Resilience reshapes global supply chain

This year, shipping rates, a key indicator of supply chain fluidity, finally collapsed 80% from their peak in early 2022 to pre-pandemic levels as the industry irons out its kinks. Nonetheless, industry players are not banking on a smooth-sailing ride for the rest of their voyage. Instead, businesses are continuing to reconfigure their supply chains to deal with economic and political challenges.

Indeed, some experts believe the global flow of goods has evolved forever to adapt to a new normal. Companies and countries have learnt from the chaos in supply chains over the past several years although most pandemic restrictions have been lifted and even should geopolitical tensions wane.

While some of the shift in priority away from cost efficiencies due to the rapid deterioration of relations between powerful trading economies is a disadvantage, the agility that companies are aiming to build will also insulate them from isolated incidents like the Suez Canal blockage in March 2021.

Iain Morrison, HSBC’s head of global trade and receivables finance, has another view: Supply chains were already shifting pre-Covid-19 as businesses recognised deficiencies in their supply chain models. “The pandemic was an accelerator of change rather than its sole driver,” he says in an interview with The Edge Singapore.

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And while much attention has been spent on global tensions in the post-pandemic era, there have been many other factors behind the ongoing optimisation of supply chains, adds Morrison. “The key driver of change we’ve seen is a move from being very efficiency-focused to having a multi-faceted focus on efficiency, resilience and sustainability for supply chains.”

Supply chain pendulum swings

A prime example of the acceleration of resilience-building in the global supply chain was the pivot by businesses from the convention of just-in-time inventory to just-in-case stocking due to the pandemic.

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In the pre-pandemic era, many businesses revered the cost efficiency of the just-in-time model popularised by Toyota Motor, which turned inventory management into an operational art.

Unfortunately, this model could work only in a pre-Covid-19 world without lockdowns, border restrictions and other physical disruptions. When the magnitude of the pandemic became apparent, businesses struggled to cope.

A survey by EY of 200 senior-level supply chain executives found that only 2% of companies that responded said they were fully prepared for the pandemic. Serious disruptions affected 57% of respondents, with 72% reporting a negative effect.

Many companies reacted instinctively, overstocking as they placed orders for higher inventories than they immediately required, “just in case” disruptions occurred again. “I think the pandemic swung [supply chains] in the direction of resilience, and that’s the right thing to do when you’re under pressure,” explains Morrison.

Morrison: While a lot of attention has been spent on global tensions in the post-pandemic era, there have been many other factors behind the persistent optimisation of supply chains

But even with the worst pandemic disruptions behind us, there are lingering signs that businesses will continue prioritising resilience over efficiency in their supply chains. In a report on the state of US supply chains in 2023, SAP, which sells software to help companies manage their resources, notes that almost two in three US companies are still moving from just-in-time to just-in-case supply chains by increasing the amount of inventory they store.

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Meanwhile, HSBC’s Global Supply Chains — Networks of Tomorrow report found that 83% of financial decision-makers have held excess inventory over the past two years due to logistical challenges, and there has been a 39% average increase in inventory holdings above normal levels.

One of the respondents in the HSBC report, a treasurer for a wholesale distributor in Singapore, says his board insisted that the company continue to build up inventory onshore “whatever the cost”. “We found the whole Covid-19 period to be a near-death experience as we’re going down the just-in-time inventory route; [for our business,] if we don’t have product available on demand, we don’t have a business.”

As industry players grapple with an unpredictable macroeconomic environment, Morrison does not expect changes spurred by the pandemic to be completely reversed. “I can see an adjustment coming back, but I think businesses will want to retain what they have learned from their dependency on individual components and suppliers.

“The lessons about resilience will stay, so I don’t know if we’ll see a full swing back.”

Relationship recalibration

With supply chains compelled to shift, mindsets have changed in tandem. Morrison says businesses now recognise that simple buyer-seller relationships do not necessarily translate to “holistic ecosystems” in supply chains.

HSBC’s report found that businesses in Asia Pacific are looking to reduce their number of suppliers while building deeper and broader ties with those they retain. “The need and desire to know who your supplier’s suppliers are in that end-to-end supply chain have also been a key driver of change. If you wish to go into that amount of depth, then a fewer number of trusted suppliers is important,” Morrison reasons.

In this regard, quality trumps quantity. “Having fewer suppliers and a more symbiotic relationship with them improves your ability to work closely and innovate. There’s a lot of efficiency that comes out of that coordination, which in turn gives you more resilience,” he adds.

