Creating More Resilient Supply Chains

ALISON BEARD:  Welcome to the HBR IdeaCast from Harvard Business Review.  I’m Alison Beard.

If you’ve had trouble buying toilet paper, or cleaning supplies, or even car and computer parts over the past few months, you’ve been keenly aware of something that consumers rarely think about, corporate supply chains.

The COVID-19 pandemic with its border and business closures have showed us just how hard it is to keep making things and getting them into the hands of end users in a timely fashion.  Most production is global and increasingly complex, and one kink in the system, never mind the worse health and economic crisis in a century, can wreak havoc.  Companies simply can’t meet demand.  We go without goods from nice to have like frozen strawberries, to necessities like medicine.  And the organizations lose revenue – sometimes so much that it’s difficult to stay in business.

Our guest today studies supply chains and ideas for how they can be improved.  Our guest today studies supply chains and has ideas for how they can be improved and made more resilient for future crisis.  Willy Shih is a professor at Harvard Business School and he wrote the HBR article, “Supply Chains in a Post-Pandemic World.”  Willy, thanks so much for being on the show.

WILLY SHIH:  Thank you for inviting me.

ALISON BEARD:  So, for those of us who didn’t study operations in business school and don’t think about these issues that often, could you give us just a quick explanation of how global supply chains work nowadays?

WILLY SHIH:  Well, Alison, these days global supply chains as you mentioned, are very complex.  And that’s firms tend to rely on a network of suppliers for components or subassemblies or raw materials.  And because we have experienced an era of rapid globalization, which has really been marked by really low cost and very convenient communications, and shipping, firms have tended to cast a wide net geographically when looking for sources of supply.

And these have been driven by cost, they’ve also been driven by specialization.  So, for example when you have very complex products like a phone, or a laptop computer, manufacturers will rely on specialists who might be in a distant part of the world.  And until this pandemic, that was fine because we had very reliable and very efficient and more importantly, very predictable transportation links.

What happened when the pandemic hit, it suddenly exposed the  complex network of suppliers that many firms use.  OK.  And if you’re assembling something, like an automobile, or a notebook computer, or a washing machine, or a freezer, you only need to be short one part to not be able to assemble your product.

ALISON BEARD:  And did we see any hints of this problem before the pandemic?  For example, when natural disasters would hit certain parts of the world?

WILLY SHIH:  Oh certainly.  We’ve seen a number of examples of these which have served as a warning.  So, for example, back in 2011, the East Japan earthquake and tsunami took off a number of suppliers in Japan – around Naka, Japan – offline.  And some of those suppliers were critical for these supply chains.  For example, there was one company there who made the material that made automotive black paint sparkle.

And it turns out every auto maker relied on this one company who may have been several tiers down in the supply network, so they didn’t realize they were all reliant on this one company.  So, when that company went down, all of a sudden nobody could paint cars black anymore.

There were also floods in Thailand later that year, which caused a massive disruption to the disc drive supply chain for the whole world.  Because Thailand manufactured about half the world’s disc drives at that time.  That should have been a signal to people that wait a minute, we have these really concentrated dependencies in parts of the world that we kind of take for granted that they can deliver to us on time, in full and suddenly, one day comes along where they can’t.

ALISON BEARD:  Yeah.  But as you mentioned, global corporations, they chose this for a reason, to reduce costs, increase profits, allow for just-in-time manufacturing in some cases.  So, is any of that going to change?

WILLY SHIH:  Well, we have a lot of talk about how people need to build more resilient supply chains.  And I think this is a good opportunity for people to go back and examine their supply chains and understand where the vulnerabilities are.  But I think consumers, especially in this post pandemic recession, aren’t going to want to necessarily pay more.  So, I think that causes the dilemma for a lot of companies.

What has happened is people built these globalized supply chains and the risk of disruption has been very hard to price.  So, people have ignored it.  But the tough question will be, will consumers pay more for that risk mitigation?  Because if a manufacturer wants to put capacity in a higher cost country that is closer to the market where the products will be sold, then somebody has to pay that additional cost.

So, you may have more supply security, but will consumers pay more?  Now, firms can also mitigate some of that risk by holding more inventory.  One of the assumptions that I think people have made in their supply chains has been we want to have a lean supply chain.  We don’t want to have a lot of inventory in it because inventory first, costs me money to carry, and second, there’s risk of obsolescence or loss.

So, it’s one of these tough tradeoffs which is, can I, can I carry more inventory, which will cost me more?  Or, do I pay more for local sources of supply, in an environment where I don’t think consumers want to pay a higher price?  So, that either means lower profits, or what I think firms need to do is rethink a lot of their manufacturing processes, and try to focus on process innovations that will allow them to produce at lower costs, maybe locally.

ALISON BEARD:  OK.  So, let’s look forward to solutions.  All the downsides that you’ve outlined are the reasons that companies probably didn’t act to the other warning signs that we saw even decades ago, but the pandemic does seem to have changed attitudes.  So, what’s the first step that you would recommend for an organization who wants to assess their supply chain, identify their vulnerabilities and begin to fix them?

