3 Lessons from COVID for Supply Chain Operations
A Quick Overview
Stories regarding COVID are rampant and its lessons on supply chains are only starting to be learned. Here, we’ll highlight 3 that have direct implications on supply chain demand planning and sourcing strategy. Why add to this discussion? Because if nothing else, COVID has focused the attention of EVERYONE on reviewing implications of a dramatic shock on the critical capabilities needed to protect, and for some even grow, one’s business. We often worry that many of these reviews are either too high level to be useful or too reactive to be prudent. So, the objective here is simple: Point out three lessons to “stress test” whatever decisions companies are making as they consider what new capabilities they need to not get “surprised” again in the future (because surprises are seldom a good thing) and what decisions need to be taken to (supposedly) strengthen their organizational and supply chain resilience.
With that, let’s go.
From health to supply to demand shocks; sounds like “the chicken or the egg” problem all over again
Clearly, COVID has had, and continues to have, a dramatic impact on GDP and considerable business impact (largely contractions) everywhere. Three key questions are:
1. What is the relationship between the health shocks (of the pandemic) to resultant supply and demand shocks?
2. Is the relationship a linear one from health first to supply and then to demand shocks?
3. Or is the picture more complicated than that such that the COVID shock will have a permanent or at least long-term transitory set of impacts on industries and workforces?
Companies are weighing in on one side or the other of this “permanent or transitory” question with complicated justifications underlying their answers. From our perspective, the answer to the question is simple: It’s both. And to the question of the priority of the relationship between the health shock to those of supply or demand, the answer, again, is both.
Having a simple way to explain how and why “both” is the answer to these questions has pragmatic implications on how supply chain strategies and demand planners “learn” from the sharp wake-up call that COVID has dialed us all into.
1. Ripple Effects — also known as “What you can’t see can get you.”
Here’s a non-surprise. Much as countries with trade relationships are dependent on one another, so too are industries dependent on other industries — e.g., outputs from one industry are consumed as inputs from another industry. A tariff imposed from one country on another catalyzes a ripple effect not only on the directly impacted country, but other trading countries with whom that country does business. Similarly, with industry and supply chain partners, a “shock” or risk exposure for one may have ripple effects throughout the network. The “thicker” the network, the greater the potential for ripple effects to be felt by many.
The adjacent figure depicts the degree of trade dependencies across countries. Both the x-axis and y-axis are made up of countries — the darker the color, the greater the dependency between them. (Source: Global Supply Chains in the Pandemic paper by Barthelemy, Huo, Levchenko and Pandalai-Nayar; IFM Conference on Extreme Events on Global Economies, November 6, 2020.)
In a similar vein, the following depicts the mutual interdependencies of a set of industries — either as sources of inputs or as customers of its outputs/products (with the darker again indicating the greater the dependency.) (Source: UNCTAD and World Bank Input-Output Table, ClearPrism Data Science Analysis).
For both, the point is clear — ripple effects exist across partners, industries and geographies. The degree to which they may occur, however, depends on three considerations:
1. The extent of the dependency — e.g., from a company, industry and/or supply chain perspective, or based on the degree to which suppliers and/or customers are “from” other companies, industries and/or locations;
2. The second degree of impact — i.e., a particular company may source from only a few other industries, but those industries, in turn, may source from multiple others, which creates an exposure on the company in focus if a shock impacts its Tier 2 partners (how you identify both this extended network and your risk exposure to it is the topic of a subsequent post); and
3. The degree to which any particular shock may trigger ripple effects — e.g., a heavy rainstorm may knock out the power in a particular location or say, the data center, of one of your partners, but the likelihood of that event having significant impact on your supply chain or revenue is low and (typically) easily contained. In contrast, more drastic events such as the COVID pandemic (as an extreme case) is systemic causing significant ripple or spill-over effects all over.
