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When the Chinese New Year arrived Jan. 25, it offered an unintended benefit: Saving world commerce from the coronavirus, if only temporarily.
In preparation for the largest migration season on the planet, Chinese factories annually build up inventory so plants can shut down while workers return home for the holiday. But the coronavirus prevented many from reopening and others from returning to full capacity.
The result: That buildup is now near exhaustion.
Read: Empire State manufacturing index posts record decline in March
For the U.S., it presents the very real chance that companies from auto makers to electronics manufacturers will soon begin to cease or limit production. With a downed China as the headstream of global manufacturing, mercantile America simply can’t function as it’s accustomed to. We’re starting to see this happen in official reports: The New York Fed’s Empire State business conditions index, released Monday, plunged by a record 34.4 points to minus 21.5 in March. And Federal Reserve Chairman Jerome Powell said Sunday he expects a contraction in GDP in the second quarter.
Where are parts around us made? Take the dashboard in your car or the innards of your cell phone. They’re propelled by semiconductors, resistors and capacitors, which U.S. industry relies heavily on China to produce.
These components are then shuttled to other Chinese factories, where printed circuit boards and sub-assemblies are manufactured, becoming the foundational hardware used to operate everything from Apple AAPL, -7.34% iPhones to anti-lock brakes.
Yet with Chinese plants still shuttered or running at half-capacity — and parts stockpiling in ports where ships refuse to stop — Western companies are nearing crisis mode. Some have resorted to airlifting components. Others can’t even get their suppliers on the phone.
For automakers including General Motors GM, -10.18%, Ford F, -9.68% or Fiat Chrysler Automobiles FCAU, -19.04%, it means that U.S. assembly plants may begin closing later this month. IHS Markit is now predicting that the coronavirus alone will reduce global car production by nearly a million units this year.
The just-in-time supply chain, exposed
Consider it among the pitfalls of the just-in-time supply chain. The notion of avoiding the expensive stockpiling and housing of inventory has been a sound practice to streamline costs and operations. But when it comes to disruptions, like pandemics, natural disasters, or their subsequent fall-out — say, the Fukushima meltdown — its virtues tend to unravel rather quickly.
That’s soon to prove especially true for automakers. Not a single U.S. plant can operate on American or Mexican parts alone. While deadly diseases can erupt anywhere, China presents unique threats to the just-in-time philosophy.
Despite its economic might, China’s strength rests with the simple possession of cheap manufacturing cost, not managerial acumen. In an age of real-time analytics, much of the local production information is still compiled manually, or with limited understanding of its implications beyond the four walls of the plant. Factories often survive not because they’re profitable in a conventional sense, but due to subsidies from governmental entities yearning to take part in certain industries.
Throw in a top-down tendency toward secrecy, and fragmented communication with the outside world, and U.S. manufacturing relationships can become a nightmare when disaster strikes.
An American automaker may know who’s producing its electronic assemblies and circuit boards, but have little knowledge about second-tier suppliers manufacturing their ingredients. Some companies have even shipped tooling to a specific plant, only to discover that production is actually taking place at another.
When you work with China, automotive or otherwise, your roster of suppliers never quite carries the full degree of certainty as in the U.S.
This, as we’re soon to see, becomes especially traumatic when disease renders them incapacitated, and the root of your troubles can be traced to a supplier you’ve never heard of.
A reckoning with risk
Though perhaps for reasons more political than practical, politicians have warned for years of our dependence on China, urging U.S. companies to diversify their supply chains. But it’s easier said than done.
For crisis planning, the U.S. military has traditionally utilized the World War II mindset of running multiple risk-scenario analyses for its combat-supply chains. Yet it has the advantage of a seemingly near limitless pocketbook in these situations, and an absence of shareholders hawking its quarterly short-term financial performance like a publicly traded or private company.
Even after an immediate crisis steps off the stage, full-fledged reexaminations of how and where they’re supplied tend to languish on to-do lists. Executives are too busy responding to the new day-to-day problems and neglect to plan for yet more crises in the distant future.
One obvious solution would be altering just-in-time supplies, in order to store inventories in the event of potential production interruptions. But this could come with significant costs.
So does diversifying suppliers to sources in other countries, or by bringing production in-house. There’s a reason China remains the headstream of global manufacturing: It’s cheap. In a world of short-term financial pressures, executives aren’t prone to raising material costs today in the name of some vague, faraway catastrophe.
However, does anyone truly assign an additional risk premium cost for the potential disruption of a global manufacturing and supply operation?
In the meantime, buyers may soon find car selection limited and incentives ceased. Smartphone prices could rise as stockpiles dwindle, with all manner of goods following suit.
As these types of business disruptions become more frequent, the fallout from disasters like the coronavirus needs to be considered, more than merely a peril we’ll have to live with.
Business leaders need to step up their game, and truly invest in “strategic” manufacturing planning, whether reconsidering decision rules for diversified production operations or closer management attention to their global supply base. These analytics are not everyday calculations, but the potential upside and downside impacts could be enormous.
Daron Gifford leads Plante Moran’s strategy and automotive industry consulting services.