WILLY SHIH:  Well, I think the first step obviously is mapping your supply chain.  And while that sounds obvious, it’s actually a much harder task than most people appreciate.  And the reason is because these days with kind of the division of labor and specialization of many firms inside the supply chain, we have many tiers.

So, for example, I might be a manufacturer who will rely on 50 or 100 suppliers.  And those suppliers, those immediate suppliers, are what I think of as my first tier suppliers.  OK.  Those first tier suppliers will in turn rely on others – and so on.  So, you’ll have kind of this layer cake of suppliers. The numbers get very large, very quickly for complex products.

Oftentimes when you got to your suppliers and say, I want to know who my tier two is, who is supply you?  They don’t necessarily want to share that because their worried that you might find out their cost data, or you might find out some competitive information.  So, understanding those vulnerabilities, which is really the key to starting to address those risks, is a much more difficult task.  I would suggest to you that most companies don’t know who their suppliers are beyond the second tier.

I’m doing a study right now looking at pharmaceuticals and active pharmaceutical ingredients.  That was something that the pandemic really exposed.  And people didn’t really understand that we might import for example, generic pharmaceuticals from Indian companies who in turn relied on Chinese manufacturers for an active pharmaceutical ingredients.  And, as you follow supply chains down, it’s not really clear how many of the people who your supplier may be buying from is in fact a manufacturer or just a reseller.  So then the material may pass through many different hands and it’s hard to get to the root of who actually made the material.

ALISON BEARD:  Right.  And even once you’ve identified all those tiers, which as you said is an arduous process.  How do you then evaluate where your highest risk spots are?

WILLY SHIH:  Risk assessment is really key.  Because as you look through those tiers then you can say, well, how easy is it for me to substitute somebody else?  Are there alternative sources of supply?  Find those ones where they have a high revenue impact to me, if one or more of those suppliers is unable to deliver for whatever reason.

A lot of other ones you can mitigate some of these risks by saying, well, maybe I’ll carry more of a stockpile because that will give me time to find an alternative.  But what you want to really do is find the ones that cause you the most potential heartburn.

ALISON BEARD:  Yeah.  So, the solutions you’ve mentioned so far, one is stockpiling.  Another is bringing sourcing closer to home. And then process improvement.  That seems to be your favorite solution.

WILLY SHIH:  Process improvement is my favorite one.  Especially for companies like in high cost regions like the U.S. or Europe.  If you think about why manufacturers outsourced their supply to Asia or East Asia, or South Asia in the first point, place, it was to save costs.

Process technologies is, process technologies are constantly moving forward as well.  Depending on the field, if you can use newer process technologies that may be lower cost then you can offset some of that cost differential of going into higher cost country.  Let me give you an example.

After World War II, the American steel industry was on, was the king of the hill.  We were the largest steel producer.  In fact, American industry, it won the war.  And the American steel industry did very well in the late 40s and 50s, and even into the early 60s.  But then they started facing competition from Europeans, especially Germany, but also Japan.

And after World War II, for example, Germany and Japan, their steel industry was in ruins.  But as they rebuilt, they used newer technology – that were more efficient, produced better quality, at lower cost.  But incumbent manufacturers who has their existing process technology, that was fully depreciated, were slow to adopt the newer technology.

Now, we’ve seen that pattern in many other industries. Where I think this is particularly relevant is when you look at chemical manufacturing.  For example, active pharmaceutical ingredient manufacturing.  The new technology that I think would afford a lot of opportunity to the Western manufacturers is continuous flow manufacturing.  Now, it’s still a nascent technology, but there are firms that are working on it in the U.S. and other places, and what it does is it allows you to use much lower capital intensity, smaller reactors, higher temperatures and pressures, and it should produce less waste products.  It should be more efficient.

And, it would be an opportunity to kind of obsolete the installed base of the incumbents.  So, it’s those types of things that I think about and obviously, there are other newer technologies like 3D printing, which especially when applied to metal.  I’m a big fan of that in terms of low cost manufacturing of tooling, for example.  Or, things that really change the equation on labor intensity and could give you an, could give a manufacturer an advantage if you wanted to step up and use kind of that newer technology and produce things at lower cost.

ALISON BEARD:  So, how do we incentivize companies and their leaders to focus on an invest in these things, in a period of recession, reduced consumer demand, hence lower sales?  And then also in an era when there’s pressure to keep people in jobs?

WILLY SHIH:  Well, I think one of the things that I’ve observed in this pandemic and the recession that’s going with it, is that companies who use the crisis as a way of unfreezing their ways of working, unfreezing their organizational processes, adopting new ways of doing things.  Those are the ones who I think can survive and thrive.

The ones who hope that things will go back to the way they were, and are just waiting for it, we’re already seeing a lot of problems there.  So, I think what managers need to understand is I’ll have new challenges.  There will be pressures to regionalize manufacturing.  At the same time, I’m not going to have levers to increase prices as much as I’d like.  What am I going to do differently?  How am I going to think about my processes?  How am I going to organize my supply chains to give me kind of that more resiliency?  What should I move?  What can I rely on distant sources for?

