Supply Chain Resilience

As China imposes it’s largest lock-down since the early days in Wuhan, the United Kingdom is shedding the last of its pandemic restrictions. Numbers alone do not explain the distinction. [Updated through April 4, see below.]

According to the South China Morning Post, “Shanghai reported 3,500 new locally transmitted cases on Monday, most of them with mild or no symptoms. More than 10,000 infections have been found through mass testing in the past week – over 9,900 of them asymptomatic.” (More)

Over the weekend the United Kingdom confirmed more than 215,000 new infections. The recent surge in the BA.2 variant has hit Scotland especially hard. But Scotland’s legal restrictions related to covid were still discontinued on March 21. Wales has since taken similar steps. England began unwinding last month, even as hospital beds were filled about as much as during the omicron surge (see chart below)

China’s legal, political, and cultural context facilitates more rigorous restrictions than the UK. China’s public health demographics arguably justifies more containment. Vaccination rates in Shanghai are close to 80 percent, but Sinovac (CoronaVac) has demonstrated less efficacy against omicron and BA.2 (more). More than 130 million Chinese over age 60 have not been vaccinated. British vaccination rates (with a so-far more efficacious mix of vaccines) have approached 90 percent of the over-sixty population. The United Kingdom has hospital intensive care capacity about one-third larger than China. Different risks motivate different responses.

It is also worth acknowledging that the risk of more virulent mutations persists in China, UK, and wherever transmission invites adaptation.

The Wall Street Journal observes, “A lockdown in Shanghai marks another potential setback for China’s export machine, reigniting concerns over the risk of renewed disruption to global supply chains pummeled by the pandemic and war in Ukraine.”  This is possible. There is also evidence that disruptions can be mitigated.

Supply chains prefer — work hard to create — continuous, predictable flows. What we are seeing in China — the world’s largest exporter — is analogous to a three-year-old fascinated with toilet flushing downstairs while upstairs a teenager is in the shower. Big sister may still get clean enough, but she will not be happy. Mix in disrupted financial and commodity flows (especially for petrochemical and agricultural volumes) related to the Russian invasion of Ukraine, some indiscriminate cyber destruction, and a host of other risks and the whole family feels very much on-edge.

March 31 Update: According to the Financial Times: “China’s manufacturing and services activity contracted in March for the first time in almost two years, highlighting the economic strains of the government’s strict coronavirus measures. The official manufacturing PMI, a gauge of factory activity in which a reading of 50 separates monthly expansion from contraction, fell to a five-month low of 49.5. The non-manufacturing PMI dropped to 48.4, its lowest level since August.”

According to Loadstar: “The Shanghai lockdown is playing havoc with Chinese supply chains, driving up inland logistics costs and disrupting shipping schedules…”

April 1 Update: Bloomberg has a long-form assessment of China’s options — and potential implications for the rest of us.

April 3 Update: All of Shanghai is now locked down. According to the Financial Times: “Shortages of food and medicine have left residents in China’s biggest city desperate and frustrated as authorities struggle to gain control of a Covid-19 outbreak.” According to an April 2 report in the Global Times (Chinese language, official Communist Party publication), a new variant of coronavirus is now confirmed as being transmitted in Suzhou, near Shanghai, “The infection was sequenced and compared to the BA.1.1 evolutionary branch of the VOC/Omicron variant strain. No highly homologous sequences of the novel coronavirus genome were found in the database.” (Google translation). Meanwhile in the United Kingdom, last week the coronavirus infection rate reached an all time high (more), without prompting new public health measures. The currently surging BA.2 version of the virus is highly contagious but typically features mild morbidity. Does the high transmission rate increase mutation probabilities? Yes. Britain is betting its “carry on” approach to living with covid is worth the mutation risk (more and more). China has, so far, decided the risks remain too high. But containment costs have also accumulated and are increasing. By Easter BA.2 will almost certainly be surging in many parts of the the United States.

April 4 Update: The Financial Times has a long-form assessment of China’s counter-pandemic policy and practice: “the measures introduced in Shanghai on March 28 highlighted the government’s commitment to a now-globally unique strategy — fine-tuned across outbreaks from Xi’an to Shenzhen — of attempting to completely eliminate local cases no matter the economic and social costs.” Bloomberg is reporting on new mutations (more). This report’s tone and details are cautiously optimistic, emphasizing cautions. Loadstar reports, “Covid lockdowns in China, war in Ukraine and the threat of hyper-inflation are a toxic mix of unpredictability for liner trades, but they have so far not had an impact on container freight rates. Indeed, container spot rates, although trending down, are broadly in line with normal seasonal falls and, moreover, ocean carriers are succeeding in driving-through significant contract rate increases.”

