Sink or Swim - The Adaptation of Firms Among Complex Supply Chains

By Krystal Yip (University of Warwick) and Keshav Menon (Columbia University) 

Synopsis


Logistics firms, which are involved in the movement, storage and flow of goods, have been directly affected by the series of unstable events, including the pandemic and US-China trade war, etc. Today, with the volatility of the market and economy, global supply chains require greater resilience and efficiency in the flow of goods between and within countries. Firms in the supply chain and logistics industry either sink or swim - do they have the resources to develop a more efficient approach or are they forced to exit the industry? 



Table of Contents 


Section 1: Overview of the Supply Chain and Logistic Industry

  • Limited cross-border transport, quarantine of transport workers and provincial border checks have exerted great complications onto the sector. 

  • The pandemic and the US-China trade war has brought light to China’s dominance among supply chains, pushing companies and countries to become less reliant on the superpower country. 


Section 2: Geo-political Policies

  • The UK is bracing itself for potential slowdowns in domestic deliveries and increasing complexity around import/export processes as Brexit deals emerge. 

  • Companies have been moving to other cost-effective countries such as Mexico and Vietnam which have not been largely hit by the US tariffs. 


Section 3: China’s Manufacturing Mights

  • Other Asian countries have been quick to respond to the geopolitical tensions by rolling out packages that will divert supply chain investment away from China. 

  • With trade talks between the U.S. and China seemingly at an unyielding crossroads, China’s role as the epicentre of manufacturing is in question. 


Section 4: Pressure on Margins

  • Pressure on margins have surged within Chinese supply chains given the trade war constraints. 

  • Many local firms are faced with even more cost-cutting decisions to remain competitive among the supply chain and logistics industry. 


Section 5: Future Outlook 

  • The restructuring of supply chains as countries and companies shift reliance from China and align with cost-cutting objectives and market localization. 

  • Implementation of technology and the development of the Internet of Things (IoT) within the sector for better visibility into supply chains and increased efficiency. 



Overview of the Supply Chain and Logistics Industry


Inevitably and just like any other industries, the supply chain and logistics sector has been largely affected by the COVID-19 pandemic. Limited cross-border transport, quarantine of transport workers and provincial border checks have exerted great complications onto supply chains, preventing many businesses specifically among the logistics sector from operating. For example, the lockdown in India created a shortage of truck drivers which resulted in over 50,000 containers piling up in the ports of Chennai, Kamarajar and Kattupalli. If anything, this black swan event has reinforced how global and inter-connected supply chains are. When one of China’s major hubs, Wuhan, became the epicentre of the pandemic, disruptions to manufacturing in China rippled through global supply chains. According to McKinsey, Mexico, for example, relies heavily on China and India for up to 95% of its active pharmaceutical ingredients and therefore faced greater risk because of the inter-reliance and pandemic disturbance. The situation has brought light to China’s dominance among supply chains and has pushed companies and countries to become less reliant on the superpower country. On top of that, economic trade wars between the US and China have potentially stripped China’s competitiveness within supply chains. 



Geopolitical Policies


Increasing trade tensions have affected the risk of escalation among supply chains. Brexit, for example, could alter defence strategy given that the UK is currently the EU’s biggest defence spender and cause many companies to relocate their production. As supported by BDO, the British International Freight Association (BIFA) has even stated that all modes of cargo transport will be affected by Brexit, with over-the-road the most significantly impacted. As a result, the UK is bracing itself for potential slowdowns in domestic deliveries and increasing complexity around import/export processes as deals emerge. 


Threats of the United States imposing tariffs on European and Japanese auto imports have also affected confidence surrounding supply chains as this results in lead time changes and more complex operational cycles. Since 2018, the two superpower countries, US and China, have been in an economic warzone; so far, the US and China have slapped tariffs of US$550B and US$185B respectively to each other’s goods which have ultimately affected many bystanders (i.e companies with production in the regions). In fact, trade analytics showed that China lost its global export market share at an accelerated pace in 2019 as companies move to other countries such as Mexico and Vietnam which have not been largely hit by the US tariffs and are able to benefit more from low-cost production. Together, Mexico and Vietnam have grown their market across the consumer goods by 12% which begs the pertinent question -  has China lost its competitiveness among the supply chains?  



COVID-19 and China’s Manufacturing Might


China has historically been regarded as the world’s manufacturer. Since surpassing the U.S. in 2013 and claiming the coveted title of the largest international trader, China has never looked back. Their dominance over supply chains is exemplified by key manufacturing metrics. In 2018, they accounted for 28 percent of global manufacturing output as supported by Statista, enjoying a TAM of USD $4 trillion and were 12 percentage points higher than their nearest competitor. Last year, Fortune 500 also alluded to this dominance, with more Chinese companies gracing the list than their American counterparts. In fact, China’s export-oriented growth model translates to a business ecosystem that was established to create and maintain a control over global value chains. By gradually reducing dependency on foreign imports and carefully increasing their exports over intermediate goods, Chinese conglomerate manufacturers like Sinopec, SAIC Motor and China Construction Bank have surged to the top. Even the production of face masks, a good more important now than ever, embodies the over-reliance, with 80% of mask production happening in the country. 


Title: Top 10 Countries by Share of Global Manufacturing Output (Statista)


It is no surprise, therefore, that when the pandemic first hit in early January and the state of Hubei was placed under complete lockdown, supply chains across multiple industries in China were hugely disrupted. Fiat Chrysler, Hyundai and Nissan were among the first to express a temporary closure of factories and supply shortages. Thus, as COVID-19 continued to wreak havoc across the world, forced factory closures and diminishing demand has extended the supply chain conundrum. Most importantly, the pandemic not only revealed the extent of global manufacturing reliance on China, but also reignited talks of a supplier exodus from the country.  


