VINAY PIPARSANIA is Consulting Director -Automotive at Counterpoint Research
The COVID-19 pandemic has demonstrated how vulnerable automotive supply chains are to disruption, bringing under scrutiny the extended global supply strategies. The abrupt closure of production centres in China and its domino impact, causing widespread chaos among global auto manufacturers, were felt progressively in Europe, the US, India and South America. Having offshored their manufacturing activities to low-cost countries, many automotive OEMs and suppliers are now scrambling to establish shorter or localised regional supply chains.
THE DRIVE TO SHORTEN SUPPLY CHAINS
Even months before the COVID-19 outbreak, there was a growing interest among global automakers to localise manufacturing of critical components. Trade tensions were at their peak with the escalating tariff war between the US and China, resulting in a broader nationalistic spirit arising in some other countries too. The intensification of protectionism through targeted financial trade barriers, had become a real and present threat for multinational auto operators to deal with.
With globalised supply chain networks currently programmed for the lowest possible price, most Western companies had set up centralised manufacturing facilities in lower-cost economies, where the final products are assembled competitively and shipped to higher-income markets. Automakers, in particular, source parts and electronics from China, mainly because they are cheaper. However, rapid political developments, natural disasters and now the global pandemic have revealed the inherent weakness at the core of such a model of offshore manufacturing. For example, when the pro-Brexit (UK’s decision to leave the European Union) vote was announced in 2016, European auto OEMs and suppliers immediately planned for the worse and rushed to invest in new supply chain resources in the UK. While a change towards more flexibility and multi-level sourcing by the global auto industry had already begun cautiously, the COVID-19 impact has now made it a more definitive and urgent course of action.
Over the next few years, Counterpoint analysts expect to see a broad overhaul of the global automotive supply chain infrastructure based on the following trends:
Globalisation to Regionalisation
Currently, most leading global automakers source 30 % to 60 % of their parts from China, including modules and sub-assemblies. Given the incredibly higher number of parts required – each with different lead times – a return to regional supply chains does present an incredibly complex challenge. However, that challenge is being considered worth taking on by stakeholders for a post-COVID world.
Intending to establish alternative, flexible and adaptable supply chains — while mitigating single-source vulnerabilities – OEMs, component manufacturers and auto sub-system assemblers are now looking to strategically source, assemble and deliver from within their regional borders, and are also reconsidering setting up regional logistic hubs.
Fundamentally rethinking the supply chain
The COVID-19 has exposed the weaknesses of a globalised manufacturing system, necessitating a fundamental rethinking among existing supply chain operations. The distributed global business model, being primarily driven by an objective to achieve minimum cost, needs to be resilient. Supply chain models will need to be reconfigured, based on business optimisation. Modifying the supply chain as a key business driver and bringing back timely human oversight are some critical factors that can bring inherent agility.
With volatility in production volumes and schedules expected to be a norm, suppliers and logistic operator chains will have to be adaptive, and be able to recover quickly from major natural and man-made catastrophic events such as earthquakes, floods, fires, industrial strikes and social unrest. Human overrides and protocols will need to be reintroduced to bring stability back to the global supply chain during such a crisis. As the current pandemic stress-test has demonstrated, large variances and disruptions cannot be managed through statistical and algorithmic models with such unusual events typically disregarded as “outliers” and overlooked in operational programming.
Resilience through re-shoring — easier said than done
Despite the pain caused by production losses, the business case for increasing supply chain resilience is not straightforward. Reconfiguring and reducing the length and complexity of global supply chains is not without its challenges. Inevitably, short-term costs will be a consideration as well as the ability to recruit new staff with the requisite skills, knowledge and experience, and access to adequate capital.
With thousands of suppliers involved in a vehicle’s value chain, diversifying suppliers to increase resilience involves significant investments and recurring costs. Automotive components are typically sophisticated, intricately engineered, bulky and also fragile, with high logistics and transport costs. In most countries, government policies encourage sourcing from local producers by achieving a local content threshold to qualify for reduced import tariffs. However, even if such suppliers are considered as alternatives, they are required to be tooled, trained and resourced to produce to specifications and quality standards.
Nonetheless, the benefits of shortening supply chains are considerable, specifically greater security and increased resilience to causes of disruption. Although COVID-19 has brought these into focus, it is not the only risk to established OEMs. There is the ever-present threat caused by natural and man-made events, the ongoing trade disputes and tariff wars between major trading nations, and political instability in regions that supply critical raw materials, combined with a rise of nationalism and protectionism around the world.
The current configuration of international supply chains relies predominantly on low trade barriers and assurances that they will remain for a reasonable time period. Unfortunately, the devastating economic impact of COVID-19 has led to a resurgence of protectionist sentiments in most countries, and a highly probable threat of such benign policies being withdrawn. Further, the economic arguments for offshoring are not as persuasive as they used to be, with average wages in China’s manufacturing sector, for example, having increased over countries such Brazil or Mexico.
There could be many other significant factors behind re-shoring decisions too, such as access to qualified personnel, skills, technology and innovation. Proximity to primary markets is another key consideration, as well as improved quality. OEMs look for quality at the most competitive cost. One of the advantages of working with local suppliers is their ability, if set up correctly, to deliver both. Working with localised suppliers also reduces challenges associated with communicating across multiple time zones, languages and cultures.
Among the deciding factors will be the types of components or aggregates being produced, along with market demand, speed of response and ability to supply custom-engineered solutions with short lead-times.
The sheer number of suppliers to the automotive industry, who are currently clustered in specific regions of the world, present major obstacles to diversifying risks. Reducing or expanding the number of suppliers is not necessarily the only way to configure resilient supply chains.
Counterpoint Research believes that ultimately we will see a combination of traditional extended supply chain models with a growing alternative network of short and localised supply chains. The latter network will most likely be established in alliance with specialised suppliers that can deliver components and services, and have the capability to adapt resiliently to changes in market conditions.