The Wall Street Journal has produced a video primer on recent supply chain stress. It is fifty-four minutes of well-researched, well- produced insight on sometimes hidden aspects of sociology and technology and their intersections. I have characterized supply chains as “socio-technical systems,” so I am sympathetic. The video is a great companion piece to Arriving Today: From Factory to Front Door by WSJ reporter Christopher Mims. This soon-to-be classic will appear again and again in classrooms nationwide. (And… the critical role of demand is referenced occasionally, but too easy to neglect along the way. Concentration effects are implicitly referenced (e.g., “ports” and “clusters”), but may not be obvious to many viewers. The focus is mostly on US domestic supply chains. This is mostly the story of shelf-stable flows. And, somehow, the producers are not aware of my argument (more and more) that not every instance of disequilibrium between demand and supply should be labeled a “shortage”. But in less than one hour we see and hear much that we really need to know.] Probably worth your time…

February retail sales were the highest on record, one-fifth above February 2020.  See first chart below.

Despite — because of? — this robust spending, American consumers continue to have significant cash reserves. The M2 money supply in February is very close to late December’s record-setting high. The USA currently has about one-third more cash on hand than pre-pandemic. See second chart below.

Mostly this is due to reduced-spending during the pandemic and “Economic Impact Payments“.  The Personal Saving Rate was much higher than usual from March 2020 until September 2021. Wage growth has also been strong, especially since May 2021. See third chart below.

As a result — regardless of supply chain “shortages” and inflation — many Americans continue to pull very hard on supply.  Inventories remain tight.  Individual products and even entire categories can mysteriously ebb and as suddenly flow again.

This level of demand — and potential demand — is unusual (perhaps not seen since the late 1940s). Current demand is motivating maximum throughput of current production and distribution capacity. But the structure of this demand and prospects for its continuity are uncertain or, at least, product or category or sector specific. Investment in additional production and distribution capacity is strong, but uneven — depending on perceived longevity of current demand.

To resume reliable flows requires reclaiming an improved equilibrium of demand and supply. There is evidence that disequilibrium is not getting worse. There is not — yet — persuasive evidence of equilibrium emerging any time soon.

This is the seventh — and perhaps final — in a series of posts examining supply chain resilience reports released by the White House on February 24.

Most of the “Sectoral Supply Chain Assessments” are grounded in recent challenges, especially pandemic-prompted problems. The energy report is an outlier with much more attention to emerging issues of climate change (more).

Each report tends to be preoccupied with upstream concerns and complications related to sourcing and production capacity.

Each report gives attention (some more, some less) to potential over-concentration of upstream flows. Significant dependence on proportionally few high-volume nodes and channels increases network vulnerability. This could be the most helpful insight identified by the reports — when accurately and meaningfully received.

None of the reports give much attention to the influence of downstream demand on upstream behaviors. Mid-stream is sometimes treated as almost detached from up or down. In my judgment, this tendency fails to reflect fundamental realities.

All of the reports are mostly examples of the public sector — really just the federal sector — talking to itself. This can be helpful, especially if this internal process is conducive to ultimately involving other sectors in well-conceived shared conversations. [Conducive: connect, bring together, collect, join, assemble]

As a collection, the assessments are culturally coherent (reflecting a generally shared understanding of problems and problem-solving-processes), but strategically inconsistent, maybe even strategically incoherent. Key connections between the five policy documents examined here (also see note below) remain obscure or simply absent. This is not uncommon (or even unexpected) from a year-long interagency process. But supply chain practitioners, network scientists, and even some public servants will be annoyed by the interstitial opportunities lost in the process.

I want to avoid damning with faint praise. I recognize earnest, expert effort expended on a very difficult problem-set during a troubled time. I know the challenges of interagency policy-making well-enough to envy no one involved therein.

