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Knowledge at Wharton

Management

Should U.S. Companies Stop Relying on China?

The global supply chain is affected by the pandemic but also China’s increased consumption of its own products

Published: Thursday, September 30, 2021 - 11:02

After more than a year of being pummeled by pandemic-related supply chain shortages, computer maker HP had some good news to report during its third-quarter earnings call last month. Revenue is up 7 percent over the prior-year period, even though it fell short of projections.

The problem isn’t demand. Chief executive Enrique Lores told Barron’s, “We are selling everything we can produce.” Yet supply chain problems persist, especially across Southeast Asia where many factories have been forced into Covid-19 lockdowns.

“We could have grown more if it wasn’t for the shortage of components,” Lores said.

Although well past the initial shock wave of the pandemic, industries across the spectrum are still grappling with ripple effects that threaten to sink profitability. Gad Allon, Wharton professor of operations, information, and decisions, said now is the time for business leaders to rethink their reliance on China as the main supplier for everything from computer chips to shoes.

He said nearshoring, or working with suppliers that are closer to home, is one way that U.S.-based firms can reduce the uncertainty that comes with procuring parts from far across the globe.

“If the cost of shipping is a big part of what you do, if uncertainty is something you want to try to hedge against, it starts to make sense to move closer to home,” Allon said during an interview with Wharton Business Daily on SiriusXM. (Listen to the podcast.)

Allon, who is also director of the Jerome Fisher Program in Management & Technology at Wharton, wrote an opinion piece for Newsweek that highlighted previous research he conducted on sourcing from Mexico vs. China. Some factors underlying firms’ reliance on China, like cost difference and scale, diminish in importance as firms grow. But volatility is a constant worry.

“Every increase of volatility, no matter how slight, either on the demand side or the supply side, immediately reduces the amount firms can afford to order from China,” he wrote in the opinion piece.

Perils beyond the pandemic

Serious supply chain problems were percolating long before the pandemic, Allon said, and they are compounded by events that have nothing to do with the virus. Weather-related disasters, governmental regulation, and politics all come into play, as does China’s growing role as a consumer of its own goods. The world’s most populous country has a burgeoning middle class, and those customers have more money to spend on discretionary items. That increased consumption raises demand, which in turn raises prices.

“We see a big shift here where China becomes a dominant player [as a] consumer of goods,” said Allon, adding that he thinks China will remain a dominant supplier because of its capabilities.

“Volatility has a multiplying effect,” he said, especially on firms challenged with providing good service at low prices. “The argument I’m trying to make is that decision makers underestimate the impacts of uncertainty, and it’s not just in the U.S.”

Economies around the world are being strangled as countries implement lockdowns to contain the spread of the highly transmissible delta variant. The latest virus surge is just one more reason why Allon is exhorting supply chain managers to think far ahead—and far outside of the box—for solutions.

“For a while we thought we could wait, and once everybody was going to be vaccinated, we’d be able to go back to normal,” he said. “Now we have delta, then we’ll have eta. Should we wait until zeta? We should start thinking about creating some type of normalcy where we can anticipate where things are going to go, even though we understand we cannot anticipate everything in reducing this level of volatility.”

He noted that before the pandemic, more firms began hiring lawyers to anticipate changes in global regulations. Massive companies like Amazon and Walmart can afford a stable of lobbyists who help manage and shape that regulation. But small suppliers are at the mercy of big changes.

“This is not an easy problem. But I think it will be much, much easier if governments would try to commit to some type of normalcy” during the pandemic, he said, citing the United States and Mexico as an example. The neighbors worked together to get unused coronavirus vaccines from the United States into the arms of Mexican factory employees to help prop up both economies.

The potential benefits of nearshoring are becoming clearer to other companies, including HP. In an interview with Yahoo! Finance, Lores said he’s looking into moving production back to North America or Europe, and he’s working with the federal government to find alternative suppliers to China.

“One of the big lessons of the last month is the fact that we need to improve the resiliency of our supply chain,” Lores said.

First published Sept. 7, 2021, on the Knowledge@Wharton blog.

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Knowledge at Wharton

Knowledge@Wharton is the web-based research and business analysis journal of the Wharton School of the University of Pennsylvania. Launched in May 1999, its goal is to disseminate business knowledge and insights to readers around the world. The Knowledge@Wharton Network offers free access to analysis of current business trends; interviews with industry leaders and Wharton faculty; articles based on the most recent business research; conference overviews, book reviews, and links to relevant content; and a searchable database of more than 1,500 articles and research abstracts.

Comments

I am not sure why we rely on the PRC at all

I am not sure why we ever offshored these capabilities at all. Does importing things such as computer chips from places like the People's Republic of China give them some kind of "imported" exotic value they would not have if they were made in the United States? I am sure some managers wanted the cheaper labor but semiconductor manufacture is capital-intensive rather than labor-intensive.

In addition, the PRC is well known for counterfeit and substandard semiconductor components, active pharmaceutical ingredients, toxic pet foods with melamine, and other low-quality work. This is not to say that companies in other countries including the US have not sometimes done these things as well (e.g. Ford Pinto, defective ignition switches from General Motors, Takata air bags) but the recipients of the poor quality have recourse against the manufacturers in question as they are within the reach of US and Japanese courts respectively. A back-alley PRC chip "maker" (they repaint computer chips and add serial numbers to make them look like the real thing) can sell them and then be nowhere to be found when a product becomes unusable as a result or, even worse, causes deaths and injuries. I also recall that Canada discovered hundreds of thousands or even more PRC-made KN-95 respirators that did not meet standards and could have put countless users at risk for Covid-19.

Even worse, the PRC threatened openly to cut off supplies of rare earths and, more recently, medications for use against Covid-19. That is, the PRC threatened explicitly to cause the deaths of American and other countries' citizens for going against Beijing. This should not be tolerated for an instant and the US should do the things it and its enemies did in the Second World War (e.g. inventing synthetic rubber to replace the natural rubber that fell under Axis control, while Germany found ways to turn coal into motor vehicle fuels when the Allies cut off its oil supplies) to end completely its dependence on a hostile government that has threatened its neighbors such as Taiwan with war and curtailed the freedom of Hong Kong.

In addition, even reputable suppliers in places like Japan are subject to force majeure from earthquakes, typhoons, and so on that can imperil long and complex supply chains. We have instead learned the hard way that absence of even one item from a complex bill of materials can idle a manufacturer completely, to the extent that our major automakers cannot make cars and have had to cut work hours.