Over the past two years, escalating trade frictions and pandemic-related supply disruptions have led many companies to completely rethink their supply network strategy. Until recently, Stanley Black & Decker (SBD) has sourced most of its product components from China. Tariffs stemming from the U.S.-China trade war, coupled with new exposures from being single-sourced during the pandemic, have led SBD to dramatically transform its network to be more regionalized.
For the rest of us, the need to shift supply chain design will persist as our new normal is likely to involve increasingly frequent disruptions — other pandemics, earthquakes, floods, hurricanes, trade disputes, perhaps even human-made disasters. In addition, globalization is expected to yield highly unpredictable opportunities that will require prompt action to meet customer needs and demands.
A Multi-Pronged Approach is Required
A survey of global corporate executives (Cohen et al. 2018) found that supply chain design requires a balancing act among multiple objectives and risks, requiring careful consideration of the following factors:
Assessment of Total Landed Costs: One pitfall in redesigning the supply chain either by moving a factory to a new location or diversifying to multiple locations is an incomplete landed-cost analysis. The total landed cost is the end-to-end cost from sourcing point to product delivery, covering transport of the raw materials for production through multiple intermediate points to reach the demand destination. The cost should also account for the riskiness of disruptions and other vulnerabilities throughout the process. Careful evaluation may reveal that a new supply source is not as attractive as it first appeared.
Less obvious, but critically important, are the costs associated with crossing borders — what the World Bank calls “cross-border logistics frictions.” In addition to customs duties, these are the costs and time involved in getting products through borders, such as loading and unloading from shipping vessels, documentation requirements, waiting for inspections, and delays incurred at port facilities. It is, likewise, important to account for the risk of problems or violations in sustainability in new supply sources. Finally, another component often missed is the cost of exit (closure or discontinuation of a relationship), which may be prohibitive.
Customs Duties, Trade Agreements and “Product DNA”: The calculation of customs duties as part of the total landed cost may not be simple. It depends on the bill of material for the product (i.e., the components and subassembly of the product) and the location of the manufacture of the components, subassemblies and final assembly, all of which are often governed by various bilateral and regional trade agreements. Whether a final product can be labeled as made in a particular country depends on its content, or “DNA” — its structure and the origins of its components. All these factors determine the customs rate for products entering a country.
There has been a proliferation of trade agreements in the past several decades — from three in 1970 to more than 300 in 2020. The rules may allow duty-free treatment or reduced duties if certain requirements are met. The agreements may have expiration dates, with options to renew or modify rates and terms. For these reasons, trade agreements often affect supply chain design decisions.
In the United States in 2019, as import tariffs on bicycles made in China increased and threatened to go up even higher, some bicycle companies were able to switch to make bike frames in Cambodia while continuing to buy about half the components from producers in China (Singh 2019). The finished bicycles from Cambodia could enter the U.S. tariff-free, designated as made in Cambodia if 35 percent of the costs were derived from that country.
Optimizing Mixed Sourcing for Cost Efficiency and Flexibility: When companies use a dual or multisource strategy, they need to consider the characteristics, strengths and weaknesses of each site. Broadly speaking, sites can be classified as “cost-efficient” or “flexible.” Cost-efficient sites provide a low cost for production or procurement but may be less flexible and require longer lead times. Flexible sites tend to have better engineering support and capabilities to enable quick responses, but higher costs. Offshored manufacturing sites in very low-cost countries may be viewed as cost-efficient sites, and onshore (domestic) or nearshore (regional) sites as flexible sites. A combination of these types may be effective.
There are other ways to use multiple sites based on the characteristics of the sites and the products. Within a company, the needs of multiple products at various stages of the lifecycle and the manufacturing processes involved are different. The different product needs and manufacturing processes must be matched with the sites that have the right characteristics. Some examples of this are shown in the table below.
Balancing Cost Efficiency and Redundancy — Capacity Building and Agility: Besides a resilient supply chain design, best practice calls for reexamining the need for buffer inventory and buffer capacity. With the increasing uncertainties of the new normal, two additional capabilities are needed: quick capacity building and agile configuration of the supply network. Companies must strengthen their ability to create new capacities as needed. The know-how involved in manufacturing process technologies is critical and should not be outsourced or offshored. When companies diversify their manufacturing footprint, they should locate some sites in a region with a capacity-building ecosystem. Companies need to have the capability to configure a new supply network on the fly. Such a network is not just about suppliers of materials and final assembly, but about quickly connecting designers, intellectual property (IP) owners, prototype builders, market testers, and new sales and logistics channels.
An agile configuration platform requires a network of multiple modules, as shown in the figure below. The technology exchange module allows designers and IP holders to collaborate on new product design, do rapid prototyping, perform feasibility tests and design for manufacturability. With the user-interaction design module, potential users test the product, provide feedback and give an early indication of market acceptance. The sourcing and configuration module facilitates the identification of the component, subassembly and final assembly partners in the supply network for building the product, and the logistics management module engages the right players for channel development, order fulfillment and after-sales service and repair.
Global supply chain design in the new, post-pandemic normal requires a full understanding of total landed costs, integration of product design, alignment of the characteristics of production sites with product DNA and trade restrictions, and, finally, the ability to build capacity and reconfigure supply networks quickly. It’s clear that supply chain is now playing 3D chess in today’s uncertain and dynamic world.
Professor Hau Lee
Stanford Graduate School of Business
Adapted from an article published in the National Academy of Engineering’s, The BRIDGE
Cohen MA, Cui S, Ernst E, Huchzermeier A, Kouvelis P, Lee H, Matsuo H, Steuber M, Tsay A. 2018. OM Forum—Benchmarking global production sourcing decisions: Where and why firms offshore and reshore. Manufacturing and Service Operations Management 20(3):389–402.
Singh RK. 2019. How US bike companies are steering around Trump’s China tariffs. Reuters Business News, Feb 25.