Morrison believes another dimension that affects supply chain partnerships is the “lateral” driver of ESG considerations. All three factors of ESG — environmental, social and governance — require a “depth of understanding” among partners. “ESG brings in an additional dimension of considerations in terms of distance travelled and better understanding of who your suppliers are,” he says.

For example, Morrison cites multinational retail corporation Walmart’s science-based sustainability targets for the supply chain finance programme created with HSBC and CDP, a non-profit that runs a global disclosure system for investors and businesses to manage their environmental impacts. The programme was created to help Walmart’s private brand suppliers — particularly small and medium-sized businesses, some of which are based in Asia Pacific — by introducing enhanced standards, tools and capacity building to help align their operations with transparent sustainability objectives.

“That’s a fascinating case because what Walmart has done is they’ve used supply chain finance as a tool to drive their ESG objectives and put metrics around that to incentivise their suppliers to meet ESG targets,” Morrison says.

He believes these multiple drivers of supply chain behaviour — efficiency, resilience and ESG — are beginning to “converge”. “Knowing where something is and where it has come from actually ticks multiple boxes — efficiency, resilience and sustainability,” he says. “All of these factors lead naturally to fewer but deeper relationships.”

Geo-economic fragmentation

While many organisations continue to reduce their number of supply chain partners, especially within Asia Pacific in continuing a multi-year trend, HSBC found that outside of the region, there has been a relatively strong drive to increase the number of supply chain partners.

Compared to just 27% of Asia Pacific respondents looking to increase their number of supply chain partners, 36% of respondents from outside the region continue to seek diversification in their supply chains.

Moody’s Analytics Asia Pacific head of compliance solutions, Chua Choon Hong, notes that with the global scale of the pandemic and different rates of recovery across the various markets, businesses have been forced to look for a “diversified base of alternatives”.

“The supply chain [industry] now understands that different jurisdictions have different ways of dealing with the pandemic or any other potential global situation, creating an inconsistent rate of recovery,” says Chua in a separate interview with The Edge Singapore. “To have stability within your supply chain, you need to build a buffer of alternatives, which we saw in Singapore as well.”

He notes that recent global events have continued to disrupt supply chains that have grown “increasingly complex” with the impact of globalisation over the past several decades. “Conflicts and tensions come with a lot of regulatory pressure. We see various sanctions implemented, with major corporations having to navigate these markers.”

Chua emphasises that even though the world may have entered a period of de-globalisation or geo-economic fragmentation, supply chains have grown more complex. “With globalisation, we saw that different economies with their unique characteristics contributed to different advantages across manufacturing,” he says. “Now, with de-globalisation and the tendency towards protectionism, unfortunately, that does not benefit the supply chain.”

Chua believes that this will “inevitably” drive up costs and remove the previous advantages of truly global supply chains. “In the past, businesses probably had a bit more leeway in where they might want to place their primary production sources. Now, businesses have to navigate geopolitical tensions and jurisdictional regulations’ challenges, which further complicates the situation.”

Given this increasing complexity, Chua believes that resilience in supply chains requires businesses to understand where their supply risks lie.

“The primary consideration of resilience is looking for a stable and constant flow from your primary sources into your supply chain. By that definition, businesses first have to understand where the risks are to achieve this consistency of materials and production without disruption,” he explains.

He adds that taking an “anticipatory approach” to these potential risks could allow businesses to find alternatives that can maintain the supply chain consistency.

Chua: Businesses have to understand where the risks lie in their supply chain so that they can achieve a consistent flow of materials and production without disruption

Chua says that while cost efficiency has “traditionally” reigned supreme in the supply chain as businesses try to maximise their earnings, a different “balance” has now come into play to mitigate against supply chain risks.

“Businesses might look for sources that are further away, which might have an increased impact and pressure on costs, but they will have to find a balance to ensure their supply chains are not disrupted.”

Tech-tonic movement

These conflicting approaches to building resilience in supply chains have disrupted the fragile balance of trade flows, with equilibrium not quite in sight for a global supply chain overhauling its architecture.

Stéphane Monier, chief investment officer at Lombard Odier, says increasing geo-economic fragmentation will create corporate and national winners and losers while reducing efficiencies and perhaps adding to inflationary pressures.

“While higher trade barriers between competing blocs and redundant capacity building would be negative for the global economy, businesses have demonstrated the ability to diversify resources, labour and capital across markets while rerouting trade around restrictions,” says Monier.

Highlighting the potential severity of this situation, the Monetary Authority of Singapore’s (MAS) latest biannual Macroeconomic Review published last month dedicated an entire subsection to dissecting the impact of geo-economic fragmentation on trade and investment flows in the global electronics supply chain.

