Beyond the pandemic: rethinking the supply chain
Why supply chains are on the agenda
Lockdown restrictions have disrupted supply chains. The challenges were particularly acute for global manufacturers when the pandemic was peaking in China, with its factories forced to close and its ports unable to operate.
Many production facilities have since reopened, albeit often at reduced capacity. But in many parts of the world, smaller suppliers may not survive the downturn and the shock of the pandemic. This means that supply chains are in danger of continued disruption even after the health crisis subsides.
Political pressure has been growing for companies to reconfigure their supply chains in response to a range of external factors, including:
- the US-China trade war, which is leading to higher import tariffs on thousands of raw materials and products; and
- countries wanting to ensure supplies of items critical for strategically or economically important industries.
These concerns have led to incentives to reduce the dependency on supplies from certain jurisdictions by either bringing existing manufacturing operations closer to home or building capacity from scratch.
Building a European EV battery industry
In 2017, the European Battery Alliance was formed to develop a ‘competitive battery manufacturing value chain’ and prevent Europe’s electric vehicle (EV) manufacturers having to rely on Asian suppliers.
According to a 2019 European Commission report, Europe has 3 per cent share of global cell-manufacturing capacity while Asia has 85 per cent. The report also points to:
- Europe’s reliance on third countries for the five essential battery raw materials (lithium, nickel, cobalt, manganese and graphite); and
- the fact that battery-grade refining and processing facilities for these materials are concentrated in China, which consequently ‘dominates the lithium-ion battery supply chain’.
More recently, in light of COVID-19, international organisations such as the OECD have been calling for government support measures to be designed to 'build back better' with a view to making economies more 'green' and resilient to shocks. One way of doing this is to encourage 'circular economies' that use more local suppliers and – in the longer term – reduce reliance on inputs from overseas.
Geopolitical trends have also led to governments seeking to protect critical strategic businesses from foreign control. While this has been on the agenda for some time, the COVID crisis has seen governments designate a broader range of sectors as critical to not only national security but also national wellbeing. For example:
- the EU Commission’s guidance paper on protecting strategic assets in response to the pandemic specifically mentions the production of medical or protective equipment, research establishments and biotech companies (read more in our blog);
- Germany has announced tighter FDI controls on deals involving activities seen as crucial for its health system (read more in our blog);
- the UK government can now intervene in certain deals involving businesses critical to the UK’s ability to combat – and mitigate the effects of – public health emergencies such as COVID-19 (read more in our blog); and
- the French government and pharmaceutical industry have signalled agree that drug production should return to France or Europe from overseas.
Meanwhile, Japan has announced it will direct more than $2.2bn of its coronavirus stimulus package to incentivise domestic companies to move their production out of China.
FDI screening in the EU
In 2019, the EU published its foreign direct investment (FDI) screening regulation, which includes the following measures:
- A set of rules to which member states choosing to have foreign investment screening mechanisms must adhere, although they themselves remain the ultimate arbiters of whether or not to permit an FDI in their territory, subject to certain investments coming under the jurisdiction of the Commission.
- A co-operation and communication mechanism between member states and the Commission for when FDI is taking place. Other member states may then provide comments, while the Commission can issue a non-binding opinion. The member state where the FDI is taking place must give due consideration to (but is not bound by) the comments/opinion when deciding whether to permit the investment.
The regulation was fully implemented in October 2020.
Lack of transparency
For many businesses with multi-tier supply chains, it's not always clear who exactly is supplying their own immediate suppliers.
As a result, businesses are finding it difficult to anticipate disruption to, and identify environmental, social and governance (ESG) compliance violations along, their supply chains. This can pose a significant liability and reputational risk.
Environmental due diligence – Europe’s proposals
Moves are afoot in Europe to introduce mandatory environmental due diligence rules.
In April 2020, the EU Commissioner for Justice, Didier Reynders, announced that, in early 2021, the European Commission will propose new EU legislation on mandatory environmental and human rights due diligence.
Then, in August 2020, the UK government began consulting on a potential new law requiring larger companies to carry out due diligence on supply chains for products that may be contributing to deforestation.
While very much work in progress, the EU proposals are likely to be cross-sectoral, cover the entire supply chain and include companies of all sizes (albeit with exceptions for SMEs). Meanwhile, the UK proposals currently appear more limited in scope, only applying to businesses ‘operating’ in the UK that use ‘forest risk commodities’, such as beef, cocoa and palm oil in products created via their supply chain.
Suppliers in distress
The COVID-19 pandemic has increased the risk of financial and operational distress among suppliers, with the insolvency of a key supplier having dire consequences on production plans.
This is leading manufacturers to keep a very close eye on their supply chains and the financial health of suppliers of vital inputs.
Rising stakeholder scrutiny
Under increasing pressure to promote ESG standards, businesses are taking steps to identify and prevent adverse human rights and environmental impacts in their supply chain.
Having strong sustainability credentials also helps attract the rapidly growing pools of ESG investment capital.
Human rights compliance – more vital than ever
Having to face the challenges posed by the COVID-19 crisis, manufacturers might be tempted to deprioritise human rights issues in their supply chains.
However, given the current legal framework, which has evolved and expanded significantly over the last decade or so, this would expose the business to significant risk.
For example, California has its 2010 Transparency in Supply Chains Act, the UK its 2015 Modern Slavery Act and France its 2017 Duty of Vigilance Law.
In 2019, the Netherlands adopted a law on child labour due diligence while in 2021 Germany adopted a human rights due diligence law that will come into effect in January 2023. Further, the EU is considering a value chain due diligence law too that will cover not only human rights but also environmental and governance issues.
There are also the increased stakeholder expectations to consider. As businesses emerge from the pandemic they may find their investors and consumers closely scrutinising their conduct during the crisis, particularly multinationals whose choices can have such a profound impact on the lives of those who work for them or in their supply chains around the world.
Race for technology
Digitisation can help improve supply chain visibility and efficiency, monitor inventory and ensure product safety.
As a result, manufacturers in traditional sectors are looking to acquire technological capabilities or collaborate with tech players in order to harness systems such as predictive maintenance, automation, AI and data mining (which improves inventory management and therefore working capital).
This is particularly true for the automotive industry where the advent of electric, connected and autonomous cars is challenging the traditional OEM business model.
Questions for supply chain managers to consider
Manufacturers across all industries have been assessing how to reshape their supply chains in response to the challenges set out above.
Many of these drivers have been accelerated by the COVID crisis, with the following questions high on the agenda.
- Do we need greater visibility over our entire supply chain to better anticipate disruption and compliance issues at sub-tier suppliers?
- Do we need to relocate production of critical items?
- Have we become too dependent on certain manufacturing hubs or third parties? If so, do we need to diversify suppliers?
- What is the risk of terminating a particular supplier? Could we re-start the relationship if necessary?
- Do we need to boost our tech capabilities in order to create digital supply networks/ecosystems?
Rethinking the supply chain
- Why supply chains are on the agenda
- Supply-chain legal issues
- Technology and data
- Regulatory compliance
- Renegotiating long-term contracts
- Informal renegotiation
- Contract-renegotiation law in nine key jurisdictions – a summary