Faced with the pandemic, we were suddenly unable to find what we needed: hospitals were short of N95s and fans, car manufacturers were missing critical components, and store shelves were suddenly empty of everything from sneakers to sofas.
Costas Bimpikis, assistant professor of operations, information and technology at Stanford Graduate School of Business, discussed with the news organization how to keep our supply chains secure even when the world is upside down. His comments have been edited for clarity.
Q: What has COVID-19 shown about our supply chain?
A: He showed two things. First, how interconnected the supply chains are. The situation in Italy, Taiwan or Korea can be felt all over the world. Secondly, it became clear how fragile the supply chain is. Any deviation from normal operation causes a huge shock throughout the world.
Q: What got us into this mess?
A: One of the trends is the so-called “just-in-time” production. Firms usually produce as much inventory as they need for short-term sales. This reduces costs. They don’t necessarily have excess supplies.
The second reason is the specialization of product lines. For example, cars are produced with thousands of components. Disruption to a supplier of a specific component – for example, a cog somewhere in a car – can stop production of the entire car.
And third, outsourcing and globalization of production. For example, a disruption in Taiwan affects our internal supply chain as well.
Q: What drives these trends?
A: Typically, companies strive to minimize costs, maximize speed, maximize efficiency, and maximize consumer choice.
Costs are kept to a minimum by the very low “safety stock”, as it is very expensive to store excess inventory. Increasing speed and efficiency means lean and just-in-time production. The maximum choice for customers indicates the specialization of the line. You can buy Nike sneakers in countless colors.
They have great advantages, but they also have disadvantages.
At the start of the pandemic, shortages were mainly driven by a sharp increase in food demand. Now more problems arise from supply chain problems.
Q: Some industries are more ruined than others – and why?
A: Industries with strong demand and high geographic concentration have experienced the greatest shocks.
For example, the semiconductor industry is still undergoing significant upheaval. The demand for semiconductors has skyrocketed because they are used in many consumer products such as cars. And the semiconductor industry is highly concentrated in two geographic regions, Taiwan and South Korea. Only two companies are engaged in production.
And the last thing, especially for the semiconductor industry, is that the start-up costs are very high. Deciding to become a semiconductor manufacturer is not easy tomorrow.
Q: Can we mitigate the risks by making more products in the US?
A: Products that are manufactured in the USA do not experience such severe disruption because they are not subject to shipping restrictions.
But to be realistic, outsourcing and trade globalization cannot be easily reversed because of the benefits it has. Outsourcing has resulted in much lower prices due to much lower manufacturing costs.
Domestic production needs to be developed in industries of strategic interest to the United States. Semiconductors are a good example of this. The White House has a number of initiatives to invest heavily in the domestic semiconductor industry to increase production capacity.
It is unlikely that all production will be onshore. But maybe we’ll see more in strategic industries.
Q: Can supply chains be made more resilient?
Answer: There is a trend towards diversification of the supply chain called “dual sourcing”. This is China Plus One, an alternative source of supply outside of China.
But this takes time. Especially in China, there is a lot of investment, know-how and infrastructure here that make it much easier to work there. Companies are trying to replicate the same infrastructure and the same efficiency in countries like India and Vietnam.
Q: Are there any other strategies?
A: One way to prevent shortages is to increase excess safety stocks.
It also makes production more flexible. If you have a simple product line and one of your factories is experiencing a disruption, you can increase production capacity in other factories. This is “reverse specialization” – if you make components more common across all of your product lines, then it will be easier to deal with interruptions.
Q: What should be the role of government?
Answer: The government is already taking certain steps to increase production capacity for strategically important industries. And the government can stimulate domestic production through tariffs, subsidies, and so on. Another action is to hold strategic reserves for important products, as we do for oil.
It can also provide greater transparency in complex international supply chains. Risks are not easy to identify at this time because firms do not have full visibility of where their suppliers are getting their raw materials. One way to identify risk is to do a “stress test” similar to what we did with the financial industry — to simulate adverse effects and see how they propagate throughout the supply chain.
Q: When can the current instability subside?
A: It will take some time – maybe three to six months, maybe more. Firms usually underestimate the investment required to fix them. I assume that the situation will return to normal not earlier than in a year.