional suppliers and investing billions of dollars as well in mining companies.
Geopolitical tensions, access to raw materials and markets are the most important factor in changing supply chains.
Let us analyze one last factor which also contributes to change supply chains: regulation.
Starting in 2021, with the adoption in the U.S. Uyghur Forced Labor Act, we witnessed the introduction of a new paradigm in supply chain regulation: Moving from Self-Reporting to producing Diligence Statements.
The Uyghur Forced Labor Act obviously has a strong political dimension, but it introduces new requirements for manufacturing companies and importers: a due diligence duty throughout supply chains. It is a dramatical shift from the previous supply chain regulations. For example, the modern slavery acts adopted in California, England, Australia, New Zeeland, and this year by Canada include a duty to investigate and report, but not to issue due diligence statements. These legislations have proven toothless and ineffective and this why tougher legislations mainly in Europe, have lifted the bar.
New regulations were adopted this year applying the duty of due diligence and more are to come.
Companies must now demonstrate with supporting evidence that their operations and those of all the supply chains’ actors do not violate applicable human rights and environmental laws in the various legislations where they operate as well as international standards. Sanctions will be high for non-compliant companies and allegations made by third parties will have to be investigated. It will become increasingly perilous to operate in long, complex, and opaque supply chains.
To summarize, four factors are coming into play and cause major changes to supply chains and how they operate.
?Let us now analyze the main consequences.
In response to widespread disruptions in supply chains, many companies are analyzing their supplies and suppliers and making significant changes. Some have begun to bring production and suppliers closer to home to reduce complexity, increase visibility and ease delays. These measures are costly given the investments that these same companies have made in the past to offshore their production. Supplier diversification and inventory decentralization are also applied to increase resiliency.
Supply chain decoupling is the main outcome of this reorganization. This is currently happening in North America, across Europe and in South-East Asia. Production facilities and suppliers are brought closer to customers and consumers.
In addition to the governmental aid that we have mentioned, these structural changes are facilitated by technological advances aiming at reducing production costs and addressing labor shortage:
When asked about their intentions, many leaders of manufacturing companies indicate that they have already started, or plan to do so in the short term, the relocation of their activities near their markets. Geographic diversification to reduce risks as well as changes in their supplier bases are also part of their strategy.[xiii]
In an article published last June, the Financial Times gives the example of Nokian Tires, a Finnish listed company, and explain why they had to reorganize their production and supply chains.[xiv]
Around 80% of Nokian's tires were manufactured in Russia. And the country represents 20% of its sales. Low energy costs were the main reason to produce in Russia, but the invasion of Ukraine in February 2022 changed everything and significantly impacted their stock value. In January 2022, its price exceeded €34; currently it is below €8.
The company had already planned to bring its production closer to certain markets. In 2019, it opened a factory in Dayton, Tennessee. But now it was necessary to carry out a thorough reorganization and reinvest massively to restart production by 2025.
The factors and considerations that management studied before making its choice are interesting and support our analysis. There was, of course, the availability of industrial land and its cost, the cost of energy and labor, the efficiency of the transportation network and a business-friendly environment. But above all, there were geopolitical risks. Thus, certain countries were excluded because they were not members of NATO and the European Union, or too close to Russian leaders.
At the end of the process, six sites were considered: two sites in Romania, two in Poland, and one each in Portugal and Spain.
The choice ultimately fell on a site in Romania, near the Hungarian border, where 650 million euros will be invested to build the new Nokian factory. And although cheap Russian gas has contributed to the company's financial performance for several years, the new plant will be emissions-free to stop dependence on fossil fuels.
The case of Nokian Tires perfectly demonstrates why and how supply chains are changing.
These changes, repositioning and reinvestments will themselves have global repercussions:
Managing supply chain risks is becoming a priority to maintain business competitiveness. Diversification may not be as cheap as offshoring production, but it is much safer.
Are reshoring and decoupling a good thing?
Not necessarily. It is a reorganization whose main goal is to reduce disruptions and regularize the production of manufactured goods closer to the main markets. It seems that the big industry, at the opposite of the World Trade Organization, does not think that globalization is still a guarantee of resiliency.
However, this does not change the major problems we have such as climate change, increasing inequalities, and migrants. In addition to the repercussions mentioned above, this will undoubtedly increase the struggle and tensions to ensure the supply of critical raw materials on a global scale. Which is not good news at all as it will fuel global geopolitical tensions.
[i] World Trade Report 2021
?[ii] World Trade Report 2021
?[iii] IMF Blog, December 16,2021 ?? https://www.imf.org/en/Blogs/Articles/2021/12/16/the-worlds-top-recipients-of-foreign-direct-investment
?[iv] United Nations Conference on Trade and Development, World Investment Report 2023 ? ?https://unctad.org/data-visualization/global-foreign-direct-investment-flows-over-last-30-years
?[v] OECD
?[vi] Our World in Data ?? https://ourworldindata.org/co2-and-greenhouse-gas-emissions#global-emissions-have-not-yet-peaked
?[vii] World Resources Institute
?[viii] About 90% of Top-Polluting Countries’ Net-Zero Targets Unlikely to Be Achieved: Report, Martina Igini, June 12, 2023 ? ??https://earth.org/net-zero-study/
?[ix] The World Bank ?? ?https://www.worldbank.org/en/topic/fragilityconflictviolence/overview
?[x] ACLED Conflict Index: 2023 Mid-Year Update, September 8, 2023 ?? https://acleddata.com/2023/09/08/acled-conflict-index-2023-mid-year-update/
?[xi] GMF, Bonnie S. Glaser & Abigail Wulf, August 2, 2023 ??? https://www.gmfus.org/news/chinas-role-critical-mineral-supply-chains
?[xii] Chips, subsidies, security, and great power competition, John Edwards, Lowy Institute, May 28, 2023 ??? https://www.lowyinstitute.org/publications/chips-subsidies-security-great-power-competition
?[xiii] EY, Why global industrial supply chains are decoupling, June 2022 ??? https://www.ey.com/en_ca/automotive-transportation/why-global-industrial-supply-chains-are-decoupling
?[xiv] The New York Times, The Russia-Ukraine War Changed This Finland Company Forever, July 11, 2023, Patricia Cohen ??? https://www.nytimes.com/2023/07/05/business/economy/nokian-tyres-finland-romania.html
?