What We Are Seeing Now Is a Movement Towards the “Localization of Supply Chains” – conversation with Robert Handfield

In the past decades, the world has witnessed the rising importance of global supply chains along with outsourcing productions and services. What in your view have been the main consequences of this phenomenon for businesses?

Global supply chains have been increasingly relying on low cost manufacturing from overseas sources. This trend has been occurring for the last thirty to fifty years. Much of the activity has been driven by the continued pressure to buy products and sell them at the lowest possible cost. Accordingly, many companies moved their manufacturing to low cost regions to gain on labor costs, which was often the highest contributor to the total costs. This wave of offshoring was enabled by international trade agreements struck between nation states aimed to reduce duties and taxes.

Offshoring the production often meant that firms would establish large and centralized production facilities to exploit volume advantages and locations often as China, India, Thailand and Vietnam etc. The final product is manufactured in centralized facilities, and is shipped around the globe to large distribution centers in the U.S. or in Europe largely through ocean freight. The product is distributed with significant markups to large retailers. This practice was encouraged by consumers who voted with their dollars and pay for the lowest price and for the large brands and retailers.

Did this trend accelerate by the fall of the command and control type economies?

Absolutely, this was another major driver. As the Eastern Block opened up to broader economic reforms, they no longer did as much manufacturing within their own countries. The formation of the European Union also led to greater outsourcing to lower cost regions. Buying on the basis of low cost and price became the predominant force of offshoring in these low cost countries. Unfortunately, they did not consider associated with doing so.

What are the trade-offs of low costs and worldwide long supply chains?

There are some significant trade-offs. First, there is a lack of direct oversight over the whole operation. You are more likely to have quality problems and less control over the labor force, which allows the abuse of labor and in some cases even led to slavery. On the other hand, most of the shipments were made by ocean freight and the lead times for these became longer and longer, while the ships became larger and larger. They made more frequent stops, they slowed down what they call slow steaming. As a result, companies have a lot inventories on the water. That meant they had to increase the inventory they had on hand because the lead times were so long. It also exposed us to additional disruption such Brexit or the US – China trade war on tariffs, which lead to supply being constrained. However, one of the biggest risks completely overlooked was the possibility of export control and product shortages with cut off supplies in critical material such as medical supplies. So the chickens have come home to roost in early 2020. What I also observed in this situation that it is very difficult to have visibility into material that was in the supply chain. It would go into ports, it would go into custom locations, it would be on a ship but you did not really know where it was. You just have to sit and have to wait and you hoped that it has got here as quickly as possible. That created a lot of problems.

What are its impacts on national economies and local production or services? Can we speak about a specific global v. local dilemma?

The dilemma came from the outsourcing many of these critical materials. If you look at semiconductors, they are not just used in electronics but also in cars, airplanes, weapons, in the thermostat of your house, so they are everywhere. We have outsourced the production of semiconductors largely to the country of Taiwan. I know an executive in electronics who says: “I have a nightmare every night”, which is that there is an earthquake in Taiwan because the majority of semiconductors are produced by a single a company, the Taiwan Semiconductor Manufacturing Company (TSMC). If they shut down, the entire global supply chains of every industry will shut down too. It increases dependencies and thus it increases risks. In a certain sense, it also hollows out key skills. We do not make anything in the United States anymore, we only make very little. The Department in Defense is concerned because we are very often and completely relying on the Chinese for the goods that we require for our national defense. That allows the risks of potentially having back doors and we saw this recently. It also opens up the possibility of hacking. We had a cyber attack, the Colonial Pipeline cyber-attack here a couple of weeks ago that shut down gasoline pumps all over the East Cost. I could not buy gas in North Carolina and I had to stay home for a week since there was no gas.

As you pointed out several factors from cyber attacks to the recent Suez crises to global health crises increased the risks of significant disruptions in various global supply chains. This also revealed the weaknesses of outsourced productions. What, in your view, are the major lessons learnt?

I think the lesson learnt is when you have this very long supply chain that goes all over the world, it is very difficult to start them up or shut them down. We are seeing this today: massive shortages of fuel, shortages of appliances, shortages of lumber. Because what happened during the coronavirus pandemic is that most of the supply chains were shut down. When we shut a supply chain down, you cannot just start it up automatically. It is not like stepping on the gas and move forward. Instead, you step on the gas and wait several months before you can move forward: there is a startup period. When you have something like the Suez crises, which shuts down the entire global shipping industry that goes through that single bottleneck, that also delays it even further. We have created in a sense these very vulnerable supply chains that have led us to this situation. We created it through the pursuit of lower and lower costs while ignoring the risks of these outsourced supply chains to low cost countries.

However, from a broader perspective, we can also witness renewed efforts to realign global supply chains closer to home countries. For example, the US-China trade war already pushed companies to explore options elsewhere than China. The French president also announced his commitment to relocate strategic production sites in France. Protecting economic sovereignty is on the rise. How do you see this trend and its effects on supply chains?

These trends are certainly significant. What we are seeing now is a movement towards I would call “localization of supply chains.” For instance, I believe that an economic regionalization will occur. I suspect you will see closer ties between U.S., Canada and Mexico, between Europe, Eastern Europe and Northern Africa, and between China and South East Asia. You will start to see regionalized supply chains beginning to emerge. What I envision in my latest book titled Flow: How the Best Supply Chains Thrive is greater regionalization that combines low cost labor, natural resources with the ability to bring domestic manufacturing back. I recently testified in a Senate hearing this week. There is a U.S. bill (the HOME – Help Onshore Manufacturing Efficiencies for Drugs and Devices) that is seeking to encourage domestic manufacturing of critical drugs and devices.

How do you think of the situation of the EU and the role of Central and Eastern European countries from that perspective?

The EU is also going to need to pull together closer. There is no question that Central and Eastern Europe including Hungary has the resources to play a significant role. They have highly educated but lower cost workforce, great productivity, great engineering skills. For example, many contract manufacturers like Flex have established manufacturing centers in Poland and Hungary, as they recognize that the workforce there is well-educated, highly motivated, and productivity is high. These are the types of skills that will be important in advanced manufacturing and supply chain distribution centers in the digital future. I think Eastern Europe can really emerge as a key component of domestic EU manufacturing strategy going forward.

As you mentioned, we can simultaneously see another a trend that is digitization. Many are of the opinions that the old school economic globalization that involved worldwide long supply chains began to decline while digitization along with automated decision making could provide new opportunities with businesses. How do you see this trend?

As we digitize supply chains what we will see is what I call the “white space”, which is the gaps between decision-makings, actions and data. That will shrink. What that means is that we will use artificial intelligence and automation to make more decisions that humans made in the past. For example, if the lead time changes on a product, a human has to go into the system and make an adjustment and also readjust the inventory and order points. There has to be a whole series of manual transaction. Machines can do that instantaneously with no input. I think that machines will be running supply chains more often. That would lead to incredible improvements in productivity that has never been seen before. The productivity improvement in the future will not be inside the four walls of manufacturing plants during the global supply chain. I think that this will be the greatest leaps in terms of economic activity and productivity occuring in the supply chain and the movement of materials and products between businesses and consumers.

Would it reinforce reshoring?

Yes, I think it will be driver for reshoring because the economics will no longer be only on labor costs. The economics will also be on working capital, on velocity, inventory and organization will focus on moving material more quickly and responding more quickly to costumers not on low cost not on shipping from the lowest cost countries and not on seeking arbitrage on labor costs. I thank that type of strategy has run its course and it is not going to continue.