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Chief Economist’s note: supply chains in the spotlight, again

Chief Economist’s note: supply chains in the spotlight,

Yael Selfin, Chief Economist in the UK discusses the impact of COVID-19 on supply chains.

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Yael Selfin - Chief Economist at KPMG in the UK.

Chief Economist

KPMG in the UK

Contact

Also on home.kpmg

Key points:

  • The COVID-19 shock has pushed resilience back to the top of the agenda for supply chain leaders
  • The UK’s manufacturing supply chain appears relatively well-diversified internationally, with 30% of value added from outside the UK
  • The EU plays an important role in the UK’s manufacturing supply chains; any post-Brexit trade frictions could accelerate the sector’s decline

Global supply chains have come under renewed pressure during the COVID-19 pandemic. This comes hot on the heels of Brexit-related concerns and geopolitical tensions between the US and China last year. The initial outbreak, which began in the industrial city of Wuhan, caused shortages of components in the manufacturing sector. Even as early as February, when the official number of coronavirus cases in the UK was in low double digits, at least one major equipment manufacturer had to briefly halt production because of a lack of parts supplied from China. In the same month one of the UK’s biggest carmakers had to fly component parts in suitcases as the virus had disrupted the usual routes. 

The risks of a ‘just-in-time’ operating model

For decades, companies have been able to unbundle different stages of production across different countries, to take advantage of the efficient scale of production and lower wage costs in developing economies. Efficient supply chains tend to operate on a ‘just-in-time’ basis. They minimise the stock of components held in any one location, as these are delivered as and when they are needed, reducing inventory and thus working capital requirements.

There are risks associated with lean supply chains: a disruption in one link of that chain can endanger the entire production process across the world, and a lack of stock can exacerbate the business impact of that disruption. In 2011, a devastating earthquake and tsunami in Japan disrupted the country’s domestic and international supply chains, with difficulties in local suppliers of metallic paints for examples impacting automotive production around the world.

Diversification is the key to resilience

Efficient, robust and resilient supply chains are crucial to the viability of UK manufacturing, which is heavily integrated into the global economy. The chart shows the proportion of foreign value added embodied in total UK manufacturing output. For the most part, it shows a relatively diversified network of suppliers, with nearly 30% of value added by foreign intermediates producers split across different regions. A geographically diversified network of suppliers creates greater resilience. It allows manufacturers to source parts from alternative locations and, in the event of localised disruption, get back to normal operations more quickly. 

Chart: Foreign value added embodied in UK manufacturing output
batch-13-graph

Source: WIOD 2016, KPMG analysis

View a larger version of the graph from here.

Despite being geographically resilient, companies may still wish to reconsider their ‘just-in-time’ strategy to reduce their vulnerability. While ’just-in-time’ helps eliminate waste and results in lower production costs and working capital, in our modern inter-connected world, it may no longer be adequate for those products deemed essential for health or national defence. A more proactive response to building resilience may be to shift to digitally enabled end-to-end visibility of complex supply chains, enhancing operational agility and reducing exposure to emerging risks. 

Brexit could transform supply chains

Brexit could represent another vulnerability. While the reach of many values chains is global, a large share of production chains tends to be regional. This cuts transportation costs between the various stages of production. The EU represents a large share of the supply chain across UK manufacturing. UK automotive manufacturing has the third highest share of foreign value added, with nearly 38 percent originating from outside the UK. More than half of that, 21 percent, originates from countries in the EU.

As the UK reaches the end of its transition period with the EU, any trade friction could significantly impact on UK manufacturing supply chains, to the point of changing the viability of some production activity in the UK. Even in the absence of explicit tariff barriers, additional costs and time at the border, and other non-tariff barriers, will add friction to existing supply chains and may encourage some production to be relocated outside the UK. Delays at the border risk becoming prohibitive for supply chains involving perishable goods, such as food manufacturing.

Manufacturing has been declining as a share of the UK economy for decades. It represented 15 percent of the UK economy at the start of 1990 and is just 8.7 percent this year. A Brexit which increases the challenges for supply chains risks accelerating this trend.

A possible vaccine early next year could improve economic prospects 

On a more positive note, a candidate vaccine developed by scientists from the University of Oxford revealed some promising results from the first two phases of its clinical trials. According to a study published in the Lancet on 20 July, the vaccine induced a strong immune response to the SARS-CoV-2 virus. Although further research is required to determine if the vaccine will effectively protect against the disease in the whole population and for an extended period of time, it raised hopes that a vaccine for COVID-19 may be available by the start of next year. This will lift GDP growth next year and limit some of the permanent damage to the UK economy.

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