Insurance companies, particularly reinsurance companies, model such ripple effects pretty routinely as they underwrite risks they’re being asked to insure against. Often, they make a distinction between an initial “destructive cost” (of an event) and the “loss of economic output” as the result of ongoing performance impacts. In economic terms, the difference between a destructive cost and loss of economic output is one of “stock” versus “flow.” The full impact of any particular (especially severe) event is the combined total of stock and flow losses, with the latter typically being the most difficult to model and consequently plan for and mitigate. (Source: https://axaxl.com/-/media/axaxl/files/optimizing-disaster-recovery.pdf)
And, here it gets interesting.
Risks to one’s supply chain always exist, but a key question is which ones actually “matter” in terms of the likelihood of impacting you directly… and indirectly through ripple effects sourced elsewhere — from locations, partner networks, and even other industries. Another is: what are the specific impacts of the ones that “matter” on your organization’s SPECIFIC capabilities and KPIs?
For now, the point is pragmatically simple: Being able to answer both of these questions is a critical (new?) capability to strengthen your organizational and supply chain resilience. Resilience is often characterized as the capability to respond quickly ONCE a “bad thing” has happened. That’s a fine start but is hardly enough.
It is critical to have the foresight (i.e., predictive insight) into the potential sets of risk exposures and their implications on specific capabilities, partners, locations and KPIs. The combination of “responding quickly” and having “foresight into” is what creates dynamic resilience — and need to become part of the quiver of the demand planning and sourcing toolkit.
2. You have both less and more control of your path forward at the same time — a.k.a., the “whack-a-mole” lesson
COVID requires responses, clearly. Yet, as we have all learned, decisions made and actions taken also trigger responses from others, and those responses, in turn, can lead to subsequent ripple effects. The degree to which you have “agency” depends on a variety of factors, including your degree of “connectedness” that creates exposure to ripple effects from others.
Which helps to explain why a number of organizations — and countries — are rethinking their sourcing strategies. Should we pull back from our dependence on China? Should we pull back from globally dispersed locations? Should we restructure our partner network depending on their locations? And, as some policymakers are thinking aloud, should we go so far as to nationalize critical supply chains to reduce our exposure to both the existing COVID pandemic and yet unknown, but certainly expected future shocks?
Aside from the “being late to the game” or the “shutting the barn door after the cow has fled” adage, discussions of nationalization and sourcing “pull-back” are understandable… but blunt (in the sense of too broad) and, as such, could use some refinement.
Let’s start with the nationalization of the supply chain discussion, and then consider its implication from a global sourcing perspective — because the logic is similar.
Clearly, GDP has contracted significantly due to COVID globally. The graph below summarizes country-specific GDP retraction as of November 2020. (Source: Bonadino, Huo, Levchenko and Pandalai-Nayar, IMF Conference November 2020)
Now, take a look at the following projection of GDP contraction if countries nationalize their critical supply chains. (Source: Bonadino, Huo, Levchenko and Pandalai-Nayar, IMF Conference November 2020).
There is one key point and one key implication to highlight based on the above.
The point? There is no hiding from “ripple effects.” Ripple effects do and always will exist across industries, workforces and locations.
The issue is: What are the sources and extent of potential exposures and ripple effects? If you nationalize, you move the sources of potential ripple effects from trading partners (other locations) and how well they are mitigating risks to how well you are.
You can change your hand position and grip on a balloon in an effort to control and contain it, but parts of the balloon will still, stubbornly pop out somewhere. Or to use a different analogy, it’s like whack-a-mole. You respond to a mole popping up in one part of your garden and it pops up in another.
The same applies to tariffs on a particular industry or location. And it equally applies to your sourcing strategy — and changing that strategy with respect to the types of partners you engage with, the products you need from them, and the locations from which they and your other materials are sourced.
The implication? You have agency, of course. You decide your course of action. But agency doesn’t mean control. Every decision made and action taken has implications on others. Similarly with others and the decisions they make and actions they take — with ripple effects on you.