According to Singapore’s central bank, following the “rapid globalisation” phase that took place from the mid-1990s until the Global Financial Crisis of 2009 — which saw the ratio of global merchandise exports to GDP rising from 15% in 1994 to its peak of 25% in 2008 — the world has since entered into a period of “slowbalisation”, with increasing trade frictions impeding the flow of goods and capital.

“There have been concerns in recent years that global economic integration across countries is plateauing, amid rising geopolitical tensions and protectionism,” says MAS, citing the compounding effect of the US-China trade war that has heated up since 2018.

From 2009 to 2021, the ratio of global merchandise exports to GDP “levelled off” at an average of 22%, while the ratio of global foreign direct investment (FDI) to GDP hovered at around 2%.

These trade frictions have already led to “reconfigurations” in the global electronics supply chain — which has been made “vulnerable” by its extended global value chain with multiple cross-border nodes of production and a relatively low geographic distribution — through diversification and insourcing, notes MAS in its case study.

While Asia’s electronic exports to the US have continued to expand, there is some evidence that the associated trade routes may have been diverted through alternative regional production nodes. Although the US share in China’s electronics exports fell by 4.1 percentage points between 2017 and 2021 to 17.5%, China’s overall electronics exports continued to trend higher.

MAS says that this was achieved by China diversifying its export markets towards geographically nearer markets, such as Vietnam, Taiwan and Thailand.

Meanwhile, the US share in the exports from these same Asian economies in this same period increased, particularly for Vietnam, which saw a 14 percentage-point increase in its exposure to the US market.

Aside from trade diversification, MAS points out that trade frictions could also result in greater insourcing of electronics components in major economies like the US and China, dampening cross-border trade flows.

A broader indication of this insular trend can be seen in the faster growth of the global production of electronics of an annual average of 8.7% from 2018 to 2021, in contrast with the slower growth of electronics imports by 7.2% per annum, unlike in earlier periods in which the imports rose “more rapidly”.

HSBC’s Morrison believes that given the “highly innovative” nature of the electronics industry, it has always had a deeper understanding of the dependencies within its supply chains, which has, in turn, allowed the industry to create a “symbiotic” supply chain that will soon become characteristic of more industries.

“If you look at the big electronics manufacturers, they have key suppliers who have historically been part of their supply chain, and they innovate and evolve with these suppliers,” he says. “It is more obvious in the high-tech industries but the concept also applies more broadly to many industries.”

Given the crunch the electronics manufacturing industry still faces, some are redesigning their products to use fewer electronics components. For example, T3 Motion is redesigning its electric stand-up vehicles to use a centralised, integrated board with a single processor to control all the vehicle parts instead of multiple components to control various features.

In an interview with The Wall Street Journal, CEO William Tsumpes says this move will eliminate five individual circuit boards. And although it was tough to quickly execute the redesign, the initiatives, which involve an engine change, will lead to an increase in vehicle range. “It’s spurring innovation,” says Tsumpes.

As businesses across the spectrum begin to understand the importance of intra-supply chain innovation, this could answer how they should better support their supply chains through networked ecosystems.

Emerging winners of new trends

The corporate reaction to these operational impediments has seen a new vocabulary emerge to describe this particular brand of building resilience in supply chains, including terms like “re-shoring” — defined as relocating production to a firm’s home market — and “near-shoring” — to bring production facilities closer to home.

Meanwhile, “friend-shoring” aims to concentrate production in allied countries to ensure reliable supply between allied economies of different income levels.

Monier of Lombard Odier adds that emerging markets will fall into three broad categories if global supply chains and investments are fragmented along these lines.

The first includes highly industrialised economies such as South Korea, which are important to global technology supply chains. A second group of natural resource exporters, including Saudi Arabia, may try to remain non-aligned, focus on long-term development, and maintain stable prices.

He says that the third group will include countries already gravitating toward a specific bloc but are looking for stronger inducements, such as India and Asean countries.

Key to the spotlight on Monier’s last group of emerging markets — some of whom have remained relatively “non-aligned” to avoid the “binary” choice between China and the US — has been the regained significance of the China Plus One strategy, a term first coined in 2013 as businesses assess their concentration risks.

Of Monier’s five potential winners from the US-China power struggle, three come from Asia — India, Indonesia and Vietnam. “India and Indonesia have large domestic markets, and strong exports complement Vietnam’s economy. This group’s strategic importance makes it difficult for the US to pressure them to halt trade with China or Russia. As they continue to develop, they should also attract direct investments for their manufacturing sectors,” he adds.

