Covid-19’s unprecedented impact on the global economy has been notable for its simultaneous disruption of both demand and supply. As nations and industries restart the economy, resuscitating supply chains is critical.

A typical modern car comprises thousands of parts, each of which is required to assemble the final product. Measured by value, about 65 per cent comes from suppliers. Automakers typically source parts from several hundred suppliers, each of whom will likely have a dozen or more sub-suppliers.

This network usually casts a large footprint across the globe. Many automakers are not adequately familiar with the capacities, locations or constraints of their lower tier suppliers. Re-starting production will depend upon each of these hundreds of sources being prepared to supply the required parts at the expected rate, and each having access to an operational logistics network.

Suppliers in the industry have a similar construct to automakers and hence face similar challenges in this environment: managing cash, allocating investment and preparing their organisation for the future.

Near-term issues

The shutdown of the auto industry triggered by Covid has abruptly choked cash flows, leading many suppliers, especially the smaller ones, to acute financial stress. With limited reserves many of them may not survive the summer. Bringing alternative suppliers on stream at short notice is not easy. Creating new tools and production systems with requisite quality takes time, effort and expenditure — not easy in an economy just stirring from enforced hibernation.

Furthermore, the uneven pace of resumption of activity across regions and sectors results in uncertainty across all elements of the value chain. Many suppliers depend on contract labour — often migrant labourers who have been through considerable hardship and will take some time to return to work.

Demand uncertainty at each retail location will be amplified by the reactive and fast-changing production plans by automakers, leading to a whipsaw effect for production schedules expected from suppliers. Scarce capital will mean that no entity — not the dealer, automaker or supplier — will countenance being saddled with inventory that in normal circumstances serves as useful buffer stock.

In conducting military campaigns, US five-star General Omar Bradley used to say, “Amateurs talk strategy. Professionals talk logistics.” Any supply chain is only as good as the logistics system that supports it. Logistics service providers depend upon well-orchestrated schedules so that outbound and inbound loads are matched. Ferrying empty trucks and ships one-way destroys the economics of transportation. In the current circumstances, tracking and tracing of inventory in real time, from supply chain through the automaker to dealer points of sale, will become critical so that demand and supply mismatches may be anticipated and avoided.

Strategic challenges

The anticipated recession and corresponding demand sluggishness for the near term will encourage downsizing of capacity and in turn this is likely to motivate industry consolidation. Even before Covid, preparing for a shift towards electrification and a larger role for electronics, the auto industry had launched a flurry of acquisitions and mergers among suppliers. Now, suppliers whose finances have been ravaged will encourage a fresh wave of acquisitions by relatively well-funded rivals.

Traditionally, pressure for local content had compelled many automakers to persuade their suppliers to set up plants near their global production hubs in places like Europe, China and India. Already, Covid has caused many global automakers to retreat from some markets, licking their wounds. Renault has announced its exit from China while Nissan looks like it will pull out of much of Europe. GM had already exited India and Ford appears half way out the door. Without sizeable local demand, their supply chains in these regions may be vulnerable to re-sourcing.

The surge of nationalism across the globe was already gaining momentum before Covid. Mohamed El-Erian, Chief Economic Advisor at Allianz, asks: “How could the US, the champion of free trade, become the most protectionist advanced economy?”

The impact to the auto industry and its supply chain had figured prominently in the tearing up of NAFTA and its replacement by USMCA. Brexit and the implications of the UK leaving the European Union will disrupt the integration achieved for auto and component production across Europe. On an average day, 8,000 trucks cross the Ambassador Bridge connecting Windsor in Canada with Detroit in the US. A large fraction of them are related to auto supplies. Post Covid, additional safety protocols for cross-border transit of people and goods may render such supply chains less viable.

Three nations that had been prominent suppliers to the auto industry — China, Japan and South Korea — were also the ones that were hit badly by the pandemic. More than 75 per cent of the auto industry’s supply chains are directly or indirectly linked to sources in China. Covid has unleashed a new level of geopolitical and trade friction and the pressure to relocate China sources to local or near-shore sites has gained momentum.

Way forward

Going forward, supply chains will focus on three topics: resilience, flexibility and technology.

Covid has exposed the vulnerability of a globally optimised supply chain. Automakers have come to realise that efficiencies gained in the process have compromised resilience. It is clear that this will not be the last pandemic or natural calamity the world will face. As global disruptions become more frequent, supply chains will evolve to place more emphasis on adaptability.

Supply chains that pursued single-source strategies for economies of scale will increasingly involve a second source for the same part from a different geography. This redundancy will likely increase cost but will contribute to build in the required resilience. Capital and operational efficiency at more flexible and smaller scale of production will become important skills. Countries like India, where one-time set-up costs are competitive, can serve as attractive second locations for global sourcing.

Lockdowns under Covid have also highlighted the expanding role for digital technologies and virtual platforms. Post-Covid, protecting the workforce will require additional investment and cost. This is bound to encourage more automation on production lines. Many elements of Industry 4.0 that emphasised the value of cyber-physical systems in orchestrating complex manufacturing activities will become indispensable.

Tracking the lifecycle of a part and all its components through the production system will become more prevalent. Digital tools to sense, measure, monitor and analyse supply-chain performance will be increasingly employed to contribute to lower cost and better predictability and reliability of manufacturing.

As a rule of thumb, the supply chain employs six persons for every person employed at an automaker. So, as governments seek to revive their economies, flowing cash into the pockets of the working population, their focus on restarting supply chains and MSMEs is logical.

(This is Part 4 of a 5-part series)

(Dr V Sumantran is the Chairman of Celeris Technologies and Dr David Gonsalvez is CEO & Rector of the Malaysia Institute for Supply Chain Innovation. They are co-authors of “Faster, Smarter, Greener: the future of the car and urban mobility” published by the MIT Press in 2017)