Supply chains: companies shift from ‘just in time’ to ‘just in case’

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Heineken sells 300 brands to customers in 190 countries. But part of the brewer’s strategy has been to produce regional brands locally and then export them to bigger markets. When it bought majority control of Red Stripe in 2015, it repatriated production to Jamaica. Similarly, the Dos Equis brand was brewed exclusively in Mexico, though much of its sales were in the US and elsewhere.

That single sourcing came back to bite last year when the Mexican government declared beer non-essential, and temporarily closed the country’s breweries during the first wave of the pandemic. Rather than just give up on Dos Equis, Heineken regrouped, sent the labels and bottles to the Netherlands and started brewing the beer there. Production in Mexico has since restarted, but the company is now far more aware that it needs to have alternative production hubs — with access to the necessary supplies — for its biggest, most lucrative brands.

All over the world, companies have encountered snags in their supply chains during the pandemic and the shipping bottlenecks that have followed as economies restarted. Car production lines have been halted by a lack of semiconductors, liquor distillers have run out of bottles and department stores are short of Christmas stock.

Such troubles are forcing a rethink of corporate strategy. For decades, companies prioritised costs above all else when selecting suppliers, building factories and deciding how much stock to keep on hand. This philosophy was often dubbed “just in time” because it emphasised keeping inventory to a minimum and using short-term, flexible contracts that could be adjusted quickly to changes in demand.

But the drive for efficiency encompassed far more than that. Companies also moved production to low-wage locations, consolidated orders to maximise economies of scale, and tried to minimise their physical presence in high-tax jurisdictions.

The pandemic forced Heineken to rethink its strategy of producing regional brands locally and then exporting them to bigger markets © Jasper Juinen/Bloomberg

“A lot of the operating models in the supply chains we see as broken today, were cemented 20 years ago on what at the time were universal truths, that going after low-cost suppliers . . . made a tonne of sense,” says Brian Higgins, head of KPMG’s US supply chain and operations practice. “It lends itself to these very long supply chains because they are [focusing on] cost, not risk. We’ve seen that fracture many, many times.”

Companies are not entirely abandoning existing supply chain policies, but they are revamping them to build additional resilience.

Some businesses are increasing the inventory they keep on hand and entering into longer term contracts with key suppliers. Others are diversifying their manufacturing to create regional hubs with local suppliers and investing in technology to give them greater advance warning of potential bottlenecks. Some companies are also investigating ways of working with their rivals to share information to develop emergency back up facilities without falling foul of competition regulators.

“What companies love to do is to optimise working capital. So many manufacturers went to just-in-time inventory, and, pre-pandemic, that worked pretty well,” Carol Tomé, chief executive of UPS, said at a recent industry event.

“But when the pandemic hit and everything was shut down, including manufacturing, and then the economy started to open and the demand . . . jumped, well, that just-in-time inventory didn’t work any more. Companies are now thinking about, I need ‘just in case’ inventory,” she added.

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‘The pandemic changed everything’

The changes are being driven by the pandemic and the supply chain shock that followed. But they also reflect the geopolitical tensions between China and the west and the growing pressure on companies to reduce their carbon footprint.

Tens of thousands of tiny changes are fundamentally reshaping the way things are designed, manufactured and sold. In some cases, these shifts are driving up costs and contributing to inflation, but the end result may be more reliable, more local supplies, reducing both price volatility and future carbon emissions.

This new mindset took root in the early days of the pandemic, when a McKinsey survey of senior supply chain executives found that 73 per cent of companies had encountered problems with their supplier footprint — from parts shortages to shipping delays — that required changes.

“The supply chain is like your car. If it runs, you don’t give it much thought. But when it breaks down, you sure know the difference,” Hamid Moghadam, chair of Prologis, a real estate investment trust that invests in logistics facilities, said at the same industry event. “The pandemic changed everything.”

