When Your Supply Chain Gets Sick

by Bill Pifani Mar/Apr 2020

As the coronavirus continues to disrupt global supply chains, sectors with increased exposure to China, including technology, manufacturing, auto and retail, are most at risk. Can modern companies with experience handling supply chain disruption minimize the threat posed by the virus?

Bill Pifani Director of Credit Management TD Bank Equipment Finance

The coronavirus COVID-19 continues to disrupt global supply chains as it spreads throughout China, with more than 75,000 confirmed cases as of February 20, according to the World Health Organization. Generally, this has had broad implications for the market, but sectors with increased exposure to China — including technology, manufacturing, auto and retail — are most at risk. Products like semiconductors and smartphones that are extremely concentrated in the affected region are especially vulnerable.

With an increasing international reliance on Chinese production, this is likely to cause deeper disruption to supply chains than previous outbreaks like SARS. However, modern companies with experience handling supply chain disruption should be able to minimize the disruption from the virus.

Supply Chain Disruption

Global reliance on China has never been higher. Additionally, China has continued to grow as a consumer and represents
one of the largest economies in the world. The virus has caused major disruption to China’s workforce through travel restrictions and lockdowns, with The New York Times reporting that more than 150 million Chinese citizens were under coronavirus lockdown this February. All of this means that the possible disruption to the supply chain is extremely high.

In the past, when we saw large-scale disruptions from pandemics or natural disasters, multi-national companies were largely able to pivot production to new re- gions. However, since the SARS outbreak in 2003, multi-nationals have increased their dependence on China for production and distribution. China now accounts for 16%of global GDP, up from 4% in 2003, according to The Economist.2 During the SARS outbreak, multi-nationals were able to rely on built-up inventory and shift production to other regions without major disruption. It remains to be seen if other regions will be able to absorb the lost production from the coronavirus.

This is especially true for the technology sector. Industry giants like Apple have intentionally concentrated on China as a production hub, meaning that there could be an outsized impact on products like smartphones and laptops. Factories manufacturing iPhones and other devices were closed for weeks, and The Economist estimates that disruption from the virus could lead to Apple shipping 5-10% fewer iPhones in
the second quarter. Additionally, the virus outbreak has caused a decline for iPhone purchases in the region. As a result, the company had to slash its quarterly revenue forecast for the first time in more than 15 years, according to The Wall Street Journal.

The scale of the disruption will primarily come down to timing. The outbreak occurred at a time of year when many companies had already built up their inventory ahead of the Lunar New Year, which helped alleviate the immediate impact. Additionally, most companies were able to resume operations in most parts of China during the week of February 10.

However, the longer the outbreak lasts, the higher the risk for supply chain disruption. The initial hope was that the pandemic would be contained by March, but now the virus is continuing to spread. If containment of the virus is delayed until the fourth quarter or beyond, Dun & Bradstreet predict that the global economic cost could be as much as a full percentage point slowdown in global economic growth.5 China would fare even worse in this scenario, with the chance of up to a 3% blow to GDP growth. End-users may begin to feel disruption from coronavirus as soon as April, when experts estimate that we may begin to see empty shelves for some products.

Many companies will be able to pivot production to other regions, though this is likely to have a negative impact on pro t margins. It remains to be seen if companies have the capacity to fully ramp up production in other regions. Many multi-nationals have made long-term commitments to China, but in the short-term, they will need to nd a way to continue production.

Preparing For Disruption 

Disruption from coronavirus has serious credit implications for companies. Depending on the industry, companies may see a reduction in revenues, an increase in operating margins, a decrease in demand and lower net pro ts overall. This may result in lower cash flows in the second quarter, causing companies to have to increasingly draw down against revolvers in the short term, especially if they need to move operations to more costly locations while the outbreak continues.

The higher the reliance on Chinese production, the higher the current risk of disruption. Companies with a shorter-lead time replenishment model, like Target and Walmart, are especially at risk if the outbreak is not contained soon, as shipping remains disrupted in and out of the region.

Fortunately, multi-nationals today have ways to offset the coronavirus disruption. The majority of impacted companies already have financing in place to help alleviate situations like this. They will be able to draw down from existing revolvers and enter into sale-leasebacks to generate liquidity to help transition to new regions or offset downtime costs.

In the short term, companies need to get a sense of the risks to their supply chain by ensuring they have disruption monitoring and response programs in place for impacted regions. If there is a lack of transparency among lower tiers of the supply chain, it is important to prioritize discovery to get a sense of the full picture as soon as possible. Once there is a deep understanding of the supply chain, the next step is to adjust inventory to ensure it is kept outside impacted areas and logistical hubs. The World Health Organization also recommends companies work with their legal and HR teams to fully understand possible repercussions of not providing supply to customers and guidance to employees in affected areas.

Working Together

The coronavirus outbreak highlights how the global community has become increasingly interconnected. There are 51,000 multi-national companies with Tier 1 suppliers in the impacted region of China, according to Dun & Bradstreet. There are more than 5 million companies with one or more Tier 2 suppliers.

In this interconnected world, it is important for companies to work closely with their partners to help create risk management plans. By working with their suppliers to understand where supply chain risk may occur, they can proactively identify ways to respond in the event of a disruption — whether that is through increasing backlog inventory or identifying alternative suppliers. Additionally, borrowers should work with lenders to ensure that they have flexible financing to help them in the event of reduced cashflow.

In the long term, businesses will need to focus on preparing for the next possible disruption. Unfortunately, it is not a matter of “if” so much as “when” the next unexpected crisis may occur. To prepare, businesses need to balance running lean with building buffer stock of inventory. Diversifying their supplier ecosystem can further reduce risk.

Looking back on the coronavirus will surely have some lessons for multi-nationals, just as the SARS outbreak did for companies in 2003. The importance of a regionally diversified supply chain, inventory backlogs and risk management plans are all highlighted by the current outbreak. It is important to deeply understand the credit risks of a supply chain disruption event, and for companies to work closely with their financial institutions to ensure that they have the financing necessary to make changes to their supply chain.

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