Coronavirus and Global Business Impacts
What's coming, and what to do about it
David Iwinski Jr.
Coronavirus and Global Business Impacts
What's coming, and what to do about it
February 6, 2020
By David Iwinski
The whole world is concerned about the coronavirus with good cause. A largely unknown virus, coming seemingly out of nowhere, which apparently spreads easily and has a two-week incubation period, has rapidly globalized with documented cases in over 20 different nations, according to the United Nations. The most recent statistics on infection show the current case load at 31,481, of which 4824 are currently in critical condition, with 638 deaths to date.
In response to this serious health crisis, the Chinese government has quarantined major cities, restricted travel, closed borders and sought guidance and expertise from all corners of the globe. One of the most unfortunate realities of this outbreak is that it exploded during the Spring Festival, commonly known as Chinese New Year, when an extraordinary number of people were traversing the country. Over 413 million train trips, 73 million airplane trips and countless more bus and automobile travel plans meant that over a billion people were traveling in close proximity.
One of the critical early actions was the quarantine of Wuhan and a governmental extension of the Chinese New Year holiday. Rather than people coming back to work on February 3, the official date is now February 10 – although we have been informed by scores of businesses that they have either voluntarily extended this time an additional week, or are being quietly urged to maintain closed facilities so people are not encouraged to come to the core manufacturing centers in China.
For those who suggest that the worst has passed, just today Guangzhou, the capital of China's southwestern Guangdong Province and the country's fifth largest city with nearly 15 million residents, has imposed a mandatory lockdown on all citizens, effectively trapping residents inside their homes, with only limited permission to venture into the outside world to buy essential supplies. That suggests that “business as usual come February 10” is a pipe dream.
Supply Chain - When it comes to the business impacts, there have been several stories about potential effects on supply chain. Most say something to the extent that deliveries may be delayed a week or two, and so you may have a small “ripple” in the steady flow of goods coming from China, but that it should not be serious, as most businesses carry enough stock to manage an interruption of one week.
If we were simply talking about a seven-day delay, we think that would be reasonable and practical advice. However, the most thoughtful commentators we have found think that this disease will actually peak in April or May, and we may be well into late July or August before all the effects are erased. That suggests that the reality may well be that we are in for a much longer and more protracted delay.
If that happens, there are several other trigger effects that will start to cascade into serious problems for the global economy, and that will most definitely affect businesses in North America. Goods that we expect to be on the shelves at Wal-Mart and places like Home Depot will be in short supply, and possibly with higher prices.
The effect on United States manufacturing and assembly will be more severe. Even for companies who manufacture sophisticated goods and technological devices primarily in the United States, if even a small percentage of the parts that go into those US-made devices are delayed, the entire factory can grind to a halt. This is exacerbated by the decades-old trend towards “just-in-time” parts delivery and maintenance of very low levels of locally maintained stock and supplies. Those business practices that work so wonderfully to reduce capital costs when all is well may dramatically accelerate the crisis when supply suddenly becomes short.
Shipping and Transportation Problems - Products shipped by air and sea will both face significant restrictions. As severely reduced forecasts in product volumes coming out of China have already dropped the demand for shipping container movement, giant shipping companies such as Maersk, MSC Mediterranean Shipping, Hapag-Lloyd and CMA-CGM have said that they have reduced the number of vessels on routes connecting China and Hong Kong with India, Canada, the United States and West Africa. Many North American and European airlines have already canceled all flights in and out of China, both for carrying people and cargo. Even while some cargo flights may run reduced schedules, the severity of quarantines within China will mean that whatever limited production is available can’t get to the shipping facilities, and will be trapped in the factories.
Labor Shortage - One thing that many Americans may not factor into their evaluation is that when Chinese workers are advised not to return to the factory for an additional one, two or three (if not more) weeks, they do not receive compensation for that time when they are not working. This was confirmed by several calls to our contacts in China factories last week. There are not a lot of people in the working world who can easily handle a month off of work without pay. We anticipate that many of these workers will seek alternative employment closer to home, and as labor markets shift and additional fears of infection grow, they may simply never go back to their previous factories.
