Potential impacts on supply chains from the global COVID-19 pandemic

This article originally appeared in BCR’s World Supply Chain Finance Report 2021 and is reshared here on Insights. You can download the World Supply Chain Finance Report 2021 here.

Real economy crisis

Richard Hayes, Head of Working Capital Advisory at Nordea

The COVID-19 pandemic has been a multifaceted and evolving crisis. It certainly is not the first global crisis or pandemic, but what has made it unique is its fluidity and impact in a time when the global economy is so interconnected and dependant. Unlike the global financial crisis, this is a crisis which has not been founded in the financial sector but the real economy. It has and continues to be both a supply and demand crisis, and as cases of the virus ebb and flow around the globe the impacts continue to change and impact businesses differently based on their location.

Those impacts on business have been real and very visible with certain specific sectors being impacted severely, such as travel, hospitality and retail. It is likely that in the medium-term the challenges these sectors face will continue, despite the anticipated roll out of vaccination programmes.

For treasuries and supply chain professionals, systemic supply chain shock isn’t a new phenomenon. SARS, the tsunami in Japan in 2011 and flooding in Thailand occurring in the same year all stretched supply chain resilience. What makes this systemic shock unique is the level of interconnectivity and integration of global supply chains, which are now more intricate and globally dispersed than ever.

The move from in-house production to sourcing, generally at the lowest cost, has resulted in a myriad of suppliers and sub-suppliers connected together to enable complex products to be assembled. Even products with relatively few components have evolved to require multi-layered supply chains of one kind or another. It is therefore inevitable that a systemic shock of the magnitude of the COVID-19 pandemic will have impacts on how supply chains are structured and operated in the future.

In the Nordics we have already seen the initial impacts of the COVID-19 pandemic on corporates. The WTO indicates that global container throughput is down 20%, and the number of new export orders down 40%; Nordic companies have been heavily impacted as well. Nordea’s analysis indicates that Nordic corporate revenues are down 7% compared to 2019 interim reports, with Sweden and Norway’s heavy industrial and commodities industries taking the biggest hit. When comparing the second quarter results to the first quarter, a 3% decrease in revenues is seen. Although it is too early to tell, this may well indicate a ‘W’ or ‘V’-shaped recovery of the Nordic economy.

Besides decreasing revenues, operating profits are struggling as well. The average operating profit for Nordic Companies fell 21%, with Sweden seeing the largest decrease of 28% compared to 2019’s half year results.

With decreasing revenues and margins, the study also reveals a slightly increasing level of networking capital. The development is mainly due to a fall in trade receivables, as companies are struggling with sales. Furthermore, a small increase in inventories has been detected which would be a sign of a potential recession under normal trading conditions.

Aim for full visibility

Early in the crisis, the sudden halt in manufacturing and decreased availability of raw materials plus restrictions to international trade left companies supply chains suddenly vulnerable in all sorts of unexpected areas. In order to ensure they are more resilient to a sudden change in business conditions in the future, companies will need to fully map their supply chains to ensure extensive visibility.

In many corporate supply chains, professionals and buyers have good visibility of their primary suppliers and their financial health, but they do not necessarily have visibility further along the supply chain into their secondary and tertiary suppliers. It’s only really once a company understands what their full set of supplier’s suppliers are doing and how they’re performing that they can gain the necessary insight, set and analyse key risk KPIs and understand early warning signs of stress. This should then position them to understand where system pressures are building that could subsequently disrupt manufacturing in the future.

Vehicle production provides a good illustration of the challenges faced in controlling supply chains. It might be possible to manufacture 90% of a car, but if you cannot source the steering wheel assembly, then you have not got a finished product to sell. The manufacturer of the key steering wheel components might actually not be a primary supplier, but a secondary or even tertiary supplier where your visibility is limited.

Methods for ensuring improved visibility of the supply chain includes better use of data analytics to fully map interconnectivity and reliance between suppliers in the production network. Also, a more focused approach in understanding supplier relationships is recommended, even if buyers and sellers do not directly interact as the next primary step on the supply chain.

Increasing knowledge of the downstream supply chain means using data not only to predict your own sales, but to predict your customer’s customers sales, as this will of course influence you with regards to ordering volumes and sales forecasts. As companies move further from offline to online sales as a resilience measure, more enhanced and relevant data becomes available to assist planning, meaning companies need to be increasingly mature in their thinking and approach.

Evolutions in supply chain financing can certainly provide much-needed support to suppliers further down the supply chain. The market is beginning to look more into opportunities around purchase order (PO) discounting, which provides much needed working capital earlier in the process. Tokenised SCF is another interesting topic which will continue to gain traction and pace as a result of the COVID-19 pandemic. Data held securely in a DLT environment allows suppliers to discount some or all of a token, passing the rest further down the chain to provide needed working capital to secondary and tertiary suppliers.

A rise in supply chain costs?

As businesses look to recover and grow when the global economy begins to emerge from the pandemic, it is likely that many companies will carefully examine their sourcing processes to establish whether there is the possibility of increasing the diversity of their suppliers. The early stages of the pandemic showed that a heavy reliance on China caused significant production delays. China no longer simply assembles products; it manufactures the components to go in them to further increase supply chain risk and interconnectivity, whilst creating a potential new bottleneck.

