Supply chains are complex, interdependent systems with multiple stakeholders and actors; all significant shifts are systemic. In the immediate aftermath of 9/11 attacks, airports and ports across the United States were immediately closed. This interruption to cargo movement led to weeks of disruption in cargo capacity for both sea and air routes. Facing evolving security risks, US Customs and Border Protection and the newly-established Department of Homeland Security designed new protocols, and exporters across the world had no choice but to comply. New operations standards catalysed, in turn, new approaches to global cargo movement.
Supply chain disruptions are not exceptional, per se. They take place daily, given the multitude of factors that impact a supply chain. But when disruptions are systemic, like those which followed 9/11, an adjustment process is universal. In such a situation, there is a direct impact on the flow of goods and cargo carrying capacity, but also on the data flows and information that need to be shared across the chain. And, of course, cost parameters go through changes of a similar magnitude.
Since the late 1980s, as models of shop floor efficiencies became the driving force of cost optimisation, ideas such as ‘just in time’ (JIT) manufacturing and postponement led to a singular focus – cost rationalisation. This intense focus on cost efficiencies in supply chains led companies to seek locations where they could arbitrage labour and capacity. Given its ability to provide these leverages, China became the “factory for the world”. Companies started developing single source supplier relationships with key contractors spread across just a few provinces in China. As years passed, these supply chains became more intertwined and integrated. The cost reduction focus brought in reduced inventory buffers, increased demand for shorter delivery windows and therefore shorter lead times. The logistics providers responded to market needs, and large mother ships with capacities of 10,000-plus containers became a norm. In an effort to keep the freight rates low, massive manufacturing of containers took off in China, just to keep the supply steady. Few thought about the vulnerabilities this introduced to businesses; risk assessments that pointed out supply disruptions were largely ignored.
The Trump administration’s confrontational trade tactics brought a few mild shocks to established global supply chains between 2016-19. Even though a full-blown trade war between the US and China would have serious ramifications for global supply chains, it was thought that these tensions were transient and that a systemwide change was not warranted. But with the advent of the Covid-19 pandemic, the risks inherent to skewed supply chains became real and present. The shutting down of Wuhan in the middle of January 2020 sent shock waves across global supply chains. Up until then, more than 200 of the Fortune Global 500 companies had a manufacturing presence in Wuhan. According to research released by Resilinc, a company that maps global supply chains, at the beginning of the pandemic in February-March 2020, the world’s top 1000 companies owned 12,000 facilities in Covid-quarantined areas in China, Italy, and South Korea[i].
The pandemic opened a Pandora’s box of the vulnerabilities that had lain concealed for decades. As the virus spread across the world, the dependencies in supply chains came apart, thwarting the movement of cargo at an unprecedented scale. This acted as a wake-up call for Western firms about their reliance on a single country for carrying on business as usual. There was a commotion of sorts in aligning supply chains to reduce risk. In the aftermath of the pandemic, China’s geopolitical posturing increased the concerns in boardrooms across the world. Companies that were only thinking about reducing their dependency on China until then, in earnest began to look for alternatives. This further rattled the regime in China and a large scale systemic disruption came to pass.
Months of desperate attempts to relocate suppliers in the midst of the pandemic have not been easy for multinationals across the world. Decades of close partnerships had created a certain comfort and reliability with suppliers both at the tier-1 level through direct sourcing but also at tier-2 level with indirect sourcing. Additionally, the cascading impact of airlines grounding aircrafts with no plan for resumption of operations, and ports shutting and opening seemingly at random across the globe led to supply-side constraints in cargo carrying capacity on both sea and air routes. This led to a cost shock to the system and eroded some or all of the cost efficiencies achieved over decades.
The figure[ii] below shows the trend of spot prices of containers since 2016. Container freight spot prices rose another 5% in August 2021 and contract rates are also increasing, with the average up 6-9% in just four months. Large companies tend to have some buffer to bear such steep price increases, but medium, small and micro businesses have not been able to adjust to this price rise. Many have stopped exporting or importing, have delayed shipments, or have been forced to renegotiate their contracts.
Sea freight costs from China to the US have gone up to as high as USD 12,000 to USD 18,000 per container. Ex-India sea freight rates to the US which were approximately USD 2,500-3,000 per container are at USD 10,000-13,000 per container. The shipping rates are almost 360% more than they were in early 2020. In addition to reduced sailing capacity, there is also an acute shortage of containers. Even after paying high freight rates, there is no reliability of vessel schedules or sailing commitments at ports across the world.
Alternatives to sea routes are scarce and cannot be used for all products. Air cargo is a more limited option. It is never easy for companies of any size, unless their products demand a certain price premium in the market, to use air routes for regular supply chain deliveries. And with the airlines not being able to manage crew or flight turn-arounds due to pandemic protocols, air freight rates have also increased significantly.
In the figure [iii] above, we can clearly see how the air-cargo capacity drastically fell in Jan-Apr 2020. This capacity has not recovered fully to date even though freighters have shown steady performance and airlines have used passenger space to carry cargo. The resumption of a pre-pandemic schedule of flights is still a long way off. Therefore, a massive disruption in global supply chains is underway, with businesses and nations trying to adjust to a new way of doing business, with a sort of blame-game between the West and China as participants debate who is responsible for the unravelling of the global trade system.
