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COVID-19 means you need to diversify your supply chain, even if it’s painful

This is a guest post from Denise Abraham. Denise is the General Manager of Private Label Sourcing at etailz, Inc. etailz is a one-stop-shop for everything online retail. They can partner with brands to retail their products on the marketplaces, serve as an extension of a brand through their agency, or provide self-service marketplace ad & cost recovery software.

Whether you’re a retailer or an importing distributor, continuity of supply chain is key to maintaining required inventory levels and keeping a loyal customer base. Many businesses utilize a “just in time” sourcing strategy, which have been employed for decades in order to maximize use of capital, manage shelf life issues in some products, and meet seasonal spikes without risking excess or obsolete inventory.

However, “just in time” sourcing is a high-risk logistics strategy, a risk that has been made all too evident by COVID-19.

With the outbreak of the Coronavirus COVID-19, it has become clear that a diversified sourcing base is critical to success. The virus has caused major, if temporary, disruption that will affect the supply chain out of China for months to come.

While the virus was largely confined to the province of Hubei and the city of Wuhan, it has quickly spread to Europe, Japan, the USA, and Iran. World travel and longer incubation of this virus will cause global supply chain problems to persist for months.

In some respects, the timing of the coronavirus has been lucky for importers, as it occurred around the Chinese New Year. This holiday slows production and transport for several weeks each year, so most importers had already planned for several weeks of disruption.

According to our contacts, about 65% of all factories in China have been allowed to return to work, and the balance is said to be back to work by March 1st, though the truth of that remains to be seen. If the coronavirus keeps factories and shipping routes closed into March, there will be cascading economic impacts, many of which could have been mitigated by diversified sourcing and supply chain management.

Businesses Have Become Dependent on China

China represents over 21% of overall USA imports, making them the third largest trade partner with the USA, after Mexico and Canada. China provides a substantial percentage of components for the electronic equipment, machinery, furniture, toys, plastics, vehicles, clothing and footwear, and steel categories. In total, imports from China have exceeded $479 billion per year. All of this points to a simple fact: many US businesses have become dependent on China for sourcing.

This reality didn’t occur by chance. For the last 40 years, US consumers have become increasingly reliant on Chinese factories as the availability of and appetite for cheap goods has grown. China capitalized on this opportunity, investing in infrastructure, training, manufacturing, and kept costs down (in some cases by manipulating currency and by subsidizing Chinese manufacturers) to make China integral to supply chains around the world.

More than any country I have ever worked in (and I’ve worked in over 30), China has been the most committed to the long game. They knew that they could make manufacturing in China easy to start and expensive to leave. They had a plan 40 years ago and they have masterfully executed it.

Now, with the disruptions caused by the Coronavirus, the fragility of the single-source strategy has been exposed, and brands are paying for their dependency on China.

It will be impossible to replace the current system overnight, but it’s necessary, and the risk of not diversifying is greater than the pain of doing so. Changing infrastructure and supply lines will take years of steadfast discipline and purpose. In the short term, it will likely mean thinner margins for all who attempt it, but as the Coronavirus outbreak has shown, not diversifying your sourcing could prove fatal to your business.

Alternative Sourcing to China

For some industries like textiles (an area of importing that I can speak to with authority), diversifying sourcing is a relatively easy fix. India, Bangladesh, Indonesia, Mexico, Guatemala, Brazil, Peru, and others have robust textile manufacturing infrastructure. Most of these countries still don’t have what China has built, but they remain viable options. Some companies have already made them a part of a well-diversified sourcing base.

Having said that, some of these countries, in my experience, tend to be less reliable for on-time delivery. It is also true that Western Hemisphere countries can be more expensive than China, but the costs are often offset by differences in the tariff code.

It should be noted that in the case of electronics, while China is an integral part of the global supply chain, much of its exports are comprised of foreign produced components that are assembled in China. The fact that there are not enough suitable manufacturing or assembly plants outside of China for some electronic products remains a barrier to change in supply chains. However, China is making investment in offshore countries rapidly.

Due to the trade war with China, movement of production seems to have moved to South and South East Asia. China GDP was forecasted to be 6% prior to the coronavirus, and that was a 30-year low. The forecast is now 5.4%.

The RMB has also fallen and it appears that the China government is not inclined to defend it. This will give China an advantage in costing, making it tempting for importers to stick with the China supply. While I understand the temptation, this is not a wise strategy for the long-term.

Even China Sees the Need for Diversifying its Sourcing

China itself sees the need to diversify sourcing. Chinese labor costs are rising and with the threat of tariffs looming, China recognizes that soon, it may not be the best option. In recent years, both textiles and electronics have been migrating out of China to other countries that have abundant labor at lower cost.

As a result, China is making manufacturing investments in other countries. China is now the fastest growing source of foreign investment in India. China has also invested in Bangladesh, Vietnam, Indonesia, and Cambodia. While there are infrastructure deficits in some of these places – most notably Bangladesh – they each have a trained and well-educated workforce that can provide the needed technical skills. The challenge for China will be in cultural and language issues.

Key Takeaways

Manufacturing in China has led to improved profitability for US businesses over the past few decades, which resulted in a disproportionate dependency on China. Though the addiction to profits will not cease, the need for diversification is becoming increasingly more apparent and important. Like any evolution, it will take time for manufacturing to catch up, but necessity being the mother of invention, I do expect large companies to make diversification a greater priority and begin investing in manufacturing outside of China.

Costs Considerations

  • Travel costs could be up while you send needed experts to assess new sourcing locations to ensure quality and delivery
  • Inspection costs – third-party inspections might be required
  • Testing will be required for most goods out of a new supplier, to ensure legal and/or marketplace compliance
  • Freight could be higher if you are forced to ship LCL instead of full containers
  • Lead times could be long while a vendor works to reach optimal efficiency
  • Components shipped from elsewhere in the world could incur freight and clearance delays into new manufacturing countries

Long-Term Gains

  • More options and possibly shorter turn time if you mix Western Hemisphere options with Far East options
  • Lower overall freight cost if using Western Hemisphere options once production is scaled to full container and larger container quantities
  • Lower Landed Duty Paid cost when taking advantage of duty-free trade options

Diversification may be as simple as asking your vendors if they have offshore options. If they do, you retain the sophistication and knowledge that your current vendor has of your product while also mitigating future risk by diversifying your supply chain.

If they don’t, then diversifying your supply chain could cause a painful series of delivery delays, incremental travel cost, additional training and testing. Though change is difficult, diversification is the better supply chain strategy for long-term stability and growth.

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