The early stages of the pandemic helped illustrate that supply chain concerns are not just limited to those who directly manufacture from—in this example—China, but that disruption could be felt by those companies whose raw materials are trapped in China too. For example, a significant proportion of the factories in Bangladesh source raw materials from China. The drive to establish lean, just in time, low-cost supply chains come with clear inherent risks at times of global systemic shock.

There is clearly a significant dependency on China and this is likely to continue, but it is also likely that we may begin to see buyers looking at a China plus one or China plus two country strategy, to provide more of a hedge for future systemic shock. We often find (particularly around the more complex technology types of manufacturing) companies already operate a China plus Vietnam, China plus Indonesia or China plus Thailand supply chain model, and this is likely to increase in importance. These countries are already established as large hubs for the more sophisticated sorts of manufacturing, and it is probable that we would see a broadening out of the China plus one or plus two strategy to diversify future supply chain risk.

Complementing a China plus one or two strategy is the emerging trend of nearshoring. It is unlikely that we will see a movement of full production back to destination markets, but it could well be the case that in Europe, for example, areas such as southern and eastern Europe or Turkey see an increase in manufacturing because of the pandemic. Transferring production closer to destination markets in theory offers added protection against supply chain risks.

Closer to home

European national governments have deployed extensive support packages for their economies in collaboration with regional bodies, which means they will be looking to encourage more value with manufacturing to be transferred to Europe. With increased government support for national industry sectors, there may be added incentives for producers to manufacture finished goods and components nearer to home.

Support packages have built up both corporate and government debt, so we will very likely see measures put in place to enable national economies to grow themselves out of their debt burdens. There will of course be a strong incentive to create growth within the European Union, which supports the argument for bringing employment and growth to Europe as a natural consequence of addressing the COVID-19 problems within the national economies.

Any potential diversification of sourcing markets and increased focus on markets nearer to destination is likely to have a subsequent knock-on impact on cost. Businesses have undoubtedly seen an increase in costs due to the COVID-19 pandemic; costs of imports and exports across borders have increased due to factors such as additional inspections, reduced hours of operations, border closures and lack of transport capacity, etc. These cost increases can include the investment that is required to bring additional countries and sites into supply chains alongside or instead of China.

Companies considering near shoring will also experience cost increases as a result of these decisions. In recent years, many companies have pursued a form of cost arbitrage as they try to find countries with the lowest salaries for hosting their production sites. As they now consider alternative production locations, the obvious route to compensate increases in costs is to look at productivity.

One of the learnings from the Nordics that has been a key to growth and that may be replicated in other regions is that if you need to move your supply chain, you need to increase productivity as well. There is a natural evolution that as salaries pick up in traditionally lower cost locations, competition increases, and companies look to automate and roboticise wherever possible in order to increase productivity. Costs could well initially increase, but the demand that they come down will prove to be a catalyst that is likely to energise productivity.

Digitalisation no longer optional

One noticeable aspect of the coronavirus crisis has been limitations caused by international trade processes that are still heavily reliant on paper. Difficulties encountered in the physical delivery of trade documents has further spurred the switch to fully digital trade tools, such as blockchain-based platforms. The emergency measures taken where authorities and third parties in the supply chain have accepted electronic documents in the form of PDFs and copies rather than originals, has also shown that the switch to digital has worked and can be scaled up. This may lead to a more rapid change of culture and behaviour within trade practices.

The adoption of new digital trade technologies is expected to continue at a rapid pace, making it possible to automate the actual trade process with digitised data entry points for companies, banks and logistics providers. Advanced systems are expected to use AI (Artificial Intelligence) to robotise the necessary steps for buying and selling goods, thereby simplifying and speeding up the global trading system.

The move to fully digital and decentralised platforms in order to exchange digitised trade such as guarantees, electronic bills of lading or letters of credit as well as supply chain financing and receivables solutions, will continue to replace paper trade methods that have stayed the same for many years. Corporates and banks have had to transform the way they operate in 2020 to a more remote and digital set up. Treasuries will therefore demand that their trade infrastructure covers the entire financial supply chain, aggregated into one centralised dashboard, allowing them to transact on both a structured and open account basis, in order to support and expand their businesses.

The rapid evolution of digitised trade solutions has slowly been gaining momentum over previous years, shifting from proof of concept to mainstream adoption. The experience of 2020 has proven that digitalisation is no longer optional. Everyone has witnessed how working from home has become even more prominent, but from a purely treasury perspective the crisis really does highlight the fact that trade and supply chains specifically have got to be as digital as possible. The uncertainties and potential risks caused by an over-reliance on traditional paper trade documents are all too clear for everyone to see.

The year 2020 has undoubtedly been challenging for society and our national economies. The global health crisis has shone a light on the fragility of the interconnectivity we have relied upon for growth and unparalleled access to goods and services in recent years. The digitalisation of trade (which has historically been slow) to reach mass adoption has, as a result of the pandemic, seen a new urgent focus. Buyers in supply chain relationships will have been exposed to periods of significant stress in 2020 and through closer visibility, dialogue and engagement with suppliers, they can create stronger and more resilient supply chains. Whilst the road to full economic recovery may be long and not necessarily the most direct, it is clear that the journey has started and there will be changes to global supply chains as a result.

To hear more about robust supply chains at Nordea write to Richard at Richard.Hayes@nordea.com.

Contact your Nordea Trade Finance advisor for further assistance or find out more about we.trade here.

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