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COVID-19 And Changes To The Global Supply Chain – Some Observations From China

COVID-19 and changes to the global supply chain – Some observations from China

Post Series: 2020: Volume 19, Number 2
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Introduction

COVID-19 has proven to be a great disruptor. First it caused the national shutdown of China as factory after factory turned the lights off, sending Western firms scrambling for goods of all kinds. Next the disruption spread globally, causing a shutdown of consumer spending in the West, and sowing confusion on all sides of the supply chain.

As China factories resume operations, the risks to the global supply chain and opportunities for reducing those risks have become clear.

Sourcing

The first phase of COVID-19 served as a wake-up call for Western firms that were overly dependent on China. As province after province and industry after industry shut down, it became clear that many Western firms could not manufacture their products without China, at least not in the quantities required. Supply sources that could easily be moved to other countries had mostly already relocated. Garments and consumer electronics were in this category.  Supply chain directors faced the challenge of finding alternative suppliers of critical parts overnight, in the midst of a growing global health crisis. We saw clients trying to relocate assembly lines to places like Vietnam or Thailand, only to discover that factories in Southeast Asia also depended on parts from China. Indeed, factories in that region are mostly owned by Chinese entities.

Most companies were ultimately unable to move production, other than for small parts, at such short notice. The lesson for supply chain directors is to build in contingency planning for critical parts during calmer times. Many Western firms are now lining up other manufacturing countries for their products and components. Some are even bringing manufacturing back home, and Japan has announced a $2.2 billion expenditure on companies relocating out of China.1 Companies with security-related products are first in line, including face mask manufacturers and potentially also other medical components.

Quality

Another issue in the wake of COVID-19 is the lack of knowledge and control over the Chinese supply chain. As the crisis subsided in China and manufacturers were starting back up, we found that many factories were using alternate sub-suppliers for parts, often without informing their clients of the changes, and indeed without themselves understanding that they were changing specifications. On paper, replacement parts looked the same, but quality varied from the originals and indeed also varied within batches. The problem was compounded at this stage by the travel restrictions from the outside, as auditors were unable to visit factories themselves.

A further challenge for organizations of all sizes in many industries involves standardizing operations and processes. This is accomplished through initial alignment with international standards and then asking independent auditors to evaluate compliance and issue certifications. Yet, because operations continue after receipt of certifications, compliance often starts to slip – sometimes inviting high risks.

In these cases, we recommend a tried and true “trust but verify” method of due diligence to avoid losses and conflicts. It shouldn’t be difficult to determine which of the certified processes maintained by a partner company is most important to your organization. Due diligence then can be a one-time assessment and applied continually through process oversight. It is best not to wait for slipups because those could be costly financially, operationally, and from a reputation perspective. The same goes for quality control in the supply chain. The more complicated and high-value your product is, the more scrutiny you should apply. This is especially necessary when third-party manufacturers are returning to normal production volumes after widespread shutdowns. This “return” will likely entail a lot of scrambling and cutting corners.

Fraud

In the wake of COVID-19, the frequency of fraud and scams has gone up dramatically. The hook has mostly involved exploiting the general uncertainty in China.

Consider for example the so-called “CEO email” scam. This is when a finance person in an organization receives an email allegedly from their company’s senior executive with urgent instructions to immediately transfer funds to an outside party to help complete a commercial deal.

Scammers in these cases rely on the lack of redundant controls (secondary approvers) over the release of funds to outside parties. We have seen multiple cases of companies losing significant sums of money without much hope for recovery. It is prudent, therefore, to look at the fine details of financial management and redundant approval processes of the organization with which you plan to (or already) do business. Several governments recently issued guidance to businesses in an effort to strengthen internal controls and avoid such scams. However, application is inconsistent, and losses continue. The fix is easy, but verification is necessary.

The current situation unfortunately means an increased risk of fraud: from price gouging and online scams to deliberate and unjustified interruption of agreed payments or delivery of supplies. One of the new vulnerabilities stems from remote work arrangements for millions of people supporting supply chains. As teams and individual employees remain physically separated, isolated decision-making and degradation of compliance with existing policies and procedures should be expected.

Lessons

Make sure each manufacturer you’re relying on is aware of your concerns, and that concerns are forwarded downstream. Ask to see material bills and material samples. Don’t assume that suppliers are putting extra scrutiny on materials. Ask for estimated delivery times of key materials, and make sure you are aware of which regions your key materials are shipped from so you can try to verify independently how likely issues are to arise with a certain vendor. Please also make sure to direct questions not only to English-speaking representatives but also to top management of your vendors and suppliers in their native languages because that helps build trust and enhances collaboration in solving problems.

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