Risk, resilience, and rebalancing in global value chains

August 24, 2020

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In recent decades, value chains have grown in length and complexity as companies expanded around the world in pursuit of margin improvements. Since 2000, the value of intermediate goods traded globally has tripled to more than $10 trillion annually. Businesses that successfully implemented a lean, global model of manufacturing achieved improvements in indicators such as inventory levels, on-time-in-full deliveries, and shorter lead times.
However, these operating model choices sometimes led to unintended consequences if they were not calibrated to risk exposure. Intricate production networks were designed for efficiency, cost, and proximity to markets but not necessarily for transparency or resilience. Now they are operating in a world where disruptions are regular occurrences. Averaging across industries, companies can now expect supply chain disruptions lasting a month or longer to occur every 3.7 years, and the most severe events take a major financial toll.

The risk facing any particular industry value chain reflects its level of exposure to different types of shocks, plus the underlying vulnerabilities of a particular company or in the value chain as a whole. New research from the McKinsey Global Institute explores the rebalancing act facing many companies in goods-producing value chains as they seek to get a handle on risk—not ongoing business challenges but more profound shocks such as financial crises, terrorism, extreme weather, and, yes, pandemics.

Today technology is challenging old assumptions that resilience can be purchased only at the cost of efficiency. The latest advances offer new solutions for running scenarios, monitoring many layers of supplier networks, accelerating response times, and even changing the economics of production. Some manufacturing companies will no doubt use these tools and devise other strategies to come out on the other side of the pandemic as more agile and innovative organizations.

With shocks growing more frequent and severe, industry value chains vary in their level of exposure

The COVID pandemic has delivered the biggest and broadest value chain shock in recent memory. But it is only the latest in a series of disruptions. In 2011, a major earthquake and tsunami in Japan shut down factories that produce electronic components for cars, halting assembly lines worldwide. The disaster also knocked out the world’s top producer of advanced silicon wafers, on which semiconductor companies rely. Just a few months later, flooding swamped factories in Thailand that produced roughly a quarter of the world’s hard drives, leaving the makers of personal computers scrambling. In 2017, Hurricane Harvey, a Category 4 storm, smashed into Texas and Louisiana. It disrupted some of the largest US oil refineries and petrochemical plants, creating shortages of key plastics and resinsfor a range of industries.

This is more than just a run of bad luck. Changes in the environment and in the global economy are increasing the frequency and magnitude of shocks. Forty weather disasters in 2019 caused damages exceeding $1 billion each—and in recent years, the economic toll caused by the most extreme events has been escalating. As a new multipolar world takes shape, we are seeing more trade disputes, higher tariffs, and broader geopolitical uncertainty. The share of global trade conducted with countries ranked in the bottom half of the world for political stability, as assessed by the World Bank, rose from 16 percent in 2000 to 29 percent in 2018. Just as telling, almost 80 percent of trade involves nations with declining political stability scores.   Increased reliance on digital systems increases exposure to a wide variety of cyberattacks; the number of new ransomware variations alone doubled from 2018 to 2019.  Interconnected supply chains and global flows of data, finance, and people offer more “surface area” for risk to penetrate, and ripple effects can travel across these network structures rapidly.

[See Exhibit 1] It classifies different types of shocks based on their impact, lead time, and frequency of occurrence. In a few cases, we also show hypothetical shocks like a global military conflict or a systemic cyberattack that would dwarf the most severe shocks experienced to date. While these may be only remote possibilities, these scenarios are in fact studied and planned for by governments and security experts. The impact of a shock can be influenced by how long it lasts, the ripple effects it has across geographies and industries, and whether a shock hits the supply side alone or also hits demand.

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Here is a direct link to the complete article.

Susan Lund is a partner of the McKinsey Global Institute (MGI) in McKinsey’s Washington, DC, office; James Manyika, MGI’s co-chair, is based in San Francisco; Jonathan Woetzel is an MGI director in Shanghai; Ed Barriball is a Washington, DC–based partner who specializes in manufacturing, supply chains, and logistics; Mekala Krishnan is an MGI senior fellow, based in Boston; Knut Alicke is a Stuttgart-based partner with expertise in manufacturing and supply chains; Michael Birshan is a London-based senior partner who focuses on strategy and risk; Katy George is a senior partner in McKinsey’s New Jersey office, with expertise in manufacturing, operations strategy, and operating model design; Sven Smit, MGI’s co-chair, is based in Amsterdam; Dan Swan leads McKinsey’s global supply chain practice; and Kyle Hutzler is a McKinsey associate in Washington, DC.

 

 

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