Research from Oxford Economics has shown that foreign investment in India has grown, especially in the high-tech goods sector. However, India’s manufacturing sector has largely been skipped even as its economy has developed in favour of other Asian counterparts despite its key demographic dividend.

Within the manufacturing sector, electronics and computing products have been identified as “particularly sensitive” strategically. Given the significant trade restrictions imposed by the US, the sector has been urged to search for alternatives to China as an import source.

Oxford Economics data shows the stark effect of these sanctions. Between 2018 and 2022, US imports of computers and electronics increased by 23%, while imports from China fell by 13%.

While Vietnam, Taiwan and Mexico saw the largest gains in absolute terms, India boosted the value of its electronics exports to the US by 260% during the period, second only to Vietnam — which was able to triple its share of the US computer imports. Taiwan was able to double its US market share between 2018 and 2022.

East Asian FDI weighs in

But it is not just the US tech market share for which many Asian economies are vying. China’s reopening and deteriorating relationship with the US will likely revive its Belt and Road Initiative (BRI) investments in Asean, which could also affect the configuration of manufacturing supply chains.

The latest Maybank Asean Economics report found that Asean’s share of China’s outward direct investment (ODI) rose to 11% in 2021 from 9.6% in 2018. In contrast, Chinese investments in the US have declined by a quarter over the same period, with the share of China’s ODI going to the US falling to 3.1% in 2021 from 5.2% in 2018 (Figure 1).

Source: Maybank

Maybank research also found that lending by China’s top two development banks, EximBank and CDB, plunged to a 13-year low of US$3.7 billion ($4.9 billion) in 2021. However, investment and construction contracts from China to Asean recovered in 2022, rising to US$18.6 billion in 2022 from US$10.8 billion in 2021; this remains well below the pre-pandemic five-year average of US$27.9 billion.

Six of China’s top 15 investments in BRI countries in 2022 were in Asean, including the Silk Road Fund’s US$3 billion commitment to Indonesia’s sovereign wealth fund and PowerChina’s joint venture with Thailand’s Bangchak Corp to build a US$1.5 billion wind farm in Laos.

Meanwhile, Indonesia, Malaysia, Singapore and Thailand have all seen stronger China investment inflows or applications in the past two years, while Vietnam and the Philippines have yet to rebound.

Indonesia saw a strong rebound of 77% in 2022 in foreign investment realisation from China and Hong Kong, driven by Chinese mining companies actively investing in nickel smelters and refineries for EV battery production.

China also dominated Malaysia’s FDI in 2022, at US$12.5 billion or 34% of total FDI. In Singapore, China’s share of fixed asset investment commitments jumped to $1.9 billion in 2022 from below $250 million in 2019 to 2021. Thailand saw China return as its top foreign investor in 2022 for the first time in three years, mainly in key industries such as electronics, automotive and data centres.

HSBC’s Asean report notes that while the Chinese FDI picture is uneven across the region, manufacturing continues to be the “backbone” of FDI to Asean, a sector in which China is now facing stiff competition from its East Asian counterparts.

According to Maybank, the increasing prevalence of “friend-shoring” has seen other East Asian economies pivoting towards Asean to reduce reliance on China. While Japanese investment in China has stagnated, ODI to Asean has been rising, with Thailand, Vietnam and Indonesia receiving larger investments (Figure 2).

Source: Maybank

Meanwhile, since the launch of South Korea’s New Southern Policy Framework to advance regional ties, Asean’s share of Korean exports has risen to 18.3% in 2022 from 16.6% in 2017. Korean ODI to Asean climbed over 50% in the same period, with Singapore and Vietnam being the largest beneficiaries of Korean investment (Figure 3).

Source: Maybank

The “non-aligned” nations that are playing both sides of the trade field risk getting pulled by either US or China into their respective “friend-shoring” networks, says Monier. “Nevertheless, geo-economic fragmentation should also, over time, shorten supply chains as well as let manufacturers respond more quickly to changing consumer demand,” he says.

“The result may be more regional as corporations create hubs to supply their production and distribution networks. While that may create self-sufficient collaboration within the blocs, it will do nothing for competition, making similar products more expensive when compared to regions.”

Still, Morrison believes it is still “early days” regarding how industry players will react and redistribute their manufacturing operations. “I don’t think businesses react as quickly to change as you might expect because there’s capital investment and workforce skilling required, and therefore they carefully consider what they want to do and where they want to go,” he says.

“Clearly, companies look to maximise advantage from trade agreements. Any incentives or tariffs imposed by governments are, of course, a part of the decision-making process. However, I think it is more considered, it does not lead to sudden flip-flop decision-making,” he adds. “Supply chains don’t move on a dime.”