Impact of coronavirus on the global supply chains

A brief summary of the impact of the COVID-19 in the supply chains

It has been a short period of time since the COVID-19 entered our lives, but the virus has completely modified our routines. Nothing is as it used to be also in the supply chains and the future to come is uncertain. The impact of the change may depend on how quickly  trade recovers.

As a matter of fact, the demand patterns have been drastically modified, reducing the overall consumption but favoring the basic products over the rest. The production strategies based on the internationalization and the until now successful inventory management methods based on the just-in-time methods are now under scrutiny, and companies may now look to more conservative inventory approaches and less internationalization to ensure manufacturing. Key stakeholders in the supply chain such as the shipping lines or the trucking companies may suffer again from overcapacity and new consolidations and bankruptcies may come back to the picture. In most of the cases, government support may be critical to provide relief to the sector. As a matter of fact, many countries have already started to take actions.

In the present article we are presenting our views on what could be the implications for each of the main elements and stakeholders in the supply chain. There are many uncertainties, but we have tried to summarized the main elements in the table below:

Impact_01
Source: ALG analysis and industry reports

How did this get started and what were the first impacts?

Novel Coronavirus (COVID-19) was first identified in Wuhan, capital of China’s Hubei province, in late 2019. The number of people infected by the virus reached 100,000 by March 7, 2020, of which 80% were registered in China. Hubei, the epicenter of the pandemic, registered the largest number of cases.

The Chinese Government took quick steps to slow down the spread of the new virus. A complete lockdown was enacted and was implemented throughout the communities, organizations, and cities.

Prior to the lockdown, China supplied the world with huge range of products ranging from toys, apparatuses, FMCG, electronics, automobile spare parts, etc. The total value of trade that China participated in 2017 was 3.95 Trillion USD.

Right after the lockdown, part of the industries within China stopped producing and thus the import and export volumes partially decreased. This decrease was also partially affected by some kind of deceleration of the Western economies.

Right after this, the coronavirus quickly spread in other regions outside of China. After one month of registering 100,000 cases, the number of cases registered in April 7, 2020 was 1.3 Mn (China had only 6% of the total cases). The countries that have become heavily impacted by the coronavirus were some of the leading economic powers in Europe (Italy, Spain, UK, France and Germany) and later it was the turn of North America (United States of America). Those countries have entered into lockdown and closed totally or partially their production plants.

Overall, the coronavirus had different impacts depending on the industries and the trade. Overall retail, tourism, shipping and apparel are some of the sectors that were heavily impacted by the coronavirus.

Impact_02
Source: Moody’s Investors Service

At the beginning, panic-buying had its toll on retail shops, resulting in shortages in commodities, especially essential goods such as medical supplies, food, and cleaning products. The existing stock in the warehouses dropped. For products sourced from overseas, those products will either not be shipped to the final destination or reach the final port of destination delayed (due to the reduction in vessel capacity and due to slow steaming). All of the previous exposed the weakness of the just-in-time model implemented in the supply chains.

In parallel, the trade of nonessential commodities suddenly decreased, mainly due to the decrease in the supply, the lower demand per se and some government regulations. Some countries, such as South Africa, have banned the clearance and release of shipments that are not essential. The decrease in the trade of the nonessential goods started to have an impact on the exports from China.

At the same time, in the case of the production, many factories had to temporarily shut down as several of their components were not available as the supply chains were disrupted. It is worth remembering that during the last three decades the economies have been integrating and the productions were distributed worldwide reducing at the same time the level of stocks. As an example, some of the manufacturing of some well know products like the iPhone require the participation of more than 40 countries. Other products such as the automobiles or the airplanes also involve the participation of a large number of countries and therefore may suffer in case of borders’ closure (see below the assembly line of Airbus).

Impact_03
Source: Modernairliners.com

When is the recovery in the World trade expected to happen and how?

Taking a look at history, the world trade was having a consistent growth until the financial crisis of 2009. After the steep decline during the Financial Crisis of 2009, global trade experienced an annual average increase of 1% between 2011 and 2018, following a new trend line with lower growth.

Before the COVID-19 crisis, an economic conflict between the world’s largest two national economies, United States and China, started in 2018 when the US administration implemented tariffs on certain commodities to reduce the trade deficit and promote domestic manufacturing. The China-USA trade war contributed to trade tensions and slowed the global economic growth, having as a result a decrease of the imports and exports in value of an average of 2.9% between 2018 and 2019.

The economic shock brought by the coronavirus was compared to that of the financial crisis of 2009. Governments have developed policies to counter the upcoming downturn. Governments and countries have imposed strict regulations to minimize the spread of the virus, resulting in the stoppage of various sectors. This impacted household income, transport, travel, labor supply, etc.