Beginning with the imposition of Trump’s tariffs, a manufacturing departure from the country is technically nothing new. Companies are always seeking alternatives on cheap labour, lower rents and regulatory flexibilities. However, the reality is that US-China tariffs have hurt Chinese exports. US consultancy firm Kearney noted that while 66% of all US-bound manufacturing goods sourced from Asia in the 3rd quarter of 2018 was accounted for by China, this figure steeply dropped to 56% post-tariff imposition. In a long awaited moment of schadenfreude, other Asian countries have been quick to respond to the geopolitical tensions by rolling out packages that will divert supply chain investment away from China. Japan’s government has announced a USD $2.4 billion dollar package to help bring back domestic company manufacturing. Similarly, Malaysia has opened up an easy and quick regulatory path to fast-track investment from US and Chinese businesses seeking to move operations away from the nation. India, frequently in the shadow of their Asian neighbour, has also sought to introduce regulatory and investment incentives in a bid to finally cement their role as Asia’s primary manufacturing hub. 


These measures are reflective of a sentiment that has been compounded by the pandemic. With trade talks between the U.S. and China seemingly at an unyielding crossroads, China’s role as the epicentre of manufacturing is in question. Trump and many others have promised that industrial supply chain routes will be up for a major reshuffle. If a withdrawal of investment in manufacturing continues and businesses begin to leave the region, a radical shift in global value chains will reduce the globe’s traditional Chinese manufacturing dependency. However, interviews with dozens of analysts and government officials in the Asia-Pacific region by the Japan Times suggest that a broad effort to restructure existing supply chains will be difficult. Intrinsically, logistic routes and supply chains are difficult to dismantle and are geographically entrenched in certain sectors to certain regions. While competing governments may be able to lure some manufacturers away, it is unlikely that supply routes would be hugely diversified - despite rhetoric from Trump. What is more realistic, perhaps, is that the virus, along with the imposed tariffs, will accelerate existing market forces that have already begun to push some manufacturers away. The post-COVID world will largely be defined by the status of U.S.-China relations. Should a trade war continue, a spotlight will once again be placed on the nature of supply chains. 



Pressure on Margins


The slap of US tariffs on Chinese goods has inevitably raised the cost of goods and have negatively affected the Chinese logistics industry as they lose out of their cost competitiveness. The pressure on margins have therefore surged within Chinese supply chains given the trade war constraints, and many local firms are potentially faced with even more cost-cutting decisions to remain competitive among the supply chain and logistics industry. We expect that logistics hubs will re-emerge at the regional level more than globalized as companies and nations cut down on single-source dependencies, especially in China. The trade bureaucracy within supply chains has sparked an opportunity for M&A and PE acquisitions of firms struggling with the change in prices as supported by the unchanged figure of 37 M&A transactions H1 2020 according to PWC. One of the largest logistics deals includes the acquisition of Costco Wholesale Corp by Innovel Solutions for circa $1B to improve their vertical integration. For many struggling Chinese firms which have felt an incurrence of logistic costs, acquisitions and buy-out are a helping hand to generate operational synergies, preserve capital expenditures and improve total cash flow. 


Title: Logistics Costs in Asia (% of GDP) (Haulio)


Companies and PE firms with a strong balance sheet also see more opportunity to be explored within the logistics sector. As customers are increasingly favouring contactless purchasing via e-commerce and home delivery services to minimize contact amid the pandemic, logistic investments for warehousing and distribution will be on the rise to meet that demand whilst improving supply chain operations. E-commerce has overall prompted opportunities for logistic operations and ongoing reinvention of niche markets (i.e. cold chain services/last-mile delivery). 

Still, political tension and strict quarantine measures remain a strong constraint to any M&A activity and on a holistic level, has brought many complexities to the supply chains. No longer are potential buyers able to carry out in-person facility tours, management meetings and inspections. 



Outlook


The restructuring of supply chains is expected to occur as countries and companies shift reliance from China and align with cost-cutting objectives and market localization. For example, Taiwanese bicycle producer Giant has dropped its shares of bicycle shipments from China to the U.S by 46.2% in 2019 to 2016. Ultimately, local Chinese logistic firms have felt the greatest impact in this case.


We may also start to see more implementation of technology and the development of the Internet of Things (IoT) within the sector for better visibility/traceability into supply chains and increased efficiency in operations to cut costs. This may spark more cross-sector M&A activity among the technology and logistics industry, and reduce logistics services providers’ exposure to any labour shortages. 


Today’s globalized supply chain network has been optimized to identify minimum lead times at the lowest cost possible - this has led to a point where we are seeing a move from globalization to localization, causing major changes to the logistics sector and their operations. The shortening of supply chains may benefit countries with capable manufacturing sectors, such as Vietnam and Mexico, to partially substitute China over the medium term. 


Still, small players in the field which do not have any recovery plan or resources to capitalize on technology will be severely impacted by the series of events. Top players, on the other hand, will include more force majeure in their contracts to relieve global pressure and costs given unexpected circumstances. All in all, as logistics is a diverse sector, recovery prospects will vary depending on the length of lockdowns and the duration of the economic crisis. Companies are advised to start redesigning their approaches now to avoid facing the same problems should another global disturbance arise.