There are “constraints” and “opportunities” within every event — or shock — of relevance to you. That’s what strategy is all about…figuring out where to play and how to do so under different conditions.
The old game of GO well characterizes how effective strategy — and execution — plays out. In GO, a player (you, the decision-maker) “plays” in different parts of the board at the same time. The objective remains the same: “Win the game.” How you play the game, however, depends on how effectively your moves are in different parts of the board.
Sounds like what we do in the business world every day, yes?
So, the implication becomes: you *can* play “one part of the board” — e.g., nationalize your part of the global supply chain, change where you source your materials, etc. — but only at the cost of being surprised by what’s going on in other parts of the board (or competitive landscape)
Pragmatically, what do you do? Obtain the ability to monitor events, the hundreds of thousands of activities that could impact you, globally. Doing so is vital to identify, predict and thereby more effectively design how to respond based on action and potential ripple effects from others.
3. Granularity matters
McKinsey estimates that 16 to 26 percent of exports, worth $2.9 trillion to $4.6 trillion in 2018, could shift over the next five years as a result of systemic supply chain risk — whether that involves reverting to domestic production, nearshoring, or new rounds of offshoring to new locations. (Source: https://www.mckinsey.com/business-functions/operations/our-insights/risk-resilience-and-rebalancing-in-global-value-chains)
Interesting perhaps, but useful?. To be truly valuable, we need to know more.
What we do know is that the consumer price index fell overall between February and April 2020. That it fell from 1% to a negative value reflects a significant demand shock: in aggregate, folks purchased less given the dramatic amount of uncertainty due to the pandemic.
We also know that consumer spending has changed dramatically, and again, in aggregate, has yet to recover. In the United States, as of late October 2020, total spending by all consumers decreased by nearly 4% compared with January 2020.
(Source: https://www.imf.org/en/News/Seminars/Conferences/2020/11/05/2020AnnualResearchConference)
But these aggregate pictures masks significant differences by sector.
And here it gets interesting, again.
Prices rose in some areas, such as food and health, but fell significantly in others, including auto insurance and airline travel.
The point?
As much as COVID was and remains a systemic shock that impacts everyone, every business, everywhere, it does so differently. What specifically those differences are, and what drives them, really matters. To not get insight into them is competitively unwise. Granular insights into the extent to which your shocks are health, or supply, or demand-driven, or more likely, a differing combination of these, is important — assuming that “organizational resilience” and “competitive advantage” are more than just buzzwords.
So what and a call to action:
COVID has reminded us what we already know, but more so.
Events happen; risk exposures change; opportunities emerge — all of which require not just insights and capabilities to respond quickly to them, but also the foresight into what these shifts are — and what they mean to what we do, where we do them, the partners we engage to support us, and how we mitigate them as risks or exploit them as opportunities.
Such foresight, from an event monitoring perspective, into:
1. Identifying and amplifying faint signals of potentially high impact events of relevance to us;
2. Quantifying risk exposures and economic opportunities catalyzed as a result; and
3. Clarifying and thereby reallocating our capital and resources to move quickly…
… becomes something many have discussed, but lots fewer have implemented — until the wake-up call that has been and will continue to be COVID and other systemic shocks that follow.
One final point. The ability to:
· Amplify faint signals;
· Identify the ripple effects;
· Understand/model the different parts of your strategic execution plan and its implications on others; and
· Inform your high-level plans with highly granular insights…
… can be executed by any industry, at any size. It no longer requires the expense and time of high-priced consultants. Rather, the analysis can be set up, run and monitored, and enhanced, powered by algorithmic insights and hosted platforms… a topic for another post.
About the Author:
Ralph Welborn, Ph.D. Managing Partner and Co-Founder, ClearPrism
Previous roles included Head of Strategy & Transformation (IBM — Middle East / Africa), Senior Vice President Global Strategy, KPMG Consulting, CEO of Advanced Analytics Company. Author of three books on Business & Technology Transformation.
Ralph can be reached at ralph.welborn@clearprism.com
