China’s Zero COVID Strategy: Stairway to Heaven or Highway to Hell (Part V)

The China Supply Chain Nightmare

 As outlined in my previous article, the situation for SMEs in lockdown-affected regions is dire, in particular for those who rely on consumer spending and retail sales to generate cash flow and stay afloat. However, not all affected businesses rely on China’s domestic consumption to keep their operations running. After all, there is a reason China is dubbed the factory of the world, accounting for nearly 30% of the World’s manufacturing output (pre-pandemic levels, however according the last year’s UNIDO reports, China is recovering to pre-pandemic levels output) - the below infographic gives an idea of the weight of Chinese manufacturing on a global scale, and even though the 4 trillion USD value is from 2019, since then it has come closer to the 5 trillion USD mark:

Data Source: United Nations Statistics Divison (2019), HowMuch

With such a heavy weight on the world’s manufacturing, China’s Zero COVID policy and the ongoing lockdowns are heavily affecting supply chains and manufacturing. Industrial production fell 2.9% from a year earlier, compared with a 5% gain in March, the largest decline since February 2020. On top of that there is also the heavy toll on revenue, investment and staffing of many multinational firms. A recently released joint survey among members of the American Chamber of Commerce in Shanghai and American Chamber of Commerce in China, found that 99% of respondents were impacted by the recent outbreaks. Here are excerpts from the summary of the survey findings:

• Production: 60% of respondents reported slowed or reduced production because of a lack of employees, inability to obtain supplies, or government-ordered lockdowns. Among manufacturers, 82% reported slowed or reduced production;
• Supply chains: 57% of respondents reported that the recent Covid-19 outbreak had disrupted their supply chains due to disruptions in transportation and shipping networks. Among manufacturers, 86% said their supply chains had been disrupted;
• Revenues: 54% of respondents have decreased 2022 revenue projections following the recent Covid-19 outbreak, while an additional 38% say that it’s too early to estimate the impact on revenues;
• Investment: 29% of respondents have delayed investments because of the recent Covid-19 outbreak, while an additional 17% have decreased investments. Another 30% say it’s too early to tell how their investments will be impacted. However, 49% of companies will reduce investment if China’s current Covid-19 restrictions remain in place into the next year;
• Foreign staff: 81% of companies reported that China’s management of Covid-19 had impacted their ability to attract or retain skilled foreign staff, with 35% describing the impact as either large or severe;
• China’s Covid-19 management: 51% of respondents are satisfied with China’s efforts at controlling the spread of Covid-19. However, 77% of respondents are not satisfied with the length of quarantines, and 69% are not satisfied with restrictions on travel to China;

Apart from the impact of supply chain disruptions in companies’ operations, there is the bigger concern of how the lockdowns affect logistics infrastructures, particularly in what concerns to Shanghai, which is home to the world’s largest port. According to data from the Shanghai Municipal Commission of Commerce, its port accounts for over 3.2% of the world's total and handles about 20% of China’s exports overseas. As it is to be expected, Shanghai’s ongoing 2-month long lockdown is taking a heavy tool in the global supply chain machine.

As per this Fortune Magazine article, one in five container ships is now stuck at ports worldwide, with 30% of the backlog coming from China. And Lars Jensen, the CEO of the shipping container industry consulting firm Vespucci Maritime, told Fortune that the full impact of China’s policies will only begin to reveal itself over the coming weeks. And other experts agree that problems at ports mean rising costs for companies and increasing inflation for U.S. consumers, experts say.

Image Source: CNN News

“Companies are beginning to panic. The downstream impact is coming, and it’ll be heavy.” John Bree, the chief risk officer at Supply Wisdom, said. “The latest China lockdowns combined with the Russia-Ukraine war is too heavy a burden. The global chaos is going to further exacerbate disruption and take inflation to a new level.”

Dylan Alperin, head of professional services at the intelligent sourcing automation solutions provider Keelvar, noted that transportation costs make up 7.7% of global GDP, which means delays at ports typically lead to rising inflation. “The freight cost for a single container from China to the U.S. went from $5,900 last year to $15,764 today,” Alperin said. The impact of those price increases alone could significantly drive inflation up globally, he added.

