Kevin Keegan Principal Partner at PwC US discusses global supply chain diversification in the manufacturing industry.
1. What is global supply chain diversification?
There are a couple ways to define diversification. One is with an eye on the Social element of ESG (Environmental, Social, Governance practices that promote value beyond revenue and profit growth). The Social component here is the mindful promotion of diversity and inclusion in the way direct and indirect suppliers are selected so that those providing services and products to a company promote employment diversity and good employee management practices.
The second is a combination of good Governance and Environment practices. Here, supply chain diversification is defined as the purposeful and integrated achievement of an appropriate set of options for sources of supply, location of transformation and routes to move goods and services that can rapidly be enabled. It includes playbooks on how to govern through disruptions – with clear accountabilities, required analytics and the like. Focus is on reducing risk for both revenue and margin goals in the event of both threats and competitive opportunities stemming from:
- Natural / health disasters
- Changes to trade policy or tax policy
- Labor actions and,
- Changes to the financial, capacity or ownership status of supply chain partners
This second definition can also include setting up supply chain activity to be ‘multi-local’ for purposes of lowering the carbon footprint, increasing the freshness / fulfillment lead time of products / services and lowering import tariffs. The rest of the replies in this note relate to this definition.
2. Why is supply chain diversification important for manufacturers?
It reduces risk of supply availability / risk of revenue and, when governed well, can help manage landed costs through how manufacturing and routing assignments are made in response to spikes in cost or new incentives that become available.
Diversification also helps with responding to competitive threats. One example is when a government floats an RFP but requires high levels of local content in order to be considered for an award of work. Without the ability to spin up local market capacity, a competitor with better diversity may be able to win the work.
3. What are the best practices for manufacturers looking to adopt a more diverse supply chain approach?
- Setting a finite set of high probability scenarios for risks along the lines of those depicted above and assessing how, specifically, the existing supply chain structure and governance process is positioned to respond in a way that is timely enough. This needs to be node by node and as a system with focus on identifying gaps / ‘single points of failure’. In addition to looking at internal capabilities, this gets into confirming capacity, financial structure, contract terms with key suppliers that would need to spin up or spin down their operations.
- These scenarios should be revisited semi-annually or annually depending on the clock speed of the industry (i.e. duration of product lifecycles, changes to base of customers or competitors).
- Setting priorities (with an investment budget / risk or investment return profile) to shore up weaknesses and a timeline to enact changes (considering enablers and dependencies).
- Setting progress reporting as a standard part of quarterly executive leadership discussions. Accountability is with the COO or SVP of supply chain.
- Creating executive leadership buy in (and board awareness) for the diversification plan.
- Educating line staff responsible to use tools to see issues / opportunities as they come up and how to respond. This requires playbooks by scenarios and ‘tabletop’ exercises on how to enact needed changes within the diversification levers that are available. This is the case whether it be a simple shift of some supply for a component from one supplier to another or a more complex change to set up an additional shift in a manufacturing site or spinning up a new logistics provider.
- Companies often share the diversity they have enabled to analysts and shareholders in quarterly / annual reporting as this work aligns to creation of long-term value.
4. What is driving the adoption of supply chain diversification?
Over the past few decades many supply chain activities have been increasingly outsourced and channeled to singular suppliers often with globally spread out nodes based on where low-cost labor and IP is located.
In 2019, tariff wars exposed companies that got over optimized / dependent on ‘single points of failure. The lessons on being priced out of the U.S. market when burdened with the additional import tariffs was significant for some companies across sectors (consumer, industrial products, high-tech)
In 2020, the dependence on spread out supply chain nodes without available options to move locations of supply or manufacturing was another driver as was the realization that there was too little transparency in financial solvency for supply chain suppliers and customers. There clearly was not enough diversity based on measures of financial health. Third, the pandemic revealed that contract terms to protect supply prioritization or inventory exposure risk were often missing or inconsistent.
Across the last few years, ESG has become an important screening criterion for investors. Lack of supply chain options that improve ESG metrics has also become a driver.
Collectively, these drivers have catapulted supply chain diversification / resilience to a board level issue given the impact on share price / valuation.
5. What are the challenges of supply chain diversification?
- Inertia: it is hard for a company to quickly exit a site, a supplier contract or a capital expense that has several more years of depreciation.
- Cost: it is costly to exit a site (severance, inventory write-downs, investment in risk sensing tools, move expenses, higher overhead to manage more suppliers, loss of local customer goodwill).
- Culture: optimization and goals for low supply chain cost as a percent of revenue are deeply ingrained in the way companies manage EBITDA. There is a major cultural shift needed to create resilience options, given diversification may drive up some costs but little utilization. While there is conceptual alignment to the risk protection that diversification provides and a nod to the ESG improvement that a diverse supply chain can provide, cost and margin will continue to dominate. Finding the right balance will require leadership from the top – with the right mix of quarterly results and longer-term value creation.
6. What are the benefits?
- Improved competitive positioning through reduced supply chain risk for revenue and margin goals.
- Potential for faster fulfillment lead time / lower inventory positions.
- Being more attractive as an investment for potential shareholders that are focused on companies working on their ESG profile.