Based on the previous, the World Trade Organization (WTO) estimates that the annual global merchandise trade will decrease between 13% and 32% in 2020. All the regions will suffer significant drop in their trade volume. It is expected that North America and Asia will be the regions that suffer the largest drop. Complex sectors, such as automotive manufacturing, will be more affected by the virus due to trade restrictions than other less complex sectors. Estimating the trade recovery in the upcoming years is highly dependent on the duration of the virus spread and the success of the policies.

The experts are still debating if the world trade, due to the impact from the coronavirus, will either rebound to follow the historical trend or will develop a new trend – “post-coronavirus trend” as it happened after the financial crisis. World Trade Organization has forecasted the development of the world trade under two scenarios as shown below depending on the type of recovery.

Impact_04
Source: WTO

How has it or how is it impacting the supply chains during the initial stages (quarantine)?

The decline in trade, caused by the coronavirus, will affect supply chains in a different manner in three different timeframes: quarantine period (6 to >10 weeks, depending on country), post-quarantine period (2 to >6 months, depending on region) and a period of normalization (>1 year).

Supply chains will be especially affected during the quarantine period, due to the decrease in demand of most non-basic products and the operational constraints linked to health measures established by governments. A potential scenario of the impact of COVID-19 in the supply chains during the quarantine period has been studied.

Demand

The uncertainty and the economic shock will cause a sharp drop of end-consumer demand for most non-basic products, impacting the demand upstream to B2B a raw material. The confinement will also cause a change in shopping patterns, from physical to e-commerce, affecting businesses that are not capable of offering such service. However, medical/ pharma related and national security products (food, security, equipment, etc.) will experience a peak in demand.

Production

Production will suffer disruptions caused by operational constraints linked to healthcare measures, business continuity plans that are applied, and shortage of supplies from tier-2 to tier-3 suppliers and, eventually shortage from utilities in developing countries. Potential delays in payments and the drop in market prices will put margins at risk and lead to financial stress.

At the same time, part of the industries (mainly automobile, cosmetics and fashion) are being temporarily reconverted to produce basic products, especially medical appliances and pharma products. Many of these companies are working 24/7 to ensure the supply.

Impact_005
Source: Industry reports

Inventory management and stocks

The impact on the inventories has been different depending on the sector and the type of company. Overall, companies driven by “push” supply chains have risks of overstock due to the cut in demand, while for others the disruptions in supply chains and the surge of e-commerce may lead to a potential stockout, especially for companies with aggressive and very lean inventory management policies. As we have seen during the first days, the panic in some supermarkets helped to the stockout of basic products.

In parallel to the impact on the inventory levels, the effectiveness of warehouses might be impacted due to the implementation of new health measures that could reduce the performance.

Transportation and logistics

The transportations and logistics subsector may experience direct impact from disruptions in supply chains due to:

  • The contingency plans by shippers and FFW, targeting to secure capacity & reliability combined with the modification of the demand and supply patterns.
  • The drop in the availability of offering (e.g. air passenger services discontinued, closing of land borders for drivers, changes in shipping routes…) leading to price volatility
  • Potential disruptions in customs operations to ensure the health and safety of its employees as well as the changes in the demand

As an example, the shipping lines reacted by removing capacities to meet the sudden drop in demand. For instance, for a service that has a frequency of two times per week, the shipping line can reduce the capacity by 50% if the frequency is changed to once per week. Those shipping lines did that by assigning blank sailing, impacting the availability of space on the vessels and changing the traditional container positioning patterns. In several markets, the availability of empty containers was an issue.

The reduced vessel capacities and the blank sailing have impacted the export trade in certain countries. Several local carriers further service suspensions while others have introduced PSS (Peak Season Surcharges) charges to the containers. Other shipping lines have not added the PSS charges as the bunker prices have decreased because the current supply of bunker exceeds that of the demand.

Impact_06
Source: ALG analysis

Infrastructure investment

The critical infrastructure investments maintenances will continue, but potentially causing delays in the expected delivery dates. As for non-critical ongoing investments, they will potentially stop due to operational restrictions (health measure or lack of supplies), risk of default for those assets are dependent on highly disrupted logistics chains (e.g. airports) as well as due to the new financial priorities of the governments and the private stakeholders.

Government Policies

In the short term, the support from governments is expected in order to reduce economic shock, mainly through the injection of liquidity, and waiving or reducing logistics related taxation, including port, airport and customs duties, along with incentives. However, national security measures might be applied to critical sectors and supply chains and some logistic assets could eventually be nationalized.

Different countries around the globe have already started to implement these policies to try to soften the short-term impact.

Impact_07
Source: ALG analysis and industry reports

What could be the expected impact in the supply chains in the mid and long term?