Olgun Basel, Supply Chain Director at Einhell China, expressed his views and concerns last month since shipping lines began shifting a number of calls to Ningbo-Zhoushan port to the south. “There is evidence that the worst might have passed as the number of ships waiting to enter Shanghai and Ningbo has reduced as carriers were omitting Shanghai calls due to the drop in export cargo volumes. Waiting times at Shanghai have increased. Liner congestion is now considerably worse at Ningbo-Zhoushan as data compiled by Copenhagen based eeSea. The issue now will be the whiplash effect ports overseas will experience as and when Shanghai does reopen. Brace for impact.”, Olgun said.

Data Source: American Shipper based on data provided by eeSea, FreightWaves

However, contrary to what some looking from outside might think, the big issue is not the resumption of manufacturing activity, or the operations at the ports as much as it is the land travel. After all, there are many byways and highways in the flow of trade. Unfortunately, “zero-COVID” restrictions and lockdowns have either backed up these access ramps or clogged up the roads. And that in turn has led to many truck drivers being unable to enter or leave lockdown Shanghai. For the first few weeks of the lockdown, these truck drivers found several difficulties. Some were struggling with limited consignments from the city, while others could not obtain permits to leave Shanghai. Those stuck in Shanghai had turned their trucks into makeshift homes while running out of food, and their truck batteries were either dying or dead.

 Data Source: CNBC SupplyChain Heat Map, CNBC

This CNBC Supply Chain Heat Map, created along with 10 of the world’s top maritime and logistics data providers, also shows the challenges hitting supply chains (special note to the trucks red line on the chart). “In Shanghai, ocean terminals, warehouses, and trucking services are operating as normal but with lower efficiency due to staff shortages and lack of drivers,” said Brian Bourke, chief growth officer of SEKO Logistics.

Steve Saxon, a Partner at McKinsey & Company in Shenzhen and specializing on Travel, Logistics and Infrastructure, gave an insightful look at the ongoing effects of the Shanghai lockdown, (also raising awareness to these truck driver shortage constraints):

• Most Shanghai factories remain closed, although some are operating in what is being called ‘closed loops’, where the workers are living physically on site at the factory;
• Even these factories have reduced production levels because they are unable to get the same amount of inputs from their suppliers because of less trucking and also because they are able to move less out to the ports for export because, again, of the lacking of trucking infrastructure;
• The container port of Shanghai is still operational and there are still 80% of the previous volumes moving through it. Workers at the port are working there under the same ‘closed loop’, and there are no significant backlogs of container ships;
• Container liners have maintained service in Shanghai, even though in a few cases they have cancelled some sailings because there is a reduced amount of cargo;
• There was an increase in callings to other ports, notably the Ningbo port in Zhejiang, which are probably to handle cargos that would have otherwise leave through Shanghai, and have extended wait times at the port by 10%;
• The number of airline freighters in and out of Shanghai are down by 60% due to a lack of cargo handling capacity and to the lack of trucking capacity;
• Some of the air cargo capacity is being diverted to Xiamen airport in Fujian, however it is being overwhelmed because Shanghai is by far China’s largest cargo airport;

Image Source: CNR Shanghai Airport Group, PORTtoPORT

If there is one thing that is clear, it is that the COVID-19 pandemic has changed the supply chain. Two years into the pandemic, the global supply chain continues to sputter and break down. Each day comes news of choked ports, out-of-place shipping containers, record freight rates, and other problems that cause disruption and defy easy answer. Perhaps the best way to summarize these changes is by looking at the World Economic Forum’s article (part of the Davo’s Agenda) which pinpoints 5 ways in which the supply chain has changed thanks to COVID-19:

1. Supply chain now a key focus of the C-suite - The supply chain finally has the C-suite’s attention, and chief supply chain officers are its new stars. Bank of America also noted mentions of “supply chain” in Q3 earnings calls by Fortune 500 companies had risen an astonishing 412% from Q3 2020 and 123% from Q2 2021 earnings calls, when boardroom focus on the issue was already red hot. Some 59% of companies say they have adopted new supply-chain risk management practices over the past year, including diversifying to reduce over reliance on China;
2. Business continuity more important than costs - Before the pandemic, cost reduction and productivity enhancement were driving supply chain process improvements, digitization and investment. But the existential crisis brought on by the pandemic has forced companies to shift the focus of innovation and restructuring efforts to ensuring business continuity by building resiliency and flexibility;
3. Buyer-supplier relations have been altered - In certain industries, the failure of critical links in the supply chain has led to new alliances and co-development ventures between original equipment manufacturers (OEMs) and suppliers. There is a recognition that resiliency is impossible unless buyers, suppliers and other parties along a value chain are willing to share data and collaborate.
4. Supply chain workarounds are now standard - Bold companies are not waiting for supply lines to untangle themselves – retailers short on storage space are buying warehouses, shippers that can’t find containers are making their own, and companies unable to book with ocean carriers are chartering vessels, while those unhappy with their online sales are buying e-commerce fulfilment operators;
5. The inventory playbook has been ripped up - Companies know that disappointed customers might not return. That is why some consumer products brands are desperate to conceal stockouts and low inventory. More fundamentally, others are questioning the supply chain models they have worked so hard to make hyper-efficient. Automakers that spent decades perfecting just-in-time (JIT) systems have started to break with JIT practices because they do not work when there are critical component shortages. Toyota, Volkswagen, Tesla and others are stockpiling batteries, chips and other key parts and racing to lock up future deliveries.

The global pandemic shocked the established supply chain systems which relied on 'lean' practices or 'zero stock' policies bringing supply and demand severely out of balance. And the bottom line is this: unless you are the one waging the daily battle to move cargo for your organization, you should step back and look at the larger picture. Because when ports eventually clear and rates come down, the way we manage and think about the supply chain is going to be very different.

In the short-term it is all about diversification for MNCs. Using different ports, different routes, different suppliers. Diversification is key! And whenever possible, diversification on the on the receiving end can also prove a winning (more stable) strategy.

In the long run, companies must take their supply chains more 'agile' so as to better cope with rapid and unexpected changes to the environment. And it is perhaps now more urgent than ever to look at alternatives. One example is that of leaving China for Mexico as an alternative manufacturing destination, which has been on many American CEOs minds for years. Dan Harris, founder of Harris Bricken, an international law firm mostly represent companies doing business in emerging market countries like Asia and LATAM, has been a strong advocate of this assessment/move (Mexico) and points to several attractive factors such as Mexico’s high focus on the U.S. Mexico Canada Act (USMCA). And even though Mexican manufacturing cannot replace China yet, Dan points to several ups and downs and matters to consider if and when attempting to make this shift.

Yet, despite the negative outlook, expanding production in China remains a strategic focus on many other CEOs minds. According to The Conference Board Measure of CEO Confidence for China (2022 H1 Results), only 17% of the surveyed CEOs of China’s MNCs say that reshoring to their home regions (US and/or Europe) to take advantage of new policies/investment incentives is underway, with none having actually done so yet. Meanwhile, increasing capacity in China remains an important strategic focus. 60% of China CEOs say they have invested, or have plans underway, to expand production capacity in China.

So, end of the day, what is the right course of action? What are the long-term implications to those who have become too reliant and have no short-term alternatives other than relying on China? Or those who intend on investing in China even further? Has the exposure to China become too big and should there be a larger emphasis on risk assessment based on this reality?

I will explore more in my next article.

__________________________________________________________________________

This is an 8-part article series, which delves into the latest developments and impact of China´s Zero COVID Policy:

1. China’s Societal and Healthcare Concerns
2. The (Acceleration of) China’s Expat Exodus
3. The Costs of China’s Zero COVID Strategy on the Economy
4. The Costs of China’s Zero COVID Strategy on SMEs
5. The China Supply Chain Nightmare
6. The World and MNC’s Exposure to China
7. Deglobalization and Decoupling: Myths and Realities
8. Updates on China’s National and International COVID Policy

*All data, images and news sources have been properly hyperlinked in the article.

#China #Coronavirus #COVID19 #ZeroCOVID #ChinaLockdown #ShanghaiLockdown #RMBMoreira