A chain is only as strong as its weakest link

The COVID-19 epidemic has mercilessly exposed the weaknesses in the supply chains of many large enterprises. However, in recent years there have been other cases that should have prompted the companies to change.
A chain is only as strong as its weakest link

(Steve Jurvetson, Mike Bird, CC BY-SA 4.0)

“There is already evidence – although unconfirmed – that supply chains are being disrupted, including outside China”, the Moody’s rating agency has stated in the notice published in mid-February 2020. This cautious statement appeared already after car manufacturers started announcing that they would be forced to reduce or suspend their output due to interruptions in the supply of production components.

It all started in South Korea

“We are safe for this week and we are safe for next week. In the third week we have parts missing”, said, in mid-February 2020, Ralf Speth, the CEO of Jaguar Land Rover (JLR), the largest manufacturer of passenger cars in the United Kingdom. The JLR company claims that there are primarily European and British companies in its direct supply chain and the percentage of deliveries from China is small. “The coronavirus may affect us in the medium term, we are working with our suppliers to minimize any potential effects”, it was said in the company’s statement. Meanwhile, Mr. Speth acknowledged that some parts were brought from China to the United Kingdom in suitcases. The company stopped the production in its British factories by the end of March, and plans to resume in April.

JLR is not unique in this regard. While its boss was informing of critically low level of inventories, Fiat Chrysler Automobiles (FCA) revealed that due to a shortage of components for the audio systems installed in Fiat 500L vehicles it would suspend their production in the Serbian factory in Kragujevac, as well as in Tychy in Poland. Due to the shortages of parts from China, as well as the spread of COVID-19 the company stopped all production in Europe. The spokesperson for FCA assured that the company was looking for manufacturers who would supply the lacking components. In its statement FCA said also that „The Group is working with its supply base and business partners to be ready to enable our manufacturing operations to deliver previously planned total levels of production despite the suspension when market demand returns.”

Before the production of cars was first interrupted in Europe, production stoppages had occurred at the local plants of South Korean automakers, and at Nissan’s plants in Japan. This was also due to supply chain disruptions. Nissan openly indicated that in addition to the Japanese plants its factories located in other countries could also halt production. This happened in Malaysia, UK, Spain and the US.

All the companies that discontinued production were suffering from a shortage of car parts manufactured in China. Their production was supposed to be launched on January 24th, after the end of the holiday season associated with the Chinese New Year (also known as the Lunar New Year). However, due to the COVID-19 pandemic production was not launched, and its scale, despite slow recovery in China, remained significantly reduced. Moreover, there was also a shortage of parts produced in other Asian countries by suppliers who were purchasing their components in China.

The search for substitute suppliers has been difficult. Ever since the interruptions in production were announced in early February, the South Korean companies have been repeatedly informing of the resumption and then — another suspension of manufacturing activity. This has been associated, among other things, with the shortage of cable assemblies manufactured in China.

The South Korean media have pointed out that in the case of Hyundai Motor, this has been the first suspension of production on all assembly lines since 1997. Back then the reason for the suspension was the financial crisis in Asia, which began in South Korea and caused a production interruption at the company Mando, of the Hyundai supplier.

The South Korean government has responded very quickly to the difficulties faced by the local automotive companies. It supported the enterprises in their efforts to persuade Chinese authorities to resume production at the local factories. Additionally, the authorities in Seoul announced the simplification of the rules concerning the imports of car parts from Vietnam, Cambodia and the Philippines, the introduction of subsidies for local car parts manufacturers, including loans for the expansion of production lines, as well as the allocation of public funds to support research and development projects.

Automotive industry is based on Chinese components

It is not surprising that the automotive industry is the first manufacturing sector which started to feel the impact of the coronavirus epidemic on a large scale in the factories located outside of China.

According to analyses carried out by Fitch Solutions Group, across the world there are virtually no car factories that don’t use components from China. The lowest shares of Chinese parts used in production are found in plants located in Argentina and Namibia (up to 5 per cent). In many countries of Western Europe and in Canada, this share reaches up to 10 per cent. Poland is in the group of countries where the share of Chinese component used in production is estimated at 10 to 30 per cent.

