Ready for Supply Chain Disruption?

Coronavirus exposed vulnerabilities in every industry; and every industry it seems, has reported disruptions in supply chain during the pandemic. But COVID-19 shouldn't be confused with a 1,000 year storm, say observers. In fact, supply chain disruptions lasting a month or longer now happen every 3.7 years on average, according to McKinsey & Company. One reason for the increase in risk is that value chains have grown in length and complexity as companies expanded around the world in pursuit of margin improvements.

Since 2000, the value of intermediate goods traded globally has tripled to more than $10 trillion annually. Businesses that successfully implemented a lean, global model of manufacturing achieved improvements in indicators such as inventory levels, on-time-in-full deliveries, and shorter lead times.

However, these operating model choices sometimes led to unintended consequences if they were not calibrated to risk exposure. Intricate production networks were designed for efficiency, cost, and proximity to markets but not necessarily for transparency or resilience. Now they are operating in a world where disruptions are regular occurrences. For example, in 2011, a major earthquake and tsunami in Japan shut down factories that produce electronic components for cars, halting assembly lines worldwide. The disaster also knocked out the world’s top producer of advanced silicon wafers, on which semiconductor companies rely. Just a few months later, flooding swamped factories in Thailand that produced roughly a quarter of the world’s hard drives, leaving the makers of personal computers scrambling. In 2017, Hurricane Harvey, a Category 4 storm, smashed into Texas and Louisiana. It disrupted some of the largest US oil refineries and petrochemical plants, creating shortages of key plastics and resins for a range of industries.

Now, disruptions are coming fast and furious. Changes in the environment and in the global economy are increasing the frequency and magnitude of shocks. Forty weather disasters in 2019 caused damages exceeding $1 billion each. And unreliability is expected to grow as more trade disputes, higher tariffs, and broader geopolitical uncertainty become the norm. McKinsey notes that the share of global trade conducted with countries ranked in the bottom half of the world for political stability, as assessed by the World Bank, rose from 16% in 2000 to 29% in 2018. Moreover, 80%of trade involves nations with declining political stability scores.

McKinsey modeled a 100-day disruption based on an extensive review of historical events. In 2018 alone, the five most disruptive supply chain events affected more than 2,000 sites worldwide, and factories took 22 to 29 weeks to recover. In its scenarios, McKinsey showed that a single prolonged production-only shock would wipe out between 30 and 50% of one year’s EBITDA for companies in most industries. 

Having calculated the damage associated with one particularly severe and prolonged disruption, McKinsey estimated the bottom-line impact that companies can expect over the course of a decade, based on probabilities. McKinsey combined the expected frequency of value chain disruptions of different lengths with the financial impact experienced by companies in different industries. On average, companies can expect losses equal to almost 45% of one year’s profits over the course of a decade. This is equal to seven percentage points of decline on average. 

One way to reduce risk, of course, is to shorten the supply chain and bring production home. McKinsey estimates that 16-26% of exports, worth $2.9 trillion to $4.6 trillion in 2018, could be in play—whether that involves reverting to domestic production, nearshoring, or new rounds of offshoring to new locations. In dollar terms, the value chains with the largest potential to move production to new geographies are petroleum, apparel, and pharmaceuticals. In all of these cases, more than half of their global exports could potentially move. 

In a McKinsey survey of supply chain executives conducted in May 2020, an overwhelming 93% reported that they plan to take steps to make their supply chains more resilient, including building in redundancy across suppliers, nearshoring, reducing the number of unique parts and regionalizing their supply chains.