I also discern in these reports an implicit, fairly consistent operating thesis that would benefit from more explicit consideration. Behind the references to resilience are concerns about scarcity or shortages or insufficiencies. Medical personnel operating without Personal Protective Equipment and car factories closing because of unavailable parts and empty shelves where meat or soup or toilet paper have usually appeared are all recent realities. But in the vast majority of such cases, supply has not been scarce (as in rare, diminished, or poor), rather supply being pushed has often increased, but demand has pulled even faster.

Demand and supply networks (worthy of the designation) organize around demand to achieve a rough equilibrium of pull and push. The give and take of demand and supply is tangibly interdependent (and mirrored in more fungible financial flows). In mature-capitalist high volume, high velocity networks, scarcity is typically more relative than real. A disequilibrium of demand and supply may well reflect a shortage of what is wanted by producers or consumers. But this need not reflect reduced supplies. In early March 2022 grocery stock-outs in the United States are most often the result of reduced capacity to load and drive delivery trucks, not reduced production. In March 2020 grocery stock-outs in the United States were the result of a doubling or more of demand in a two week period. Swift shifts in demand capacity or distribution capacity are much more frequent culprits than lost production capacity.

Disequilibrium can certainly be caused by scarcity. A drought (literal or metaphorical) may unfold into famine for those unable to relocate closer to necessary flows (or attract such flows towards them). But it seriously complicates problem-solving to treat disequilibrium caused by flooding as if it was the result of drought.

Rather than assume scarcity, we should seek to discern disequilibrium as an expression of dynamic interdependencies encompassing both demand and supply, density and distance, differentiated durations, capacity and capability, pull and push. Supply and demand interact to create flow, assimilating aspects of both supply and demand.

On Tuesday a private-public group convened in the Old Executive Office Building. Around the table were enterprises, such as Albertsons, Target, and True Value, that focus on consumer demand. Others, including Land O’Lakes, focus on supply. Several at the table concentrate on moving supply toward demand by water, air, or land. Midstream — long-distance to last mile — was especially well-represented. These organizations have agreed to start-up a “first information exchange that will support a more resilient and fluid supply chain.” The voluntary collaborative effort is branded “Freight Logistics Optimization Works” or (of course) FLOW. According to the White House, the meeting participants discussed,

… greater data transparency across the supply chain and how this would benefit not only their respective companies but also the system more broadly, cutting waste and reducing costs for consumers. Participants acknowledged the current system is underperforming and needs greater investment and more collaboration in creating ship to shelf visibility into the primarily private-sector owned supply chain. A more reliable, predictable, and accurate information exchange about goods movement is the hallmark of a globally competitive 21^st century goods movement chain and is especially important for small- and medium-sized businesses who lack visibility into the current system. (More.)

This is an early step to facilitate ongoing communication across the various phases of flow, allowing collaborators to observe and engage a more comprehensive context — something close to the full watershed of flows — not just near-term consequences of near-by discharges. In this way, it is hoped, individual participants will be able to adapt earlier and more effectively — even collaboratively — to factors that could disrupt flow.

There are plenty of reasons for FLOW to fall apart before having a chance to demonstrate value. There are even more reasons to hope the initial participants are soon joined by many others. Enormous value is possible if participants can work through tough technical issues, treacherous competitive dynamics, and complicated regulatory prospects. FLOW is a co-laboratory where all the contending, pending perceptions set out in the supply chain assessments can be empirically and practically engaged — clarified, corrected, and even confirmed.

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Still to come is a brief note on the sixth Sectoral Supply Chain Assessment by the Department of Defense. It will appear below at some future date (maybe this weekend).

March 19, 2022 Update:

Among the February 24 Sectoral Supply Chain Assessments is DoD’s “Securing Defense Critical Supply Chains.” Of the six One-Year assessments delivered, this is arguably the most sophisticated with balanced attention to critical needs, systemic capacity, production/ distribution vulnerabilities, and aggregate demand. For those involved in the Defense-Industrial complex, this is a helpful analysis and set of recommendations. In my judgment, however, even with a $700 billion-plus budget and admittedly contentious, complex demand signals, DoD’s planned procurement supply chain is substantively differentiated from demand and supply networks organized around mostly unplanned purchasing decisions by tens-of-millions of independent consumers. For example, Americans spend more than double the Defense budget on Food At Home and another double on Food Away from Home. Supply chain thinking is relevant to military missions — as dramatically demonstrated in Ukraine. But there is a command-orientation to the Defense supply chain that is antithetical to the highly competitive demand-orientation of high-volume, high-velocity commercial ecosystems. This is why I have not given this assessment the same attention as to the other five.

