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April 28, 2020

Made in the U.S.A: Will (Should) Global Supply Chains Survive the Pandemic?

MHT Partners

The Federal Reserve’s Industrial Production and Capacity Utilization report for March, which was published on April 15, shows decreases in manufacturing output and industrial production of 6.3% and 5.4%, respectively(1). Declines that steep haven’t been felt on U.S. soil since 1946, when the country was demobilized in the wake of World War II. Manufacturing eventually rebounded significantly in the post-war era, as pro-labor legislation and limited global competition revitalized the automobile industry and paved the way for emerging sectors such as aviation and electronics. If past activity is any indication of future behavior, then the U.S. will innovate during this contraction to minimize the trough and then accelerate into recovery, but given the unprecedented nature of this crisis, can history repeat itself?

Over the past three decades, supply chains have become increasingly global – the passage of policies favoring free trade coupled with advances in logistics technology have resulted in a ‘shrunken world’: low-wage countries in regions that were once considered ‘distanced’ are now highly accessible. Further, in a capitalistic economic system where the health of a business is determined by its profitability, keeping costs low is key – in addition to labor, both land and raw materials can be significantly cheaper internationally. A single player that increases margins by outsourcing production is enough for the model to emerge as the benchmark for the industry – those that don’t adapt will be squeezed from the market and we (consumers) become reliant on goods delivered through complex supply chains.

A ‘black swan’ event, like COVID-19, is typically viewed as once-in-a-century occurrence, but the sheer magnitude of disruption caused by the pandemic should be the catalyst for a revamp of supply chains. The evolved sourcing methods that have generated a positive feedback loop between profit-maximizing producers and thrifty consumers have now been unmasked, and what we see isn’t pretty – intricate chains are inherently fragile when dependent on multiple tiers (“links”) of suppliers, alarming concentration driven by the bottom-line mentality that prioritizes price above diversity, and severe inventory shortages that were once touted as a cost advantage resulting from lean operations. Those three realities, which were previously considered to be minimal threats, have increased risk exposure to a degree that’s unquantifiable.

Remedies for these issues will unquestionably take both time and resources to implement, but the framework can be engineered now with a basis centered on shortened supply chains by way of a shift to onshore manufacturing. An upheaval of existing processes will surely come at a cost for any business, but potential losses can be mitigated. Recent advances made in automation, namely artificial intelligence (“AI”) and machine learning, have given birth to promising processes like 3D printing and other robotic-based production that offer optimization while minimizing the need for human capital, which has dissipated (for good reason) amid the social-distancing orders required to navigate a pandemic. By bolstering existing policy that encourages businesses to invest in these cutting-edge solutions, Uncle Sam can help facilitate the technological transformation, which will actually reduce costs long term through economies of scale.

While not domestic but technically onshore, Mexico represents another alternative for reconfiguring lengthy, multiple-link logistic chains – the country saw low-cost labor hover around $5 per day in 2019(2), while China’s minimum daily wage ballooned to almost $17 by the end of the year(3). Establishing supply bases in the western hemisphere would help shorten and diversify chains to reduce the risk carried in global networks that are prone to collapsing at any node.

Undoubtedly there are limitations to the changes proposed above – for example, complete vertical integration is not feasible for a U.S. manufacturer of bicycles that needs scandium, an element that’s only known to exist in Scandinavia and Madagascar, for frames. So, while it may not be possible to source all raw material in North America, larger inventories could be stored on the continent as an emergency supply. The storage of materials that are required for the production of essential goods is crucial in ensuring that a country has a sufficient supply of healthcare equipment for citizens amid inevitable future pandemics.

U.S. companies would be wise to learn from this ongoing tragedy by embracing advances in production technology and diversifying supply networks to strengthen themselves in preparation for the next event, whether it is another pandemic, a war, cataclysmic climate change, a large-scale cyber attack, or a natural or man-made disaster.

Sources:
(1) United States Federal Reserve System
(2) Thomson Reuters
(3) Trading Economics
The Wall Street Journal

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