There can be no doubt that China is an important actor, but to assign it the role of the sole trouble maker would be naïve. The Chinese have perhaps seen the supply chain substitution coming before others have. Over the past decade the leadership in Beijing have implemented policy changes to increase domestic demand and drive manufacturing to interior regions. The figure[iv] below gives an indication of how even during and after the pandemic, the value share in consumption of fast-moving consumer goods (FMCG) products in Tier 4 and Tier 5 cities continued rise.
There is also an interest from the Chinese side to move away from labour-intensive manufacturing, as costs have been increasing steadily in China’s major manufacturing hubs. Global supply chain and procurement managers have seen this trend for a few years now. A survey conducted in February-March 2020 by Gartner [v] found that 33% of supply chain leaders had already started moving out of China or were planning to do so by 2023. And the Covid-19 pandemic was only one of the reasons for them to do so.
However, a knee-jerk reaction of rapidly shifting supply chains would not only entail job losses in China but also likely lead to massive increase in costs and decreased efficiency in the global trade system. For the West, there are options to move some of the manufacturing to other countries in the region, such as Vietnam, Bangladesh, India, and Sri Lanka. But these countries do not offer the complete package of scale, cost efficiencies and supplier reliability that the Chinese can in normal times provide. To deal with this problem, some Western companies are exploring manufacturing closer to their markets; but that is proving to be inefficient from a labour and input cost perspective. Therefore, decoupling from the trade system currently established may be costly for both China and the West.
The question arises of how best to proceed in the context of rising global cost of trade and supply chain dependencies. Is there a way to mitigate this risk, and how can companies and countries prepare for such eventualities? There are some systemic issues here that need correction, without which global supply chains will continue to remain vulnerable. In this, China’s role and its understanding is as important as are the short-term actions and long-term strategies adopted by the West. To think that only geopolitical confrontations can compound supply chain risk would also be incorrect. With climate change, the after effects of the pandemic and the increased security risk to data, supply chain disruptions at a systemic scale may become more frequent.
If we apply a systems approach to the current conundrum of supply chain dependencies and resilience, we can identify the actors and levers of change and can devise an approach which does not create global imbalances or regress human wellbeing. We will need an agile and rules-based framework to devise such an approach. The current framework of tariff driven negotiations, subsidies and recognising product origin may not serve our future needs. Mechanisms such as the WTO will need to incorporate services and data flows and the new age supply chain practices of value addition and assembling. The current system of trade, driven by who makes and who buys and at what price, is perhaps too simplistic for emergent needs of business which rely heavily on cooperation, transparency and shared objectives at global scale. Resolving the current trade tensions between the West and China will be possible only if we expand our thinking in terms of what we understand by competition and cooperation. An approach where we clearly identify areas of collaboration, co-creation, convergence, competition and conflict is the need of the hour.
We know that when it comes to solving issues of societal development and human wellbeing there is an opportunity for collaboration with China. There are successful models both in the West and in China from which other nations can benefit. The West will also need to collaborate with China on innovations and ideas to mitigate the risks of climate change.
In areas of global scientific advancement in fourth industrial revolution technology and products, China has shown leadership and the West must not work in the shadow of the Cold War but find new ways to co-create some of these advancements. In matters such as counter terrorism, there can be opportunities of convergence despite the difference in approach.
Competition will always be there. China may have outmanoeuvred many to secure its “monopoly” across several supply chains, but quite a few smaller nations like Bangladesh and Vietnam have shown how they can partially replace many of China’s advantages. If the West does consider the prospect of Chinese monopoly of supply chains as a threat, then the West must also own up to its part in precipitating this situation to meet its own limited needs. The key is to not repeat the same mistakes with others.
When two divergent systems of political thought manage to get equal prominence in influence over global issues, there is bound to be tension. This is unavoidable but can be managed, so long as China recognises that a peaceful, multilateral global order is also in China’s interest, that it has a role to play in maintaining global peace, and that it needs to avoid active and passive aggression with its neighbours as well as with those it considers to be future competition.
Last but not the least, as supply chain managers are proving, gradual change and substitution is possible. If manufacturing from the US could shift to China and from China to Bangladesh, it can shift somewhere else too. The objective of the global trade system is to deliver cost-efficient, good quality products to global consumers; confusing nationalism with this goal, whether in an America First approach or No One But China approach will result in systemic failure.
In short, globalisation requires a framework of understanding. This understanding involves accepting that there will be competition between an assertive China and a defensive West, and trade will be used as a geopolitical weapon. But such weaponisation of trade will have the potential to drive nations and entire regions into economic downturn, precipitate poverty and threaten global peace. To prevent this is in our common interest; and to succeed in preventing it, we will need to create more interdependencies rather than fewer dependencies.
Ms Bhairavi Jani is a fourth-generation entrepreneur, developmental enthusiast and an avid philanthropist. She is the Chairperson and Founder of IEF Entrepreneurship Foundation and Executive Director of SCA Group of Companies founded in 1896.
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