Technicians perform production control tasks at the implant zone in the cleanroom at a semiconductor fabrication (fab) facility. Carmakers are setting up partnerships with semiconductor manufacturers to improve their access to chips
Carmakers are forming partnerships with semiconductor manufacturers to improve access to chips © Lauryn Ishak/Bloomberg

One big German industrial group caught flat-footed by the semiconductor shortage has shifted from three-month non-binding arrangements with suppliers to 24-month commitments that require it to pay in advance of receiving its chips. “We had to give the supply chain more stability,” a top executive says. “It’s a change from a buyer’s to a seller’s market.”

It is not alone. US carmakers Ford and GM are setting up partnerships, rather than just supplier contracts, with semiconductor manufacturers to improve their access to chips. Their German rival Volkswagen is looking at extending the length of its contracts with key suppliers, and Chinese energy groups have been rushing to sign liquefied natural gas contracts that extend as long as 20 years, more than double the old normal length. A follow-up McKinsey survey this year found that 61 per cent of companies had increased inventory of critical products and 55 per cent had taken action to ensure they had at least two sources of raw materials.

As a result, warehouse costs are rising sharply in many markets, as manufacturers and retailers boost inventory levels. US industrial vacancy rates — a measure of available warehouse space — hit a historic low of 3.6 per cent nationally in the third quarter, according to CBRE. In California’s Inland Empire, a key bottleneck near the ports of Los Angeles, vacancy rates scraped 0.7 per cent. And property agent Cushman & Wakefield predicts the UK could run out of warehouse space within a year.

With supply chains becoming more complex and natural disasters disrupting them more often, “you have to reinvent ‘just in time’,” says Oscar de Bok, who runs DHL’s supply chain business. “You can’t plan it as lean any more as you wanted it in the past.”

‘Local for local’ supply chains

Abandoning the “efficiency above all else” mantra goes beyond warehouses and order books.

Companies that had consolidated their production into one or a few low-cost locations got a nasty shock last year as pandemic-related shutdowns and shipping bottlenecks left them without key parts or even merchandise to sell. The message was reinforced by the unexpected February freeze in Texas which shut down petrochemical plants and led to shortages of resin, a core ingredient in everything from plastic straws to auto parts.

The pandemic strengthened the hand of corporate executives who were already exploring whether to set up regional networks for other reasons — such as sidestepping rising US-China tensions or to take advantage of government incentives aimed at stimulating local manufacturing.

Multinational companies are now talking about “local for local” supply chains. That’s partly because logistics problems have eaten away the advantages of shipping products from low-cost factories half a world away. It now takes anywhere from 28 to 52 days to ship a pair of shoes produced in China from Shanghai to Los Angeles, up from between 17 and 28 days before the pandemic. And the total cost has gone up by $1.77 per pair, according to research by consultancy AlixPartners — an additional cost which smaller industry members with slimmer profit margins will struggle to absorb.

“The problem is the volatility. If you always have a 10-day delay, you could put 10 days’ extra material into the supply chain. But some things arrive on time and others are delayed for 20 days,” says Volker Blume, who heads up material control, transport and delivery assurance at the German carmaker BMW. “Our systems are designed for smooth flows.”

Stacks of shipping containers and trucks are seen inside the Port of Los Angeles in San Pedro, California.
Companies that had consolidated production in a low-cost location were hit by shipping bottlenecks that left them without key parts or even merchandise to sell © Apu Gomes/AFP/Getty

Manufacturers and retailers of everything from cars and footwear to vaccines are rediscovering the advantages of having suppliers closer to consumers. In strategically important sectors such as healthcare, they are also receiving government support. This is reviving interest in manufacturing in North America where, for instance, Ford and South Korea’s SK Innovation recently announced a plan to build a $5.8bn lithium-ion battery plant in Kentucky, and in continental Europe, where Intel has promised to spend $20bn on semiconductor manufacturing.

“The pendulum has swung and . . . I don’t think it will ever go back completely. Not even China is going to be the low-cost manufacturing centre it [once] was,” says Simon Freakley, chief executive at AlixPartners. “It does mean areas like Texas and Kentucky become [more attractive because they] have the added advantage of just in time and just in case.”

Resilience, a San Diego-based biopharmaceutical company, is one of the beneficiaries of this trend. Founded during the pandemic, it specialises in high-tech onshore manufacturing. It received a direct investment from the Canadian government worth $164m for its Ontario site and has won contracts from Moderna and other companies that have developed vaccines and medicines to produce them in North America. It has four sites operating already and plans for at least another six.

