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The only event that’s potentially even more significant than the Coronavirus pandemic itself is the 2020 financial crisis that will no doubt follow.
As the number of infected people increases, countries are taking more drastic measures to stop the virus from spreading. Tourism and travel-related companies, airlines, hotels, cafes, restaurants, recreational centers, and more are closed around the world. Small businesses and giant companies alike are suffering from the consequences of the lockdown as their value chain is encountering difficulties.
In the US alone, 7 million people lost their jobs in March. That’s the worst report since the 2009 recession. And with the unemployment trend steadily increasing in countries all around the world, it’s not a matter of whether we will face another financial crisis or not, but when and what we can do to limit its effects.
Learning from the 2008 financial crisis
In order to be able to predict the consequences of the 2020 financial crisis and devise a strategy, we must first take a look at the last recession we went through.
Twelve years ago, supply chains globally faced a challenge beyond anything ever observed in the past. As the economy spiraled downward, the tipping point was when Lehman Brothers, the fourth-largest US investment bank at that time, declared bankruptcy. The collapse of Lehman Brothers sent a shockwave through the financial world and triggered an unprecedented decline in the global economy.
The manufacturing sector suffered particularly severe consequences as a result. Industries like machinery, metals and transportation equipment faced drops in customer orders by up to 42% within a single year. Entire supply chains have been threatened with collapse.
The organizations that survived the 2008 financial crisis partly managed to do so by leveraging innovative approaches to safeguard their internal and external supply chains amid the challenging business climate.
Today, finding new approaches for managing supply chains will be critical. Already we are seeing the effects of the retail consumer orders drop. In the automotive industry, Honda announced that it will reduce vehicle output at two of its domestic plants in Saitama Prefecture due to concerns about parts supply from China.
What to expect of the 2020 financial crisis
Let’s take another example. In 2011, tsunami waves damaged the Fukushima nuclear plant. This had many unpleasant consequences, but probably the most important one in this context is that Apple customers had to wait more than six weeks to get their new iPad 2s.
The magnitude of the Fukushima incident is in no way comparable with this Coronavirus outbreak, yet it was more than enough to have a significant impact on Apple’s supply chain.
This time, a more crucial hub has been impacted - the whole of China, where 20% of global trade manufacturing originates. How will this impact the global supply chain? Honestly, no one has any idea of the full extent, as we’ve never faced a global crisis comparable with this one.
Also, multinational corporations don’t have full control over their supply chain, they usually only deal with the first layer of suppliers. But those suppliers also buy immediate goods and services from other suppliers, who buy from other suppliers, and so on. A single bottleneck can harm the whole supply chain. And shutting down Chinese production is a HUGE bottleneck.
The United Nations Conference on Trade and Development (UNCTAD) did a first assessment of the Chinese shutdown’s impact on global supply chains. China’s Manufacturing Purchasing Manager’s Index (PMI) fell by about 22 points in February.
This index is highly correlated with exports, and such a decline implies a reduction in exports of about 2% on an annualized basis. In other words, the drop observed in February, spread over the year, is equivalent to a 2% reduction of the supply of intermediate exports for February.
Industries and countries more integrated with the Chinese supply chain will be the most affected, especially when they rely on a just-in-time supply chain with very little room for adjustment. According to UNCTAD estimates, a 2% reduction of Chinese exports in intermediate inputs will transmit through the supply chain negative consequences of $5.8 billion in the United States, $5.2 billion in Japan, and the catastrophic amount of $15.6 billion in the European Union.
And these are only the consequences of the Chinese outbreak and containment measures. The estimate does not consider locally-originated crises, such as in Italy, nor does it include demand-side shocks.
How organizations can prepare their supply chains
Management actions in difficult times include:
engaging in significant cost reduction (including overhead costs);
introducing zero-based budgets;
establishing war rooms;
redefining footprints and networks.
In addition, it’s crucial to plan for the inevitable and prepare the supply chain to deal with tough times.
In a supply chain context, there are five action areas essential to coping with any type of crisis situation, individual as well as economic:
1. Understanding true demand
One key lesson from the 2008 financial crisis was that numerous companies underestimated the severity of the decline in demand, which reached 90% in some industries. Forecasting demand is the starting point of all planning, so it’s crucial for organizations to first understand true demand.
Successful companies pursue three key actions to improve their understanding of demand:
identifying reliable demand information: establishing a process to monitor the probability of order cancellations that is similar to the processes for monitoring the probability for winning orders;
frequent communication with customers and reducing the forecast horizon;
developing various demand scenarios.
2. Monitoring suppliers
Sales and demand are not the only things organizations should worry about. The risk of losing suppliers and entire supply chains due to bankruptcy should also be accounted for. Specifically, in the current type of crisis, where the economy came to an abrupt halt almost immediately, there may be multiple situations of blockage down the supply chains, due to either lack of cash, lack of workforce, or both.
Advanced supplier risk management systems include:
identifying supplier criticality: supplier criticality needs to be evaluated based on the risk of supplier insolvency;
monitoring supplier health and lead times;
ensuring the survival of critical suppliers: paying invoices on time rather than stretching payment terms, for example, can ensure additional favors in the future as well as the relative financial health of these key suppliers.
3. Creating flexible supply chains
Procurement managers should proactively address demand uncertainty and create supply chains that are flexible to a wider range of demand. Successful organizations:
understand the effects of demand fluctuations and match capacity with demand;
convert fixed costs into variable costs: it’s crucial to do so to compensate for lower production levels by diminishing marginal costs;
define smart contracts: organizations often close long-term contracts with suppliers to benefit from discounts; however, once locked in, volume or price reductions often depend on the goodwill of suppliers.
4. Adjusting inventories
Reducing inventories while meeting service-level requirements has always been a challenge for supply chain managers. There are three practices that enable managers to avoid, or at least balance, the inventory hump:
avoiding surplus inventory intake: even if contracts don’t allow order cancellations, organizations can negotiate with suppliers to extend volume commitments over longer periods.;
adjusting inventory policies;
streamlining service offerings: organizations should reduce their service levels to move from a full-service to a cost-efficient setup.
5. Preparing for the upturn
As the 2008 financial crisis began to ease one year later, many supply chain managers were caught by surprise by the sudden economic upturn. However, some organizations that took a far-sighted approach were prepared for this and managed to gain significant market share by meeting customer demand while their competitors struggled to get back to full capacity.
Many organizations suffer significant losses during financial crises. However, by addressing the five key areas described above, they can become less vulnerable to downturns.
Overall, we encourage organizations to continuously improve their strategies, no matter the current economic situation. If you’re ready to improve your supplier relationships right now, check out Prokuria’s key features and request your demo now!