Portrait Of Young Asian Man With Face Mask To Protect And Prevent From The Spread Of Viruses In The City
Portrait Of Young Asian Man With Face Mask To Protect And Prevent From The Spread Of Viruses In The City

Coronavirus and the potential impact on Supply Chains

With cases of the corona virus currently being reported in locations around the world, Richard Hayes, Global Head of Working Capital Advisory at Nordea, considers the effects this might have on global supply chains and actions that can be taken today when talking to suppliers.

Are reported cases becoming more geographically dispersed?

As covid-19 (more commonly known as the coronavirus) spreads, its effect on business continues to amplify. Tourism into and out of mainland China has fallen sharply. According to the Economist magazine, around 400,000 Chinese tourists are forecast to cancel trips to Japan by the end of March alone. The impact has quickly spread to mainland Europe too where this week new cases have outstripped China for the first time. Towns in northern Italy were placed on lock-down and those returning from infected areas after the winter half term holidays were being asked to go into temporary self imposed quarantine by the UK and other European governments.

We have also now seen the first confirmed case in Denmark and a large hotel complex in Tenerife has quarantined its guests due to a suspected case of the virus. The impact is also spreading to sporting fixtures with several major European football and international rugby games cancelled and discussions ongoing about the future of the Olympics later this year. Global business events are also feeling the impact with the Singapore Air Show seeing a sharp drop in attendance, Mobile World Congress in Barcelona being cancelled and the Milan fashion week seeing events curtailed and completed behind closed doors. It is not surprising then that concerns should emerge about the impact on global supply chains and the cost to the world’s economy.

China no longer simply assembles products; it manufactures the components to go in them too further increasing supply chain risk and inter-connectivity whilst creating a new bottleneck.

Richard Hayes, Global Head of Working Capital Advisory at Nordea

Supply chain impacts

Systemic supply chain shock isn’t a new phenomenon. SARS, the tsunami in Japan in 2011 and flooding in Thailand the same year all stretched supply chain resilience. What has changed is the reliance on China from the global economy. Back in 2003 during the SARS crisis Chinese GDP accounted for 4% of the global total, today it is 16%. Firms have continued to build on lean and just-in-time manufacturing methods and now carry the bare minimum levels of inventory and stock, preferring to keep it up stream within the supply chain. Another fundamental change is that China no longer simply assembles products; it manufactures the components to go in them too further increasing supply chain risk and inter-connectivity whilst creating a new bottleneck. Supply chain concerns are not just limited to those who directly manufacture in China. Disruption will be felt for those companies who’s raw materials are trapped in China; the vast majority of factories in Bangladesh for example source raw materials from China.

Compounding these concerns is that the regions in China hardest hit by covid-19 to date are those focused on electronics, component manufacturing and automotives. To illustrate this, analysts suggest that global shipments of smart phones could be impacted by up to 10% this year and there could well be an impact on upcoming Christmas orders. For example, major releases of next generation gaming consoles planned for the holiday season could also be put at risk. When South Korea and Japan are added into the picture, their large automotive sectors become a clear area for concern too.

The impact throughout the supply chain will differ case by case however an understanding of the bull whip effect illustrates where the greatest risks can be; these being the smaller and more highly leveraged suppliers upstream in the supply chain.

Richard Hayes, Global Head of Working Capital Advisory at Nordea

Consider your suppliers

The impact throughout the supply chain will differ case by case however an understanding of the bull whip effect illustrates where the greatest risks can be; these being the smaller and more highly leveraged suppliers upstream in the supply chain.

The likely scenarios is that each step in the supply chain with a forecasted decline in demand creates a bigger decline in orders from the supplier. The logic is that each company in the supply chain considers that they need to make a quick decision and cut their production in line with their projected declining sales. As sales are projected to decline this will leave them with more inventory than forecasts and therefore they need to order less and use up existing stocks. This therefore leaves those most at risk being further up the supply chain where the effect is amplified the most and where suppliers tend to be most leveraged.

The short and long term impacts

Companies will be keen to increase production and get goods moving as soon as possible. However this may not be as easy as it sounds. There is of course the risk of infection recurring especially in plants and factories with company dormitories where worker proximity may well increase infection risk. In terms of supply chain disruption, even a single infected person can cause an entire factory to halt production as was the case with Motorola in Singapore in 2003 during the SARS outbreak. While ports have traditionally been kept open during previous outbreaks such as the SARS epidemic, disinfection operations and labour shortages may still reduce productivity beyond normal levels for maritime trade. Logistical challenges across China will continue for some time with truck drivers needing to report back to work, continued road blocks and restrictions and the prioritisation of food and medical goods for movement. International ocean freight rates are likely to surge when goods does start moving and then there is the transit time to Europe and the US of around three weeks to contend with.

Over the longer term companies are likely to review their reliance on China and Asia in the context of their supply chain risk. For decades sourcing decisions have been driven by a pricing arbitrage, this may well be the event that pushes supply chain management to the strategic level. This will also be an opportunity for anchor buyers who have not already completed detailed supply chain mapping to understand the risks across their secondary and tertiary supply base.

At Nordea we would suggest an anchor buyer ensures they stay close to their supply chain and works with key suppliers to ensure clear and open communication in regards to demand forecasts and sales expectations.

Richard Hayes, Global Head of Working Capital Advisory at Nordea

Thoughts for your supply chain

At Nordea we would suggest an anchor buyer ensures they stay close to their supply chain and works with key suppliers to ensure clear and open communication in regards to demand forecasts and sales expectations. This will not only help maintain relationships but insulate wherever possible the impacts of the bull whip effect. Suppliers may well need to be supported from a working capital perspective at this time to ensure they can continue to operate in a stressed environment and ultimately continue to support the anchor buyers operations; thinking cash flow versus profit may pay dividends here.

Additionally buyers should start embedding risk management practices into supply chain operations. Supply chain risk management roles and departments should start to be integrated into the end to end supply chain management and procurement process giving one holistic view.

To keep updated on key developments please continue to check Nordea Insights and Nordea Research.

For more information, please write to Richard Hayes or speak to your Trade and Working Capital Sales contact. If you would like to discuss how Nordea can work with you and your supply chain we would be delighted to assist.

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