The Economist - USA (2020-02-15)

40 International The EconomistFebruary 15th 2020

2 break of the new coronavirus.

Investors are punishing companies for

this failure. The shares of American firms

with strong exposure to China have under-

performed the s&p500 index by 5% since

early January, when news of the outbreak

first broke (see chart).

There are three reasons to think the

coming months could prove even more un-

pleasant for many firms. First, big multi-

nationals have left themselves dangerous-

ly exposed to supply-chain risk owing to

strategies designed to bring down their

costs. For example, many keep only

enough stock on hand to last a few weeks,

confident that they can always replenish

their inventories “just in time”. That confi-

dence is misplaced, argues Bindiya Vakil of

Resilinc, a consultancy.

The second vulnerability arises from

the fact that giant firms are much more re-

liant on Chinese factories today than they

were at the time of the sarsoutbreak in

2003. China now accounts for 16% of global
      gdp, up from 4% back then. Its share of all
      exports in textiles and apparel is now 40%
      of the global total. It generates 26% of the
      world’s furniture exports. It is also a vora-
      cious consumer of things such as metals,
      needed in manufacturing. In 2003 China
      sucked in 7% of global mining imports. To-
      day it claims closer to a fifth.
      Koray Köse of Gartner, a research firm,
      points out that it is not only the increase in
      size of China’s manufacturing base that
      matters. Since 2003 factories have spread
      from the coast to poorer interior regions
      like Wuhan, where the epidemic broke out.
      Workers from such places now toil at fac-
      tories all over China—and travel home for
      the holidays. That interconnectedness in-
      creases supply-chain risks, argues Mr Köse.
      So does the rising interdependence of
      many firms. Mainland suppliers no longer
      simply assemble products; they make
      many of the parts that go into them as well.
      The third reason to think that big com-
      panies may experience a supply-chain
      shock is that the regions worst affected by
      covid-19 and the subsequent government

lockdowns are particularly important to

several global industries. The electronics

industry is most at risk, according to Lla-

masoft, a supply-chain analytics firm, be-

cause of its relatively thin inventories and

its lack of alternative sources for parts.

Hubei province, where Wuhan is locat-

ed, is the heart of China’s “optics valley”,

home to many firms making components

essential for telecoms networks. Perhaps a

quarter of the world’s optical-fibre cables

and devices are made there. One of China’s

most advanced chip-fabrication plants,

which makes the flash memory used in

smartphones, is found there, too. Analysts

worry that the epidemic in Hubei could re-

duce global shipments of smartphones by

as much as 10% this year.

The car industry has also been hit. The

lack of parts from mainland-based suppli-

ers forced Hyundai to shut all its car plants

in South Korea (it is now partially reopen-

ing them). Nissan has temporarily closed

one in Japan, and Fiat-Chrysler has warned

that it could soon halt production at one of

its European factories.

Fears of the virus are now affecting the

global oil price. Chinese refiners are slash-

ing output in anticipation of shrinking de-

mand at home. Slowing Chinese demand is

further darkening what was already a dis-

mal outlook for natural gas. Chinese cop-

per buyers have asked Chilean and Nigeri-

an mining firms to delay or cancel

shipments. Mongolia has suspended deliv-

eries of coal to China.

Some Chinese firms are panicking. Doz-

ens have received official “force majeure

certificates”, which they hope will allow

them to slip out of contracts without incur-

ring penalties. They may not. Faced with

faltering demand as well as closed ports

and roads, cnooc, a Chinese energy giant,

recently used such tactics to avoid accept-

ing lngshipments. Total and Royal Dutch

Shell, European oil majors, are rejecting

the move.

What happens next? Big firms want to

ramp up production quickly. But it is un-

clear how soon workers will be allowed to

return to factories. However, factory dor-

mitories are crowded. Foxconn’s workers

are packed eight to a room at its Shenzhen

plant. If that leads to renewed infections

plants may be forced to shut down again.

Senior bosses will return soon, but some

worry that mid-level expatriate managers

with young children will not.

Even when plants are up and running,

moving goods around and out of China will

remain difficult. Alan Cheung of Kerry Lo-

gistics, a big provider in Asia, reports that

his drivers are getting stopped across the

mainland because the Chinese govern-

ment is still trying to prevent lorries mov-

ing around unless they are delivering food

or other necessities. The longer shipping

volumes are depressed, the bigger the

backlog when China Inc returns to work.

That will probably lead to bottlenecks and a

surge in freight rates.

In the longer term the epidemic could

dampen the love affair between multi-

nationals and China. Big companies had

long assumed that their mainland supply

chains were reliable and easy to manage.

Surveys have found that only a minority of

firms across all industries regularly assess

their supply-chain risks carefully. For years

bosses have devolved responsibility for

sourcing to mid-level managers, typically

instructed to extract an extra percent or

two from costs each year. The covid-19 out-

break has exposed the risks of doing so, es-

pecially since America’s trade war with

China is not exactly resolved. Tsunamis

and floods came and went and firms sim-

ply thought they could manage, says Jo-

chen Siebert of jscAutomotive, a consul-

tancy. He predicts that the epidemic will

put the question of supply-chain manage-

ment squarely on the desks of their ceos. 7

Immune deficiency

Sources:Llamasoft;GoldmanSachsGlobalInvestmentResearch

Covid-19risktomanufacturing Shareprices,December31st2019=100

90

Jan Feb

2019 2020

Dec

95

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US firms with high

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S&P 500 index

First covid-19

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Numberof

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