Rebalancing the World’s Supply Chains

Edward Barriball

Partner at McKinsey & Company

Learning Objectives

The COVID-19 pandemic is only one of a series of disruptions that are increasing in frequency and severity. Every decade, companies lose half a year's EBITDA, on average, due to supply chain disruptions. This is a critical moment, particularly for companies affected by a multitude of events in recent years from severe weather events and geopolitical tensions to technological disruption and talent shortages. The decisions executives make and the moves their suppliers take next will be critical. Join us for a discussion on how resilience directly ties to a company’s ability to withstand value-chain shocks and the pivotal role of operations for a stronger, more resilient future.

Key Takeaways:

  • Recognize the notable factors that play into value chain exposure

  • Learn what actions are needed to build resilience for the next normal

  • Understand the long-term payoff of resilience measures for companies, workers and societies

"If you're digital in your supply chain, at your fingertips, you should be able to know everyone that you're buying from, what you're buying from them, what plans they're coming from. "

Edward Barriball

Partner at McKinsey & Company


Hi, my name is Ed Barriball. I’m a partner at McKinsey & Company’s Washington DC office, and a member of McKinsey’s Manufacturing Supply Chain practice.

I spend a lot of my time working on supply chain risk and resilience. Many of my clients have been worried about this topic for the past several years due to a lot of changes in the world. There’s been a rising occurrences of floods and storms due to climate change, cyberattacks have gotten much worse and shown they can truly disrupt operations. We’ve experienced trade tensions and change in trade agreements. Given that this was an issue that for several years has been growing in intensity, and I’ve been doing quite a bit of research on, the Coronavirus pandemic has only accelerated the interest in how do we think about supply chain resilience? How do we think about supply chain risk? What should we be doing about it if I’m sitting in the CEO or CEOs suite or from government ministers sleep?

What I’d like to talk to you all about today is some research that we started actually over a year ago before the Coronavirus pandemic to understand three things. One is everyone’s talking about supply chain risk, but how big of a deal is it really? Is it something that I need to be worried about? Once I know the answer that question, then I need to say given my industry, am I more or less exposed on other industries? How exposed [unintelligible] did my peers? Lastly, once I understand this is a problem for me, and I’ll expose them, what do I go and do about it? What should I, as a CEO, COO, lead of a government agency, what should I be thinking about in terms of what I go and do? That’s what I’m going to talk with you about today.

Quickly on who McKinsey & Company is in case you’re not familiar with us. We’re about 30,000 people globally. About 750 of us are partners and McKinsey’s operation practice. We have completed about 14,000 operations projects in the last five years. We have partnerships with leading organizations around the world, such as the World Economic Forum, to think about operations issues.

For this particular piece of research, I actually brought together three different parts of the firm, because I think that this is a issue that falls on the seams for a lot of folks, which is what makes supply chain risk such a challenging issue. We actually had a joint effort between our operations practice [inaudible] described here, our risk practice which thinks a lot about how companies manage risk and build resilience in the face of a wide variety of risks. Our McKinsey Global Institute, which is our macro economic think tank, and his done leading research for a couple of decades around how the world’s changing and what clients should be thinking about. This research is really the product of our operations practice that you’re seeing about here, but also a bunch of broader swath of McKinsey. It really brings all the right perspectives to be thinking about this issue.

As I said, one of the first things we want to talk about and understand in our research is what is the cost of supply chain risk? Is this something that’s hyped up and not a big issue or is it something that we should be worried about? We found a few things as we went through this. The first is that supply chain shocks are happening with a good amount of regularity. When we think about what shocks are, for us, these are things that are unexpected events that expose vulnerabilities in your operations and cause some sort of production disruption. And shocks can be things you see here that you can anticipate. We’ve known for a while that something like the Coronavirus pandemic that we’re all enduring right now could happen, but the timing of it’s uncertain. When it happens, it can be quite costly.

As you see here, we looked at a wide range of different shocks. They’re displayed here on the 2 x 2 matrix of how expensive they might be and how able you are to anticipate them. What we found is when we looked at the shocks, and we looked out frequently in impact they’re having on companies, you’re seeing a one to two week production disruption in companies about every two years due to some sort of shock, two to four week disruption just a little bit less every three years, a one to two month disruption on production for companies due to supply chain disruption about every three and a half years, and a longer than two months disruption about every five years.

So as we started down the path of our research, we said, “This is pretty interesting. These things are happening pretty frequently.” We looked at specific shocks and the frequency in which they were recurring [inaudible] where they caused disruption, they exploited some sort of vulnerability in a company. We also found that the frequency of those types of shocks was increasing. Then, we said, “Alright, now that we know that shocks generally are happening, and they’re generally disruptive. How do we think about that disruption? Are there certain industries that are more exposed than others?”

