Summary
This week’s newsletter addresses 3 supply chain risk related topics; 1) dependence on China 2) risk of a debt crisis and 3) strategies to reduce your risk.
The speed at which companies and countries reduce their dependence on China is a hot topic. On one side of the argument is risk mitigation, political incentives, and brand reputation. The Covid-19 pandemic has accelerated the search for alternatives that was well underway due to the tariff battles.
On the other side of the argument, there are the economic forces of cost, quality, delivery, infrastructure, and access to China’s massive market. That’s a strong case for staying invested in China. This has led to the concept of a “China plus One” strategy. The link below, “Can the U.S. End China’s Control of the Global Supply Chain”, provides some context on the forces that will drive the speed of the shift. It is likely to be industry dependent.
Continuing on the theme of supplier financial-risk from last week, I’ve included the recent article, “The Looming Bank Collapse”, from The Atlantic. There have been recent articles warning of the rising corporate debt risk. (Just do a search and you will get many viewpoints.) This one is of particular interest because it suggests what might become the trigger for a debt crisis.
Finally, I’ve include the podcast link for “How to Identify & Mitigate Risk with a Category Continuity Plan” from Philip Ideson at Art of Procurement builds on last week’s risk mitigation strategies. It is an excellent high-level summary to get you thinking deeper on your strategy.
Top Links
Can the U.S. End China’s Control of the Global Supply Chain? on SCB from Bloomberg, June 15 (6 min. read)
- Many companies have already begun adopting a ‘China plus one’ manufacturing hub strategy since the U.S.-China trade war began
- Japan, Taiwan, South Korea, India (cell phones) and the US are providing incentives to build domestic capacity
- China remains unmatched as a manufacturing site given its numbers of skilled workers, deep supplier networks and the government’s support (when compared to developing country alternatives)
- The biggest force reducing China’s position will likely be the slow evolution of global trade, as companies see opportunities that arise from new markets, new technologies and changing patterns of wealth
The Looming Bank Collapse The Atlantic, July – August 2020 issue (12 min. read)
- Collateralized (corporate) loan obligations or CLOs have grown to nearly a trillion dollars in value
- For 30 “global systemically important banks”, the average exposure to leveraged loans and CLOs was roughly 60 percent of capital on hand
- 67% of the loans are rated BBB and 15% are rated CCC, which are considered likely to default during economic downturns
- Like 2009, the credit-rating agencies may have been underestimating vulnerability of these loans, assuming too low cross-industry correlation
Analysis: In recent years, global GDP has been driven by rapid expansion of debt, particularly corporate debt. This equates to pulling in purchases (i.e. expanding demand) and companies responding by expanding capacity to meet that demand. This could come to an abrupt end if defaults continue to accelerate, causing interest rates to rise. A debt crisis would shut down liquidity for many companies and stress their ability to fund their business. In addition, the world will be in a situation of significant over capacity when the loan money stops. Remember the Y2K demand pull-in?
It is easy to dismiss this scenario as being too cataclysmic. But historically, debt crises have occurred every 70 to 80 years. The Federal Reserve began a policy of purchasing corporate debt for the first time ever in May of this year, apparently to head this off defaults of “fallen angel” companies. However, if the US moves to higher taxation after the election, removing capital from the private sector where productivity occurs, the likelihood of a debt crisis will go up. Supply Chain leaders along with their C-suite team should give serious thought towards developing a strategy for this scenario, with the election outcome being one of the triggers.
How to Identify & Mitigate Risk with a Category Continuity Plan Art of Procurement Podcast – June 15 (16 min. listen)
The six key steps to follow to create your business continuity plan, and why the focus is about ensuring you are well-informed
- Understand your inherent risk – Which product or service will cause a significant problem, alternate supply, supplier, time period to switch
- Map your supply chain – Identify sources and processes and potential points of failure
- Plan for different risk scenarios – e.g. pandemic, financial, reputational, natural disaster, political, etc.
- Identify points of failure – Use FMEA to look at probability, severity, and how easy it is to detect a failure
- Determine which mitigation strategies to invoke – e.g. Make vs buy, dual sourcing, scope and specification changes, near-shoring, inventory management, KPI and governance improvements, strengthening partner relationships
Build out a response plan for when there are: 1) changing conditions, 2) an impending event, or 3) surprises with no warning. Identify a risk response team with roles and responsibilities ahead of time
Note: I am posting my past letters at sc-exec.com/newsletters and have added the ability for people to subscribe. Please feel free to forward the newsletters to your colleagues.
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Best regards,
Don
Don K Brown
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