Even if they might want to return to their original factory, the fear of moving back to a high density environment with the possibility of cross-infection may cause many of these workers to conclude that staying back home and finding employment, even at a lower rate of pay, may be the best temporary solution to the uncertainty of a possibly fatal disease far from home.
Consider also that even in areas relatively clear of a health crisis, if they are reliant upon subcomponents or parts for their production from factories located in the infected and quarantine zones, that they may simply stay closed because they don’t have enough parts to employ the workers who have come back to the factory.
That leads to another problem:
Quality and Productivity Reductions - After a long furlough and the need to hire many new workers, as even in good times an estimated 15% to 20% of all factory workers who leave for the Chinese New Year holiday do not return, we might reasonably assess that an additional 20% may seek alternative employment. This leaves many factories needing to find 40% of their workforce for replacements. That also means a massive training effort at a time when they will be pushing productivity hard to make up for the weeks of lost supply and revenue brought in by the enforced holiday extension.
We all know what happens when you have to train half of your workforce while simultaneously trying to ramrod production - quality problems will be widespread and that will further slow production. Indeed, in an effort to get product out the door so they can collect payment (more on that later), some factories may be tempted to ship product knowing that there is a higher than acceptable degree of product defects, but simply assuming that they will have to fix them later.
Working Capital and Liquidity Crisis - While there was a time in China when labor rates were low and profits were fat, that time has long since passed. Chinese producers are under intense pressure to cut costs, as overcapacity leads to a race to the bottom, while simultaneously many people are deleveraging their China supply chain and moving southwards to greener (and cheaper) pastures in Vietnam, Myanmar, Cambodia, Thailand and Malaysia, among others. This means that many of these factories are operating in an extremely narrow profit margin and are, in many cases, living paycheck-to-paycheck as the state support of decades past is generally long gone. Other factories that have neglected maintenance and upgrades while reaping profits for owners may suddenly find that pushing materials and machines harder in an effort to catch up will unfortunately lead to higher operating costs, precisely at a time when they are not getting an inflow of US dollars because shipping containers full of goods are not reaching the ocean.
Our expectation is that, particularly in markets with noted overproduction capacity, this health crisis will lead to a winnowing of weaker production facilities and a shakeout in many industries. The crisis will bring in working capital and liquidity problems, as cash flow from North America and Europe is throttled in response to long shipment delays. Industry shakeups will occur, reducing options. If, for example, the molds required to produce your plastic parts are now locked in a factory that is shuttered, then even if you have the drawings, producing new molds and getting back into production will be measured in months, not weeks or days.
In short, the combined effects of the health crisis, labor shortage, retraining costs and cash starvation because of delays in production and delivery to clients globally means that many of these factories are simply never going to reopen. The cumulative weight of these various factors will cause marginal operations to cease.
Delayed Payments and Extended Payment Terms - Should you work in a facility in the United States engaged in selling product to China, you might step back and think that most of these effects will be minimized for you, because as soon as the workforce is back in the factories your product will be needed. Consider that if the above problems come to pass, the facilities that have been buying high volumes may need to reduce their purchases from you. And, if they cannot in turn ship product to paying customers and are experiencing liquidity problems, they may immediately become very slow to pay and ask for extended terms.
Let’s consider what might occur if the above noted trends, tied directly to the expansive growth of the disease that still defies treatment, come to pass. What will happen when, slowly but surely, people start to realize that while one or two of these effects might be a small ripple, the cumulative effects of supply chain delay, labor shortage, quality and productivity reductions, liquidity problems and slow payment altogether (even in small measure) could be a pretty serious hammer blow to a North American business? All of these effects flow upstream, and the customers that are looking to you to supply high-quality product on time at competitive prices may understand that you are at the mercy of a health crisis on foreign shores, but it will not stop them from looking immediately at alternative sources of supply to give them alternatives and lead time.
But what happens when everyone does that all at the same time?