The average vehicle consists of 30 thousand components. This is about 100 times more than the number of parts in a smartphone. Nissan’s vehicles contain more than 800 parts produced in the Hubei province. The Hubei province, and its capital city of Wuhan (where the first coronavirus cases were detected), are one of China’s largest automotive clusters. According to the research company Digitimes Research, more than a thousand significant suppliers of vehicle components have plants in that province.

In China the supply chain of global automotive corporations often begins with small and medium-sized enterprises (SME). According to the latest official statistics, such entities represent 99.8 per cent of all Chinese companies. They are responsible for 79.4 per cent of total employment and generate more than 60 per cent of China’s GDP and more than half of all tax revenues.

In a survey carried out in early February 2020 by the Tsinghua University and the Peking University, 85 per cent of SME reported that they only had enough funds to survive — that is, to pay the rent, workers’ salaries, taxes, interest on loans, etc. — for no more than three months.

Risk for others

According to estimates prepared by Dun & Bradstreet, a company specializing in the collection and analysis of information about businesses, the suspension of production activities or a decrease in production in the Chinese provinces affected by the COVID-19 may have a direct or indirect impact on the 5 million businesses worldwide, including 938 companies from the Fortune 1000 list, that is, the world’s largest corporations. The data provided by Dun & Bradstreet indicate that approximately 51 thousand companies in the world have one or more important direct suppliers located in regions of China affected by the coronavirus.

Experts warn that the scale of the problem will continue to grow along with the lengthening of the period of limitations in the production in China. According to Moody’s, if the coronavirus epidemic is under control by the end of the first quarter of the year and normal production is resumed in the second quarter, then it will result in the reduction of global GDP growth by 0.2 percentage points, to 2.4 per cent. Delaying the above dates by three additional months will reduce GDP growth by approximately 1 per cent.

Possible problems with semiconductors

The COVID-19 pandemic carries a potential risk for the production of semiconductors. For the time being there are no problems with deliveries, and additionally — according to the research company Omdia — there are high levels of stocks in the supply chain. “The disruption of supply chains could have a snowball effect if the stocks of basic electronic components from China are exhausted,” warn analysts at the ING bank.

For now, production at China’s semiconductor factories continues. This also includes the manufacturers whose factories are located in the Hubei province, such as Tsinghua Unigroup. Due to the high costs of resuming the production, it was not suspended even during the holiday season.

Companies manufacturing silicon wafers, which are used as a substrate for the production of DRAM and NAND memory chips, is highly concentrated. According to the calculations of the research company IC Insight, the top five manufacturers account for 53 per cent of the global production capacity. For comparison, 10 years ago the top five companies only accounted for 36 per cent of the global capacity. The production facilities of the South Korean companies, Samsung and SK Xynix, are located in China. They are nearly one-fifth of the global production of silicon wafers, and also have production plants in South Korea. All the remaining major players — the Taiwan-based TSMC, the United States-based Micron Technology and the Japanese company Kioxia — have at least a part of their production of silicon wafers located in the countries that have recorded major outbreaks of the pandemic. The production of TSMC is mainly located in Taiwan, Micron has a factory in Singapore, while Kioxia has a production plant in Japan.

Supply chains disrupted due to transportation difficulties

The resumption of production in China is not sufficient on its own. There may also be problems with the deliveries. Such difficulties have already been faced by Samsung. Some time ago, the South Korean company moved the production of its smartphones from China to Vietnam and Thailand. Samsung’s main suppliers followed. It would seem that the South Korean giant is in a comfortable position. However, some of the components are still manufactured in China. While these parts are still being produced without any interruptions, Samsung had problems with deliveries from China to Vietnam. The drivers of trucks entering China had been subjected to a mandatory 14-day quarantine, and then the land border between the two countries was completely shut down for over a dozen days. In order to avoid problems with land transport, Samsung decided to use more expensive air transport.

