Trade Policy Whiplash is the New Norm. How Do Companies Maintain the Integrity of Their Supply Chains?
By Jim Rice, Kai Trepte and Ken Cottrill
Managing global supply chains is not for the faint-hearted, especially in today’s nerve-wracking political environment. The last few weeks have tested even the most battle-hardened practitioners, as companies have scrambled to react to abrupt changes in government trade policy.
How do companies steel their supply chains against wildly fluctuating levels of political risk? Also, will the impact of these maneuverings change the contours of supply chain risk management?
Trying times
At the end of May 2019, President Trump threatened to impose an escalating series of tariff increases on Mexican goods if the country failed to step up its efforts to combat illegal immigration into the United States. In 2018, US goods and services trade with Mexico totaled an estimated $671 billion, and the supply chains that support this massive trade would be thrown into disarray by the proposed tariff regime.
Not surprisingly, the threat triggered a flurry of analyses as companies scrambled to assess its impact and what contingency plans they should put in place. The US imported more than $110 billion in vehicles and parts from Mexico last year, and lobbying groups “warned that tariffs on Mexican-built vehicles and parts would be passed on to buyers and dent car sales, hitting a pillar of the American economy,” reported the Wall Street Journal.
A week or so later President Trump announced that the tariff plan would not go ahead since the United States had reached an agreement with Mexico on immigration. However, the threat remains. US Secretary of State Mike Pompeo reportedly said that the tariffs could still be applied if the United States does not see results in four to six weeks.
Meanwhile, the US trade war with China continues, and across the Atlantic, the never-ending Brexit saga continues to cloud the outlook for trade in Europe.
Contingency measures
In such an uncertain political climate, companies have had little choice but to prepare for the worst.
Take, for example, the prospect of a hard Brexit where the UK exits the European Union without an agreement. As the Financial Times reported, firms have built inventory and reconfigured supplier networks in anticipation of a no-deal divorce. For instance, Hitachi’s train manufacturing unit has localized most of its supply chain to the UK, with 70% of parts sourced within 70 miles radius of its main plant to mitigate supply chain risks (a strategy that can also make the company more vulnerable to localized risks such as natural disasters and local policy changes). A risk assessment released by aircraft manufacturer Airbus estimates that the company could lose about $1 billion a week in sales following a hard Brexit.
In the US, we see some responses to the threat of tariffs. One of the largest companies in the world, Walmart, has reportedly adjusted its supply practices to allow suppliers to rapidly request price changes in response to trade policy shifts.
According to the Financial Times, Cisco is reaping the rewards of its distributed supply chain by shifting demand away from China in anticipation of higher import tariffs. “When you have capabilities in multiple countries, it’s not so hard to do,” said Cisco Chief Executive Chuck Robbins. As a result, the impact of higher tariffs on Cisco is expected to be minimal.
Expect to see more actions by companies to deal with sudden shifts in trade policy.
Past research on supply chain resilience carried out at the MIT Center for Transportation & Logistics (MIT CTL) has identified various action and measures that companies can take to mitigate this type of risk. These include mapping and assessing supply chain risks, creating cross-functional advisory committees to monitor events, running scenarios of potential trade situations, helping suppliers to respond, choosing a portfolio of flexibility and robustness action plans, business continuity planning and adjusting the rate of investment in affected areas of the supply chain.
Such measures provide an excellent start, but the business environment has changed drastically over recent years, and these well-established actions to mitigate political risk may no longer be enough.
What’s different?
Traditionally, supply chain resilience strategy has focused on dealing with the uncertainty associated with disruptions that take capacity offline. Trade policy whiplash calls for a new approach that involves changing supply chain design — not just recreating capacities. Here are some critical components of such an approach.
· Supply, communications, transportation, human resources, internal operations, and financial resources are among the capacities that need to be recreated. Examples of incidents where these capacities were compromised are the Japanese Sendai disaster in 2015 that eliminated electronics and automotive supply capacity for many companies, and the Eyjafjallajokull volcano eruption in 2010 that removed air transportation capacity.
· Companies that are the economic engines of countries need to think about changing their modus operandi from being optimized for a low-tariff policy environment to a completely different design suited to high tariffs and trade barriers. This shift fundamentally changes supply chain design. For example, global supply chains are typically designed to source materials and ship to customers globally because of relatively free trade agreements. The sudden introduction of tariffs and barriers could force companies to reinvent their supply chains to put more emphasis on sourcing and producing locally (in market).
· It follows that resilience needs to be redefined as the ability to change supply chain design rapidly to keep pace with changing trade agreements (or lack thereof). Executing such a change is no small task. The inertia and cycle time for most business operations may exceed the rapid pace of trade dynamics. Within, say, one month, trade barriers may be erected and removed. However, supply systems operate much more slowly; cycle times from source to the customer are often measured in months. Today’s supply chains lack the agility required to keep pace with trade policy gyrations.
· If companies don’t keep pace, there will be wasted capacity, higher costs, and unknown impacts from the uncertainty and inability to react to change. These additional costs will be passed along to consumers, which could dampen demand if disposable incomes fail to keep pace.
· Countries have limited ability to direct corporate action except those that depend on central planning (although even these countries may not be able to direct their production enterprises to respond at the desired whiplash pace). In a free market economy, markets drive company behavior, which is typically a slow process. For example, it can take several years at least (and billions of dollars) to build a new semiconductor or automotive assembly plant; qualifying critical suppliers can take many months or longer. Moreover, future trade policy changes might undermine today’s supply chain model, locking companies into a never-ending game of catch-up.
Unanswered questions
The new emphasis on continuous supply chain design changes leaves us with more questions than answers.
· Can supply chains react quickly enough?
· Is it better to stay with one supply chain design and only change after signals indicate that there will be a lasting trade policy environment?
· Alternatively, is it better to adopt a supply chain design that is not optimal for any trade policy, but instead is a reasonable fit for multiple possible trade policies?
· At what point should firms decide to change their current design? For example, for the firm that sources from China and produces in Costa Rica, what are the signals that tell them to source and produce locally?
· How should firms deal with these other systems which may stand ready for alternate trade policy environments? A globally sourced supply chain has many assets around the world — does it shift to a model that involves more local assets and leasing or outsourcing facilities to third parties such as 3PLs?
· There also are organizational questions to be address. For example, should supply chain establish closer links with the internal government affairs department to ensure that the function has its fingers on the political pulse? Proactively reaching out to relevant government agencies can also help to keep supply chain attuned to legislative changes. Connecting with governments also helps legislatures to understand the short- and long-term impact of policy shifts on supply chains.
Call to action
Whether or not you agree with the Trump Administration’s brinkmanship, it will continue to agitate the business community at least until the next election. Supply chain professionals can expect more short, sharp shocks to the system as the Administration yo-yos between imposing punishing trade policy rules and abruptly walking them back in short order.
Moreover, if President Trump is re-elected, these gyrations will likely become a long-term feature of the trade landscape. Even if he is not re-elected, Trump’s tactics may have permanently reshaped US trade policy.
How should the supply chain community respond?
MIT CTL is planning further research to shed light on these issues. We welcome your feedback and participation.
For further information and to provide feedback, please contact Jim Rice, Deputy Director, MIT CTL at jrice@mit.edu. Kai Trepte is Research Associate, MIT CTL, contact him at trepte@mit.edu. Ken Cottrill is Editorial Director, MIT CTL, contact him at kencott@mit.edu.