We see a lot of discussion about cutting dependence of China.  I don’t, I don’t think that, that’s necessarily an answer in all industries.  Maybe I want to diversify my sources.  We already see many firms diversifying to like a China plus one, or China plus two, strategy, moving into Southeast Asia, and moving to South Asia.  So, that means I will find other low cost sources.  I will take some time to invest in developing alternative sources.  And then just having kind of a more robust mix of my sourcing strategy and my logistics strategy moving forward.

ALISON BEARD:  In a way it seems like companies should be trying to employ all the strategies that we’ve talked about.  A little bit of stockpiling, some diversification and then also process improvement.

WILLY SHIH:   It’s going to take using all these things.  I don’t think there’s any one thing that, there’s any one solution that everybody will be able to apply.  It’s going to depend on your sector and what kind of alternatives you might be able to develop and how long will that take to develop?  There’s a lot of impatience about this supply chain resilience and reshoring.  I like to remind people that it took 20 to 25 years for China to capture the supply chain in many products.  And if you want to move the supply chain, we’re not talking about something that will happen in a year, or a couple of years.

ALISON BEARD:  We also have approached this issue very much from the point of view of the big car manufacturer, the refrigerator manufacturer.  What about if you’re on the flip side of this?  You run the small business that makes the best widget and you’ve been supplying all these large companies and now, you’re facing the prospect that they actually don’t want to only rely on you anymore.  What can those small businesses and the suppliers be doing?

WILLY SHIH:  You know, it’s kind of a two-way street.  People are finding they were far too over dependent on a particular sector, or particular manufacturer.  That says diversification is one route you can take in terms of I want to diversify my customers, I want to diversify the sectors that I serve.  We’ve seen a lot of pivots where firms have really moved into, moved into new areas, moved into new ways of serving customers as well.  So, it goes back to, I have to unfreeze my organizational ways of working and think about new things that I can do with those capabilities, new opportunities I can address.

ALISON BEARD:  This obviously is a topic that’s highly relevant for people in manufacturing, consumer goods.  But what if I’m a leader of a software or a services company?  Should I care about all this and if so, what should I be doing to improve the situation?

WILLY SHIH:  Well, even software and services businesses have adopted global footprints as well.  And we’re not just talking about Asia or South Asia, but we’re seeing software companies having part of their footprint in Eastern Europe for example, or Ireland, or lots of different places.  I think the key steps are really first understand what are your risks?

Just as, is the case with the manufacturing network, understanding what are the risks to my people, especially in services businesses and mobility, or access?  We have seen that, for example, big time in all these visa restrictions that have suddenly been imposed on many foreign nationals, not just in the U.S., but in a lot of other areas.  So for companies that relied on the movement of people, this has been an impact as well.

So, I think the same type of risk assessment and casting a wider net in terms of what kinds of things can happen?  I think the scale of the disruption we’ve seen with this pandemic has been unimaginable to people.  While I think after this, the whole scenario planning and risk assessment will take on a whole new meaning.

ALISON BEARD:  You mentioned how long many of these changes will take to implement.  But what about the things that we need to overcome this pandemic?  Medicine, tests, vaccines.  Can the companies producing those things move more quickly to make sure they go into production and get into the hands of consumers more quickly?

WILLY SHIH:  One of the things that I think has been very gratifying that I have seen in the pandemic is how the crisis has unfrozen how a lot of companies act.  So, a great example has been in medical ventilators.  I’m on a board of a company that manufacturers a lot of medical equipment for other companies and they came to us and many companies came to them saying, how fast can you put ventilators into production for us?

And normally, for a new FDA licensed device that was a two year manufacturing process and they shortened that to maybe 12 weeks.  Now, I suggested to the team, it’s like OK, two years down to 12 weeks, what does that say you could have done had the crisis not stimulated that?  So, we’ve actually seen a lot of pivoting and a lot of this kind of unfreezing of organizational routines.

And I think companies need to think about gee, look at what we did in the face of this crisis.  What does that say about what we potentially could do during more normal times?  I was interviewing a number of people at a big financial services firm that moved thousands of people to work from home in about a five day period which was really remarkable.  And they had actually set up an assembly line for employees as they came through the lobby of the building so they could equip them with everything they needed to do.  And then when the, one of the things they found that people’s productivity actually went up as a consequence of this.  So, I think this crisis has really unearthed a lot of possibilities and that actually gives me a lot of optimism.

ALISON BEARD:  Well, hopefully organizations and consumers will be able to figure this out.  Thanks so much for joining me.

WILLY SHIH:  Thank you.

ALISON BEARD:  That’s Willy Shih, Professor at Harvard Business School and author of the article, “Global Supply Chains in a Post Pandemic World.”  You can find it in the September/October, 2020 issue of Harvard Business Reviewer or at hbr.org.

This episode was produced by Mary Dooe.  We get technical help from Rob Eckhardt.  Adam Buchholz is our audio product manager.  Thanks for listening to the HBR IdeaCast.  I’m Alison Beard.