Demand

In the short term, the consumer demand should be measured. Two potential scenarios are identified, which are the recovery of the peak demand or the failure to achieve a full recovery due to the conservative consumption that the households are exhibiting. Industrial demand is reactivated post confinement. This trend will take place two to more than six months (depending on the region) post quarantine.

In the long term, the economy can exhibit a slowdown due to the decrease in business activities, government expenditure, and increase in unemployment. Those paraments will have a domino effect across the whole society, which will lead to a decrease in the overall consumer demand. Instability in currency exchange could lead to potential inflation effects after central banks injections. Moreover, customer behavior is expected to change, which will have an impact on sectors such as retail, tourism, education, leisure and travel.

Production

A few months after the quarantine, production patterns may change compared to the historic patterns due to the limitations in the availability of supply and the actual demand. Companies will follow new strategies to increase and further diversify their suppliers, and rearrange the production facilities to minimize the disruptions. Certain companies, especially SMEs, will face difficulties in attaining the necessary liquidity, impacting their operations. Some of the companies, especially the ones with higher debt or lower competitive positioning, may disappear.

In the long term, companies will review their production strategies to meet their supply with the new demand expectations, the retaining economic outlook, and the suppliers’ availability. Companies will explore new mergers and acquisitions to align with the new adjustments in the sector.

At the same time, some governments (such as Japan or the Western countries), will start to implement stimulus packages to help manufacturers ship their production out of China reducing the East-West trade (in fact, this is already happening). It is expected that, with the support of the automation, certain industries will move out of China. Seeing the results of the crisis, medical appliances and pharma products could be some of these products.

Impact_08
Source: Industry reports

Inventory management and stocks

After the impact of COVID-19 during the first days and the stockouts, companies are expected to utilize more conservative inventory management strategies in the short term, partially ending the longtime used just-in-time inventory management policies, ensuring efficient production and availability of stocks even with a higher cost.

At the same time, in the short term, stocks of nonperishable products will be reallocated closer to customers. Companies will also readjust and optimize the use of their facilities.

In the long term, supply chain strategies will be reviewed to meet the new demand expectations, economic outlook and supplier’s availability.

There will also be a change in the real estate dynamics. Existing companies will consider the resiliency of their supply chain models to navigate the short-term lack of activity and the inventory surge to follow. Moreover, it is expected that the continued e-commerce adoption will definitely drive the real estate business towards new warehouses, increasing the total demand and the proximity to clients. In parallel, companies could search for means to diversify their manufacturing locations.

Transportation and logistics

Few months after the quarantine, services that are discontinued due to health measures may be ramping up to face the sudden surge in demand. Moreover, restrictions could be slowly be lifted to international flows, except for regions still affected by COVID-19 or with poor health guarantees. The process will first focus on prioritizing transnational economic unions.

In the long term, transportation offering and capacity will be revised to meet new demand expectations, economic outlook and supplier’s availability. Countries will gradually lift restrictions on international flows to meet local demand. Adjustments throughout the transportation and logistics sector will trigger potential mergers and acquisitions favoring those companies with better positioning and resilience. It would be possible to witness additional consolidation of ship lines and a change in the ocean alliances to bring more resilience to the oceanic supply chain.

Infrastructure investment

Several months after the end of the quarantine, companies will react with those investments that were stopped during the COVID-19 shock. Those companies may restructure the terms and conditions in the agreements for the assets that were heavily impacted by the COVID-19 financial stress. New force majeure clauses could be applicable in the new agreements.

For the long term, investment plans for the infrastructure projects may be revised according to new economic scenarios. Asset investment can be prioritized depending on newly set criteria for financial feasibility and strategic impact. Moreover, financing strategies may be revised to attract additional private sector participation due to increased public sector debt.

Government policies

Governments may readjust their expenditures in 2020 and 2021 budgets. In addition to that, governments may launch additional policies to minimize the negative post-COVID-19 economic impact (e.g. unemployment) based on short-term economic stimulation, leveraging on public sector debt. Governments may introduce new preventative measures to minimize risk of COVID-19 re-spreading in the country in the short-term.

In the long term, governments can review country-level master plans and vision objectives in line with the new economic scenarios. Those governments may launch new strategies to stimulate the economy’s recovery and could potentially increase the taxation to support public sector debt burden.

Impact_09
Source: ALG analysis and industry reports

About the authors
Rubén Naveiro holds a MSc. in Industrial Engineering and is a Director at ALG
Genís García-Alzórriz  holds a MSc. in Civil in Engineering and is a Manager at ALG
Mekhdi El Mussauy holds a BSc. in Electrical, Electronics and Communications Engineering and is a Consultant at ALG
For more insights, please check www.alg-global.com or contact:
rnaveiro@alg-global.com
ggarciaalzorriz@alg-global.com
melm@alg-global.com