The effects of the coronavirus are already being felt by the sewing factories in Vietnam, Cambodia and Myanmar, which produce garments for brands such as Uniqlo, Tommy Hilfiger, Gap and Nike. Even up to 60 per cent of the fabrics used by these factories are manufactured in China. The imports of these textile raw materials were suspended due to the closure of the borders.

According to Søren Sou, the CEO of Maersk, which is the world’s largest maritime transport company, the situation at the port terminals in China was very bad. “We are experiencing huge pressure at (Chinese) terminals because there aren’t enough workers at the ports to move the containers around, not enough truck drivers to move the goods, and no one to receive them at the factories or warehouses”, said the head of the Danish logistics company.

Supply chain disruptions have happened before

The disruptions in the supply chains caused by the coronavirus are not an isolated phenomenon. In recent months and years, there have been many other cases that — at least in theory — should have got the companies’ departments responsible for procurement and logistics to carry out deep risk analyses, to assess potential costs or losses, as well as to introduce some changes, such as increasing the number of suppliers and their geographical diversification.

For example, in February, it turned out that the global production of vinyl records is at risk. This was due to a fire in California that burned down the Apollo Masters factory manufacturing the lacquer used in the production to cover vinyl records. That factory supplies 90 per cent of the world’s demand for the lacquer. The only other lacquer supplier in the world is the Japanese company MDC. Although vinyl record producers claim that MDC is ready to increase its production, it certainly won’t be able to meet the overall global demand. Additionally, it is also possible to change the vinyl record production technology to one where the use of lacquer is not required.

The production of memory chips used in electronic devices was also threatened in July 2019. This happened after Japan removed South Korea from the list of preferred exports destinations as a result of political disputes relating to the issue of compensations for World War II. New requirements were introduced pursuant to which Japanese companies manufacturing two chemical substances used in the production of DRAM memory chips and NAND flash memory chips must obtain special export permits — which takes up to three months — before they can supply them to South Korea. So, the South Korean companies tried to build up inventories and search for alternative suppliers. This was not easy, however, because Japan is responsible for majority of the global production. The situation on the memory chip market was only alleviated by the large stocks of finished products.

When the South Korean car companies reported their problems with the supplies of parts from China a few weeks ago, the representatives of the German automotive industry claimed that they have learned their lesson regarding supply chain resilience following the earthquake and tsunami in Fukushima in 2011 and 2016.

The cataclysm in Fukushima in 2011 disrupted, among other things, the supplies of a pigment used in car paints and supplies of some parts and components, such as the diesel-engine sensors manufactured by the Hitachi company. As a result, many carmakers in Europe were forced to reduce their production. This included the PSA Peugeot Citroen plants in France and Spain as well as the Opel factories in Germany and Spain. In this case, the lesson that the German automotive industry derived from these events included, among other things, the necessity of ensuring geographical diversification of suppliers and increase in the inventory levels at the factories.

However, according to media reports, due to problems with the supplies of batteries Audi was forced to limit the production of e-tron electric vehicles made in Belgium. It was indicated, however, that these difficulties were not due to the COVID-19 epidemic but resulted from problems with the production of batteries at the factory of the South Korean LG Chem company located in Poland. The same problem was encountered by JRL whose Austrian plants produce the electric vehicle Jaguar I-Pace, which is promoted as a potential competitor to Tesla Model X.

Going back to the beginning of the previous decade, it’s worth mentioning the flood in Thailand in October 2011, which affected an industry cluster responsible for 40 per cent of the global production of hard disk drives and up to 70 per cent of certain components for hard disk drives. The floodwater inundated the factories of hard disk drives manufacturers such as Western Digital, Seagate and Toshiba, as well as many of their sub-contractors. The destruction of the Thai factories resulted in an increase in the prices of hard disk drives, a drop in the production of computers, and, consequently, also a decline in the demand for semiconductors and other components.

The same flood also led to production disruptions at the Thai factories of Toyota, Nissan and Honda, while its effects were felt by factories across Asia, South Africa, North America and Europe. Importantly, only the Honda plant was flooded. The remaining factories suspended their operations due to the flooding of important transport routes as well as factories supplying them with components.

(Steve Jurvetson, Mike Bird, CC BY-SA 4.0)

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