Line chart of Global purchasing managers' index, supplier delivery times (below 50 = worse than previous month) showing Manufacturers are experiencing increasing delays on deliveries

“It is a myth that cost depends on geography,” says Resilience co-founder and chief executive Rahul Singhvi, who previously worked for Takeda, the Japanese drugs group. “We had manufacturing technologies that we could deploy to reduce cost even in Japan. It was cheaper than some Indian and Chinese markets.”

Shared responsibility, shared risk

VW and BMW have been trying to standardise components across each of their various models and brands so that suppliers have sufficient volume to manufacture regionally.

VW’s design platform for petrol and diesel cars “is highly flexible so if volume decreases we can combine combustion engine cars of different brands in one plant and redesign the others,” says Arno Antlitz, the company’s chief financial officer. “We are heavily reducing complexity because we have to.”

While much of the focus on localisation has been driven by logistics issues, executives say the trend also dovetails with their efforts to address global warming, and capitalise on changing government policies.

Cutting back on the number of parts and products that are shipped around the world is an easy way to improve a company’s carbon footprint. Some groups are also moving their manufacturing to places where renewable energy is abundant and there are substantial markets for their products such as Yunnan province in China, where hydropower has helped it become a centre of aluminium production.

At the same time, the financial incentives around siting plants are changing. Not only are governments scrambling to boost domestic manufacturing, but some of the advantages of production in low-tax jurisdictions are shrinking.

The groundbreaking global deal on corporate taxes, signed in October, calls for companies to pay at least a 15 per cent effective tax rate and declare profits. And to pay more taxes in the countries where they do business. That would remove the current incentives for companies to avoid having a physical presence in high-tax countries where they have lots of sales so they can shift the revenue and profits elsewhere, says Kate Barton of EY.

The tweaks to supply chains go beyond physical shifts. Many companies are using technology to quickly identify supply chain delays. BMW has increased its use of digital trackers to follow its parts across Europe and receive real time alerts if a truck is running late. The current backlog at key ports means that sea transport times are more variable, so the automaker is working with a couple of start-ups that are trying to develop predictive algorithms. But information from direct suppliers can only go so far.

“If you have good information about your supply chain, you need less stock and you can decrease the buffers,” says BMW’s Blume. “You need a solution for standardised communications to allow participants in a supply chain to look deeper.”

That is why the major German car companies and their biggest suppliers — Bosch, Siemens, Schaeffler, among others — joined together last spring to found Catena-X. This automotive alliance sets standards for information and data sharing, to make it easier for all of them to see what is going on not just at their direct suppliers but also at the hundreds of thousands of smaller companies that they rely on.

A customer looks at Christmas-themed items inside a Toys “R” Us store in Hong Kong, China. Supply chain snags have left department stores short of Christmas stock
Supply chain snags have left department stores short of Christmas stock © Lam Yik/Bloomberg

At the same time, retailers and manufacturers who belong to the Consumer Goods Forum are exploring ways they could collaborate to build resilience, perhaps by investing in shared back-up facilities that would be needed in an emergency situation. These could include alternative ports, extra warehouses and trucks. This would likely require regulatory blessing because of cartel concerns, but there are precedents. The UK government allowed grocers and suppliers to work together to divert supplies from restaurants to supermarkets in the early days of the pandemic.

The conversations are in early stages but “the fact that the word ‘collaboration’ is even part of a boardroom meeting is a change,” says Ruediger Hagedorn, the group’s end-to-end value chain director. “If you have shared facilities you share the risk.”

Building up inventory is much easier than relocating factories or agreeing to share space with a competitor and it is not at all clear that companies will follow through. While 93 per cent of companies told McKinsey last year they intended to make their supply chain more flexible, agile and resilient, only 15 per cent had made structural changes by the time this year’s survey came around.

Still, Daniel Swan, who heads the consultancy’s operations practice, says “there’s a meaningful increase in CEO engagement in supply chain issues. That gives me encouragement that it won’t be a flash in the pan.”

Additional reporting by Claire Bushey in Chicago

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