Large-Scale Simultaneous Supply Chain Realignment - When this trickle of problems merge and start to impact companies outside of China, a lot of people will be scrambling for solutions. Immediate realignment of supply chains into countries less affected by coronavirus will probably be very difficult or impossible to achieve in the short term, as access to information, talent and materials locked in China will not be possible, even if there are production-ready facilities in other countries eager for your business. But rest assured that those other facilities are going to be besieged by hundreds of businesses just like yours, trying to figure out what to do.
We are not trying to fan the flames of apprehension, but we are simply pointing out that after speaking with our contacts throughout China over the past two weeks, as well as taking the pulse of some selected thoughtful analysts, lead us to believe that this scenario is highly possible and it is prudent to make some preparations in case the worst should occur.
Our recommendations for facing this crisis are:
Conserve Product Stock - Conserve your existing stock of products, and consider talking to key customers to see if they can accept lower volumes temporarily, to stretch out your current stock on hand to cover a longer delay than what is currently anticipated.
Locate Existing Alternative Stock - If the nature of what you’re buying from China can be purchased off-the-shelf elsewhere, from US domestic suppliers or possibly simply bought off-the-shelf of existing warehouse facilities, consider immediately purchasing a reasonable amount of stock and supplies in anticipation of further delay from your existing supplier base. Move fast and make decisions while product is still available.
Conserve Capital - Consider temporarily slowing down noncritical plans so as to have available capital on hand, should payments expected from Asian customers fail to materialize or should your existing shipments to North American clients be compromised. You will need enough cash on hand to ride out the storm.
Take A Pessimistic View Towards Optimistic Forecasts From China - I have been traveling to China for over 32 years and I lived there for 5 years. I have practical, hands-on experience working there, and I hold the greatest respect for the Chinese people and their capabilities. That said, there is a built-in inclination to project optimism and understate difficulties and challenges in production. Maintain a respectful and professional environment, but take their estimates about when they will be back to full production with a strong dose of skepticism. Add a little time to the forecasts so that you do not in turn project any undeserved optimism to your own customers.
Supply Chain Realignment and Balancing - Consider just how many of these adverse effects of coronavirus could be avoided if critical components had multiple sources of supply spread throughout nations with equivalent labor rates and technological sophistication to China? We have helped numerous clients find equivalent production at excellent prices in places like Malaysia, Thailand, the Philippines and Vietnam. For products requiring extremely high sophistication, consider also South Korea and Singapore. There are many places that have dramatically improved their production capabilities over the last two decades, that might now be fully able to deliver quality and volume at prices that are globally competitive.
Will having three separate suppliers in three separate countries of several critical elements of your supply chain add complexity and overhead to your operation? Without question, it will. At the same time, it gives you flexibility and the ability to shift production when various changes - natural, political or environmental - make certain areas untenable for production and require rapid shifts. Compared to locating qualified new suppliers and spinning them up on a wide range of complex products, it is extraordinarily easier to work with existing knowledgeable suppliers to slowly increase their product volumes over time, in products they already understand, with teams fully trained and in place.
I might add also that having multiple suppliers in multiple countries, even in good times, will allow you to constantly price check back and forth, so that the competitive pressures between these nations helps ensure that you are paying a fair and reasonable price for your products.
We have no wish to make things sound worse than they are, and it would be nice to think that within 7 to 10 days everything will be back to normal. But for the last seven days, the average number of cases added per day has ranged from 2000 to 4000. While experts are claiming that the percentage rate of growth is dropping off, that is simply because the number of affected patients is now so high that adding another 4000 in a day is, indeed, a lower percentage growth of infected patients. This doesn’t necessarily mean that the crisis has peaked.
Work toward and expect the best, but a little proactive preparation can be a lifesaver for your company if the optimistic predictions of government officials turn out not to be 100% on the mark. And if the worst thing that happens is that you have a little excess stock to dispose of slowly over the next 3 to 4 months, that is certainly better than the crisis you might face if the cascade of problems noted above comes to pass.
If we can be of any assistance in these matters, please call me personally at 412-352-7997 and we will apply our talent, experience and connections in Asia to see if we can help you.