We looked at 23 different—what we call value chains—that encompass the entire $18 trillion of global trade. You see a few snapshots of different ones here, not all of them. But you can see is that if you look at kind of an overall index of exposure, shocks, and industry like communications equipment comes up is quite vulnerable to shocks, are quite exposed to shocks [inaudible]. While an industry like medical devices, comes out across the point through value chains that we looked at as one of the least exposed to shocks are the least exposed.

However, and I think this is true with this supply chain risk and resilience topic generally, the details matter. So when you look at the specific types of shocks, you have six of the most common ones that we looked at. Here are the most high impact ones that we looked at for companies, from pandemics to geophysical risks to things like trade disputes. Even though a value chain like medical devices looks like out of the 23 value chains the least exposed, when you look at certain types of shocks, like a cyber attack or a trade dispute, they’re actually one of the most. We found one of the challenges with this particular topic is when companies are looking at and thinking about it so complex, there’s so many different vectors of disruption, that there’s just desire to simplify and boil things down.


What we’re seeing is that if you do that too much or if you do it the wrong way, you can obscure some really important information, just like you might hear if you’re a medical device company and said, in [inaudible], we look fine. In reality, you’re actually quite exposed to a few different things that can happen in the world so it’s important to understand that. Once we did that, we actually said, “Okay, now that we know how often shocks are occurring, and how they’re affecting different industries, for each industry, how costly could this be over the next decade?” Really getting to the point of if I’m sitting in the C suite or sitting at a government somewhere, should I care? The answer, in our perspective, is yes.


What we found is that, on average, companies will lose about half of one year’s [inaudible] done over the next 10 years due to supply chain disruption if they don’t do anything about it. Once again, you can see the distribution of industries in terms of who’s more exposed or less exposed to this loss, but it is a significant impact potentially. It’s also important to recognize that this is an average, and is I think all of us can now appreciate it from our own experience. Certain types of shocks to certain companies can result in a far longer than the average disruption, which will be far more costly. In our research, a disruption that last three months can wipe out over a full year’s worth of profits for a company. Given that we do think to the the first question I teed up at the beginning is it something that people should worry about? Is this a real issue? The answer in our minds is yes, it is costly. Shocks are getting more frequent, and money supply chains to they’re vulnerable to them, so you need to worry about it.


The second question that we want to explore once we understood this is given the industry that I sit in, more and more certain industries, folks are talking about reshoring. Will reshoring or nearshoring potentially provide a way to ensure some of the shocks that we now see in the first part of this are real and costly. A couple of things just to set the context on this. So regionalization is actually already been underway. If you look at the share of goods that were globally traded between regions, the share of those goods peaked in about 2012. Since then, the world has actually been becoming more regional. If you look at the $18 trillion of global trade in the most recent year that we add data when we did this research in this study, about half of that trade is already regional.


As you can see on the right hand side of the page, some supply chain are already even more regional map. We then said, “Okay, now that we understand that’s happening, how much more do we think will happen?” For context of the $18 trillion in global trade that I talked about, about 1.8 trillion is shifted over the last five years. Based on our analysis, we think about 2.9 to 4.6 trillion of the $18 trillion in global trade could shift country of origin over the next five years. So a bit more than potentially but more than double of the 1.8 trillion that’s moved over the past five years.


This analysis was based on looking at a range of economic factors and non economic factors. Saying, if we look at each of these sets of factors are the conditions in place that portions of this manufacturing could shift geography. It’s important to know that we’re not saying that 2.9 trillion will shift or that 4.6 trillion will shift, but we’re saying that the underlying factors and the KT code, there’s either an economic justification to move production or there’s a non economic justification. There are enough countries saying that this is a critical item that we’re going to invest in having closer capacity to home, those sorts of things.


Depending on your perspective, this might feel like a little or a lot. There are some opinions out there that much of global trade might realign to be regional or come back home. Our analysis would say that might be a little bit too aggressive. We don’t think that much is going to move. Conversely, there is a narrative out there that these value chains are so sticky that nothing will move. That probably isn’t quite right either. The answer is a bit in the middle. It’s important to understand the details for each of the value chains. In general, we think that some shifting is happening, but that shift is probably not going to be the end all be all. That shift in value chains, regionalization, nearshoring, it’s not going to really solve the problem that we teed up in the first part of this presentation, which is this is something supply chain disruptions are happening more frequently and are costly. So there’s more to do.


