Realign or reshore your supply chain

800,000 Chinese business are now bankrupt — How many are in your supply chain?

Back on Feb. 6, in response to the Chinese quarantine of 780,000,000 people, I wrote about the step-by-step sequence that would, in time, lead to an extraordinary transformation of the global supply-chain process. There would be significant changes in China, principally the bankruptcy of hundreds of thousands of companies.

It would not happen all at once, of course, but over a period of months as the crisis that began as an issue of global health  turned to one of workforce, productivity, quality and, with the fullness of time, liquidity and cash flow.

Once the Chinese firms started to go under, unsuspecting and trusting companies in North America and Europe who were patiently and stoically waiting for the quarantines to end and the stay-at-home orders to be lifted would be faced with an unpleasant and nasty shock.

The long-awaited supplies and components that they had anticipated were never coming. They never made it to the containers and the containers were never loaded on ships that were never coming. Phones and emails went unanswered — there was no one there to address their urgent queries.

When we predicted this, we faced criticism as those less familiar with the reality of Chinese manufacturing practices declared “fear mongering.” Some went so far as to claim that once the health crisis was in decline we would be back to “business as usual”.

They were wrong and we were right.

What actually happened

Early in April Blue Water Growth got word that a blogger (a respected writer on Chinese issues who publishes in Mandarin) had advised that the months of January and February had a total of 247,000 bankruptcies. To put this shocking number in perspective, that is a rate 6,400 percent higher than the average bankruptcies for a two-month period in the U.S., which would be roughly 8,300 bankruptcies.

Solid validation followed when the South China Morning Post, the extraordinarily reputable newspaper of record for Hong Kong, dropped the headline that documented 460,000 Chinese firms closed in the first quarter. They recorded that in the first quarter of the year new business registrations fell by 29 percent. Even China’s National Bureau of Statistics issued a report in late April verifying that in the first quarter of 2020 the China GDP contracted by 9.8 percent.

To put that in perspective, the Chinese government hasn’t reported a contraction in the economy since 1976, the year that Mao Zedong’s death ended decades of financial turmoil. Forty-four years of unrelenting and unabated economic growth has just come to a sudden and dramatic halt and reversal.

Looking ahead

Keeping in mind that bankruptcy and collapse normally accelerates with time under crisis as dwindling cash reserves disappear, things are going to get much worse.

With the further pressure caused by the fact that in mid-March numerous states had issued mandatory shelter-at-home orders closing all but essential businesses, any possibility of saving China from massive business collapse evaporated as U.S. businesses closed temporarily and new component orders for China manufacturers ground to a halt.

What China experienced was a literal “perfect storm” — a combination of decades of trends that pushed expenses up and cut earnings on many companies to the thinnest of margins, so that when the Covid-19 crisis smashed down upon them they simply did not have the financial staying power to outlast months of closures. Those few that did manage to stay alive then found 60-plus days of vital European and North American customers unable to answer the phone or place orders.

The most modest and conservative extrapolation of what happened in China in the first quarter of 2020 leads to a reasonable conclusion that by the end of June at least 800,000 and possibly a million Chinese companies will have gone bankrupt and closed. For virtually everyone reading these words, the possibility that in the entirety of your supply chain — everyone in the chain that supplies you and every vital buyer above you that purchases your product — will escape unscathed is nearly impossible.

What does it mean?

The question of how damaging these Asian business closures will be on America will be determined, in part, by how swiftly we acknowledge this reality in response to this crisis.

Yes, some large and powerful companies in China with deep pockets or those that are partially owned by the government or who are related to national interests such as defense, food and transportation will undoubtedly survive with massive infusions of government cash.

Still, many of the firms that supply the everyday items to American shelves for consumers to utilize or who provide sub-components and sub-assemblies or even simple plastic parts to American manufacturers and assemblers will not survive or are already closed. Their factories are padlocked and critical molds and fixtures necessary for the American parts are gathering dust and rust.

What should be done?

First, take the advice of Jack Welch and follow his rule No. 1 from when he first took over at GE. He said, “Face reality, face it as it really is, not as it was or as you wish it to be.”  From my recent conversations with business leaders across the U.S., a whole lot of people need to start here because the numbers above tell a tale of economic global restructuring that’s going to hit America hard.

If you think it’s going to be business as usual, then you’re going to be hit the hardest.

Next, take a cold, hard look at the entirety of your supply chain, brutally combing through risks and leaving no stone unturned in assessing areas of possible weakness. Keep in mind that you may have a fantastic device with virtually 99 percent made in America or even in your own factory but if one critical small piece of custom-made plastic comes from Wuhan, that device will not be operable or sellable.

You’ll need all-hands on-deck to look at this and to ferret out risks and dangers. Bring in help if you have to, but this needs to be done sooner rather than later. Once critical risk areas are identified, seek alternatives and workarounds, even if that means a quick redesign of a part or an adaptation from an earlier model that is still operable.

Long term, our best advice is straightforward: Realign or reshore now

With hundreds of thousands of Chinese businesses already gone, one alternative is to look to other Southeast Asian nations who have been steadily studying and learning over the past decades and whose expertise and prowess may already rival that of China. There are strong manufacturing cores in Malaysia, Thailand, Cambodia, Vietnam, the Philippines and India.

Another possibility is putting more volume into Mexico or Latin America. Keep in mind that training will be required and that the capacity of these nations is not infinitely elastic, so that if you delay long enough in a global realignment of your supply chain requirements, even people eager and enthusiastic to offer assistance may simply be overwhelmed by the volume of demand flowing out of China.

More importantly, however, strongly consider reshoring and bringing this work back to the U.S. Numerous powerful trends argue that the timing is excellent for such a transition.

While our labor costs might be higher than some foreign producers, quality and labor efficiency can offset this differential. The assistance of robotics and automation can further reduce the reliance on international labor rates. Further, there is a global resurgence in the importance of self-reliance and self-responsibility amongst many nations. This surge is powerful in the U.S., but we have also seen similar efforts resonating in the United Kingdom.

There is a growing sense that the enthusiasm for super-lean supply chains, just-in-time models and a purchasing process pushed to shave tenths of pennies off of component prices has served to lead us into a financial fantasyland where we respect boosted earnings while paying lip service to the extraordinary risk that fragile and narrow supply chains have created. That pendulum is swinging back, and swinging hard.

Companies are taking a closer look and finding that decisions of extreme outsourcing that supported bottom-line growth but created enormous enterprise-level risk are not, perhaps, prudent decisions after all.

Blue Water Growth further expects tax policy and legislation to give further benefit to companies that seek to build employment in manufacturing back on American shores. It’s about time.

Let’s not kid ourselves, it’s going to be a rough five years. The damage has taken decades to create and we won’t be able to undo it all in just a few months of concerted effort. To paraphrase the words of President John F. Kennedy,  in his inaugural address, “All this will not be finished in the first 100 days. Nor will it be finished in the first 1,000 days. But let us begin.”

It is time for American businesses to get to work bringing the work back. Let us begin.

 

David Iwinski Jr. is the managing director of Blue Water Growth, a global business consulting firm with extensive on-the-ground experience and expertise in Asia. Its services include merger and acquisition guidance, private capital solutions, product distribution, production outsourcing, and a wide variety of business advisory services for its Western and Asian clients.