This is the sixth post in a series examining the supply chain resilience reports released by the White House on Thursday, February 24.

The Departments of Commerce and Homeland Security collaborated on an Assessment of the Critical Supply Chain Supporting the US Information and Communications Technology Industry. Particular attention is given to 1) Printed Circuit Boards (PCB), 2) Fiber Optic Cable, 3) PCB Assemblies and Electronic Assemblies, 4) Routers, Switches, and Servers, and 5) LCDs/Displays.

The report includes this explanation of strategic context:

Over the past 30 years, the ICT [Information and Communications Technology] industrial base has evolved from being vertically integrated to being one that is highly outsourced, with most major brand companies outsourcing nearly every step of and input into the manufacturing process. Beginning in the mid-1980s, original equipment manufacturers (OEMs) in the computer industry, such as IBM and Cisco, that traditionally managed end-to-production services, began outsourcing manufacturing and software development to specialized technology companies, such as Intel (microprocessor chips) and Microsoft (operating software), and to contract manufacturers. Contract manufacturers are companies that perform manufacturing services for other companies on a contractual basis. To produce a computer, these OEM companies could no longer design and manufacture their own computer chips or develop operating system software, but instead, so that their equipment was compatible with everyone else’s, outsourced these needs to companies specializing in those products, such as Intel and Microsoft. This process, called vertical specialization, led ICT OEMs to focus on design and innovation of new and improved technologies. Over time, OEMs have increasingly adopted this business model with many companies eliminating all manufacturing capabilities. These OEMs now add value primarily through research and development, product design, and marketing new technologies to their customer base. By 2006, leading computer companies, including Dell, HP Inc. (formerly Hewlett Packard), Acer, and Apple, had completely outsourced their notebook manufacturing operations. The U.S. ICT industry reflects this evolution of the OEMs. The United States is the world’s leader in technology innovation, but most hardware manufacturing takes place in other countries. (Page 15)

The authors argue that as a result of this evolution, the ICT industrial base in the United States is not an ecosystem. The United States is an important source of downstream ICT demand and upstream intellectual/financial investment in ICT. But this domestic push and pull depends almost entirely on sourcing, processing, manufacturing, and transportation capacity outside the United States. If I am accurately reading between-the-lines, the authors may even be skeptical that the global ICT network of demand and supply fits the definition of an ecosystem. ICT manufacturing capacity is, potentially, so specialized by function, consolidated by enterprise, and concentrated by geography that it is much more an engineered network than a complex adaptive system. This is a provocative possibility. The February 24 report implies much more than it claims in this regard.

Even if the ICT industrial base better reflects the physics of the factory than the ebb and flow of watersheds, it is a huge and fantastically complicated factory. The report outlines:

A large multinational organization can have hundreds of tier one suppliers from which it purchases components directly. In turn, each of those tier one suppliers relies on hundreds of tier two suppliers. The whole supplier network for a large company can include tens of thousands of companies around the world when the deepest tiers are included in the network. For many companies, especially small -and medium-sized businesses, it is very difficult, if not impossible, and costly to obtain an accurate and complete picture of an organization’s entire supplier network. Making this effort even more difficult is the fact that a company’s suppliers can change on very frequent basis. Communications Equipment companies are one of the industries that have the largest number of tier one suppliers, with 2.2 times the industry median. (Page 60)

Eight recommendations are offered to increase the supply chain resilience of the ICT industrial base. I perceive that at least five of the eight (and potentially all eight recommendations) are intended to, first, reduce the current geographic concentration of ICT production capacity and, second, re-shore significant production capacity to the United States. There is a particular concern for reshoring manufacturing of PCBs and related assemblies. I do not recognize much emphasis on reclaiming a global or domestic ecosystem featuring significant diversity and independent self-organization.

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This series of posts started with acknowledging my bias regarding Supply Chain Resilience. For my principal purposes, the ICT sector is fundamental to how digital transactions and inventory management — and related network pulls — are organized and communicated to reflect demand. The Departments of Commerce and Homeland Security — appropriately — are concerned about other purposes. I am concerned mostly with facilitating downstream demand. They are concerned (mostly) with ensuring upstream supply of ICT capacity for my purposes and other purposes. These are complementary, not competitive angles. But it is also worth noting the strategic expanse extending between these two priorities.