The question is, what do I need to do? How do I build resilience if I’m sitting in the C suite or if I’m sitting at the head of a government agency? That’s what we’ll talk about here. We actually did a survey about this back in May of 2020. Much of the US and Europe were in first round of lockdown for the Coronavirus. We asked executives, “Are you planning to invest in resilience and how?” 93% of them said they would. So this was actually a bit of an increase from before the pandemic. We’re actually thinking about it somewhere in the 70% range before the pandemic, but now almost every executive surveyed said that they would.


More interestingly, from this survey, 44% said that they would do so at the expense of short term efficiency. This is clearly a topic that’s top of mine. You can see the types of levers that folks are thinking about potentially using the build resilience, a lot of them are things that won’t be surprising, dual sourcing, holding more inventory, nearshoring. Our push for companies and governments on a lot of this would be this is all great, and these are certainly levers to consider. But there’s probably a bigger picture approach that you need to take if you really want to get resilient for the long term. We think that that means that you need to have a supply chain that has four features and four ways of working, many of which will be new, at least some of them, for almost every organization.


So in terms of the features that we think supply chains are resilient and efficient to have, they need to be having end to end visibility for critical products. Many companies recognize at this point that they don’t know who their supplier’s supplier is. It is costly, in some cases, to give that information. There’s a lot of techniques you can use to go get it now from outside and analysis using data that’s available out in the market to doing material forensic some of your products. There is some filtering here for highly available products that you can easily substitute you may not need and then visibility. But for critical products and critical things that contribute significant parts of your revenue in our [inaudible], it makes sense to invest in heavy end to end visibility in terms of who your direct suppliers are, but also who their supplier’s suppliers are understanding where vulnerabilities might sit in that supply chain.


The second thing that we think in terms of features that companies that are regular stress testing. Just like after the financial crisis in 2008, banks began stress testing. We think other companies now need to be stress testing as well. The point of stress testing is not on a day to day basis to say, “What supplier is now financially in trouble? And what do we do about it?” That needs to be part of what you do, but it can’t be what your stress test is. The stress test should really be thinking about, what are the major strategic changes that are happening in the world? What trade relationships might be changing? How do we think the climate is going to change? What impact will that have? What are the things over the next five year horizon or so that potentially could really disrupt and change my supply chain strategy? How would I respond if some of those things happen if I really stretch things to kind of the most pessimistic view of what the world could look like? What would that do to me? Really understanding the outcomes there and having a data driven discussion about what investments and what do we need to be doing to adjust the stress testing point, and especially incorporating that somehow, a typical corporate strategic planning rhythm, we think is really, really important.


Third is, there should be ongoing efforts to reduce vulnerabilities in your supply chain and your exposure to your shocks. But we are talking about the start of this. Many companies are used to having continuous improvement programs around cost and earnings. I think it’s equally important to have continuous improvement programs that complement those costs and earnings offer but also resilience building efforts.


Lastly, this issue needs to be on the C suite agenda. Supply chain often does not live there. It’s been viewed as cost center, something that’s kind of a function handle beneath the CEO. Given everything going on in the world, we believe that supply chains are quite strategic, both from a ability to deliver for your customers ability to satisfy your customers, and also maintain your revenue performance, as well as an ability to control your costs. There’s some big decisions that might need be need to be made, given what’s going on in the world, and it needs to be on the C suite agenda.


Getting into these four features, we believe require four new ways of working. First is there needs to be resilience metrics that are built in the performance management system, just like costs or growth metrics. Almost every company can tell you quarter over quarter, year over year, how much have we grown in terms of revenue down over a granular level? What is our cost performance been? Very few companies have thought about given my business in the context when [inaudible], how do I quantify resilience? And how do I know if I’ve gotten more resilient year over year? That needs to happen. If you’re not measuring this the same way you’re measuring the other metrics you really care about, nothing’s going to change.


The second thing that we think needs to happen are there are new tools and capabilities that need to be built. Many procurement departments and supply chain managers don’t fully understand, how do I go and write an RFP that helps me gather the information about whether or not I’m making the most resilient and the most cost effective procurement decision? We need to make sure that we’re building capabilities in those teams to be able to do that. It’s not just about Supply Chain compliance group or Supply Chain risk group or Procurement risk group. This really needs to be something that’s built into the way that business is being done within the business units, within regular operations. It’s not just about at the sourcing decision that resilience happens, it’s also in the product design process in other places. There are new tools and capabilities into the belt throughout the enterprise to really be able to weave resilience into just a way of doing business and how things work. We think that investors and customers need to understand the value of this. Let’s say, true differentiator, when you can say that I will be able to deliver in a range of different scenarios for you. Many companies are not very good at communicating in a quantitative way, and showing how they’re differentiated from their competitors. We think it really can be a competitive advantage once you’re doing it well, and investors and customers need to understand that.


