Coronavirus gives companies sourcing headaches

The spread of the devastating coronavirus has created alarm around the world, with the health and safety of the world’s populations obviously being the most important concern. There has also been significant anxiety about the disruptive impact of the virus on the global economy—and the market has reacted to that anxiety. This special report from Dun & Bradstreet, “Business Impact of the Coronavirus,” may help companies preparing disclosures get a better handle on the effects. In addition to closure of factories, retail stores and hospitality venues, as well as cancellation of travel plans and quarantines (and resulting unavailability) of employees, the report indicates that companies may need to consider the disruptive effects of the coronavirus on both product demand and supply— the potential hit to consumer demand, especially in locked-down parts of China,and the interruption to supply chains for raw materials and components.

The coronavirus outbreak, which D&B tracks to January 23, was declared a global health emergency by the World Health Organization on January 30. While some may liken the impact of the coronavirus to the impact of the SARS virus in 2003, it is important to keep in mind the relative differences in the size of the Chinese economy then and now: Chinas economy is now second only to that of the U.S.—according to Foreign Policy, that’s “a lot, lot bigger than it was then,” to use a technical term. (However, according to this article in the WSJ, many insurers took a lesson from the SARS epidemic and now typically “exclude epidemics in standard business-interruption policies.”) D&B estimates that “the cascading effect might cause a drag of approximately one percentage point on global GDP growth if containment is delayed beyond the summer of 2020.”

D&Bs analysis concentrated on “the 19 provinces that reported 100 or more confirmed cases of the virus as of February 5, 2020,” looking at factors such as “distribution of businesses within the impacted region, annual sales, employment, supply chain, and linkage connections.” According to D&B, the “close to 90 percent of all active businesses in China are located in the impacted region,” with approximately 50,000 businesses
being branches or subsidiaries of foreign companies. D&B data also shows that these “provinces command a majority of employment and sales volume—nearly 90 percent—of all businesses located in China.”

Within China, D&B expects consumer demand “to become concentrated on emergency medical services and supplies, and food deliveries…throughout China as the outbreak spreads.” Industries such as electricity, oil, metal, manufacturing and construction are “expected to slow due to reduction of demand for most retail and wholesale goods. Of note is the manufacturing sector, which could remain active for production of medical supplies, and the construction sector, which could be boosted initially with the building of medical facilities, clinics, or hospitals.” Industries such as retail/wholesale, financial, real estate, public services and information technology “are expected to run depending on a few subsectors. For example, the demand for medical services or food delivery services will continue.”

According to D&B, the impact on global supply chains could be dramatic: “at least 51,000 companies around the world have one or more direct or Tier 1 suppliers and at least five million companies around the world have one or more Tier 2 suppliers in the impacted region…. At least 163 companies within the former group and 938 companies within the second group are Fortune 1000 companies.” In addition, D&B reports that 92% of businesses with direct Tier 1 suppliers in the affected regions are headquartered in the US. Not to mention that some companies may not even be aware of which suppliers are in the third and fourth rungs of their supply chains.

Among major industry sectors, D&B indicates that the services, wholesale and manufacturing sectors account for approximately 65% of the businesses in the impacted regions. Because of the type of products involved and “the international trading structure of China,” these industry sectors “will have business connections throughout the world with potential implications for the global economy.” Whether these companies have headquarters or subsidiary operations in the region, D&B reports that these companies “have considerable presence globally with the biggest footprint in countries and regions including Hong Kong SAR, the USA, Spain, Germany, and the UK.” According to D&B, more than “17,000 corporate headquarters are in the ground zero province of Hubei and may have experienced disruptions to business. The branches and subsidiaries
situated in the above named top five countries have a total employee base of at least one million employees and generate over $2 trillion in sales.”

This article in The Economist identified three reasons for continuing concern about the economic impact of the coronavirus. First, the “just-in-time” strategy of maintaining lower inventories to reduce costs has left many “big multinationals…dangerously exposed to supply-chain risk….For example, many keep only enough stock on hand to last a few weeks, confident that they can always replenish their inventories ‘just in time,’” a strategy that may be more problematic in the current environment.

Second, as noted above, companies are more reliant on Chinese factories than they were at the time of SARS outbreak in 2003 and thus more vulnerable to sourcing problems out of China. According to the article, “China now accounts for 16% of global gdp, up from 4% back then.” In addition, since 2003, factories (and factory workers) are more spread out across China and “[t]hat interconnectedness increases supply-chain risks…. So does the rising interdependence of many firms. Mainland suppliers no longer simply assemble products; they make many of the parts that go into them as well.”

Third, some of the plants in areas most affected by the coronavirus are especially critical to certain industries such as electronics (particularly in light of “relatively thin inventories and…lack of alternative sources for parts”), telecom networks (given that “a quarter of the world’s optical-fiber cables and devices are made there”), and the auto industry, which is experiencing a “lack of parts from mainland-based suppliers.” Moreover, the article reports, even when manufacturing plants resume production, “moving goods around and out of China will remain difficult” as travel and shipping have been limited. “The longer shipping volumes are depressed,” the article observes, “the bigger the backlog when China Inc returns to work. That will probably lead to bottlenecks and a surge in freight rates.”

What steps, if any, are companies taking to assess the risks in their supply chains? Do companies have adequate stocks of inventory or established alternative sources of supply? And even if they have, are those alternatives located in (or dependent for their sourcing on other companies located in) the affected region? How would a possible decline in revenues as a result of the coronavirus affect cash flows and liquidity? (See this article in the WSJ.) What efforts are companies making to address these issues? What could impede those efforts? More uncertain perhaps is the potential long-term impact. Time will tell if prolonged failure to contain the virus propels companies to cut their sourcing ties to China or shrink or eliminate their footprints in China. Will the epidemic, as The Economist phrases it, “dampen the love affair between multinationals and China”?