Lastly and perhaps most importantly, it sounds [inaudible], but there’s a lot of work to do on governance and processes for many companies to really make this stick over the long run and not just turn it into a post COVID exercise or an exercise after whatever shock comes next. Saying, how do we change our governance, such that we’re stress testing on a regular basis and taking those results seriously and making decisions based on them? We’re regularly monitoring what risks are cropping up on our supply chain, having the right team, look at them, and making the right decisions. But we’ve also gone through and scrubbed our processes as enterprise to ensure for new product introduction design all the way through sunsetting products. Everyone involved in those decisions is making the right decisions that result in a product that is still cost efficient, and is still meeting our margin targets, but also has resilience built in.


I think when you take all of these actions collectively and look at them, you say, “Can I do this? Can I do this in a way that doesn’t massively increase my costs?” Our answer for almost every company is yes. This, like anything, if you just try to bolt resilience on to how you do business today, there is a risk that that will significantly increase your costs. But we think that if you can embed resilience into decision making throughout the enterprise, you think about your product design decisions as you think about how you design your supply networks, that resilience is built in. This is actually something that many companies can actually do and do well without a significant increase in cost. In fact, we think that often when you roll out a program like this, you will find a lot of things that will help you get both more efficient and more resilient.


The last thing I’ll talk about before I wrap up, and the thing to leave you with is, how do you do that? Digital is something that in supply chain has been hyped for a decade or longer. It’s one of the areas where digital will have a bunch of impact. One of the first areas where artificial intelligence was really supposed to have a business impact. In some areas, there are pockets of success. But overall, I think if you ask people, they would say we haven’t really fully realized that vision.


We also did a survey and made to understand what are people going to do in terms of digital. Here’s a snapshot from a few different industries, you can see that most industries, folks do not believe they are already digital. Even in the industry that was advanced electronics and semiconductors, where the most believe they are, it’s only a quarter of companies, and their significant investment coming up on the road ahead in terms of fully digitizing the supply chain. We think that this is the first step and the real unlock for a lot of companies to building a resilient and efficient supply chain because you’ll have much better awareness of what’s going on, be able to identify opportunities, and also be much more agile when things happen.


I’ll share a couple of examples of that. So in terms of what digital means, because it’s such a buzzword. If you’re digital in your supply chain, at your fingertips, you should be able to know everyone that you’re buying from, what you’re buying from them, what plans they’re coming from. You should be able to for critical products also call up quickly who the critical suppliers of your suppliers are. Once things are in your own warehouses and things are inbound, you should be able to know what’s coming inbound, what warehouses are going to, how much stock do I have, and be able to call that information up quickly without needing to call or aggregate data from a variety of warehouses. You should also be able to understand, from an outbound perspective, what brick and mortar stores, how well positioned are we for online sales, all those sorts of things.


For many companies right now, assembling that type of picture takes a lot of work to stitch things together across databases, maybe even phone calls to other parts of the business or out to suppliers. We think what direction the world’s going, there’s just not not going to be time for that in the future. So we really think that if you want to get ahead, investments in digital under supply chain that do these types of things are absolutely critical.


To leave you with a story to make it stick as to why that’s important, [inaudible] did a case study in the McKinsey Global Institute report that released in August of Nike in China during the first quarter of 2020, so while China was locked down for the Coronavirus pandemic. Because they had a digital supply chain when the lockdown happened, they were able to quickly understand what stock they had on hand, what orders were coming in, and whether those stock they had was positioned. They were able to rapidly reposition the stock they had for online sales, were able to modify or cancel the orders they could but they didn’t think would be relevant anymore given the lock downs. They were able to quickly push that information that our marketing and sales team, was able to market and sell the things that they had on hand. When you look at their sales performance versus their competitor sales performance in the first quarter, their sales dropped about 5%, while some competitors dropped 45% or more.


For us, that really illustrated where digital can help, and help in a big way in both being resilient and also performing in a much better way. That’s one thing just to leave you with in this presentation. Talked about a lot of what resilience looks like, what we really think that digital is the foundation. It’s been hyped for a long time, but now is the time that it really makes sense to start making some of these investments.


Please leave any comments or questions you have in the chat. It was great to talk with you about this topic today. I’m very passionate about it. Please feel free to reach out if you’d like to talk more. Thank you very much.

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