COVID-19: Lessons for Sourcing

The Coronavirus has highlighted some things that companies have always needed to do, but may have become a bit complacent on due to the lack of a major disruption event in recent years. After the 2008 financial crisis led to supplier bankruptcies, and the 2011 Thai Floods and Japanese Earthquake/Tsunami upended supply chains in several industries, companies put more focus on supply chain risk.

Typically, this was focused on avoiding disruptions caused by one or a small set of suppliers that were unable to meet demand, either due to bankruptcy or an inability to produce or ship due to a local (or perhaps regional) event. Typical solutions included excess inventory and redundant supply.

As articulated by Brent Moritz on SCMR.com, the Coronavirus is very different than those past disruptions. Nonetheless, it holds lessons for sourcing managers. While this incident has been called a black swan event, companies with global supply bases will face “100-year events” somewhere with regularity.

The actions we detail below can help in any sort of disruption. Since nobody ever gets credit for fixing problems that don't happen but disruptions are now at the top of the C-suite's minds, it's a good time to obtain the resources to better prepare for the next major supply disruption by improving systems and processes to make supply bases more robust. The next disruption could be a geopolitical issue, a devastating natural disaster, a widespread cyber issue, a dock strike or recurrences of the current pandemic that continue to upend a recovery.

Here, we discuss things to do…and to be careful NOT to do…in light of Coronavirus.

Things to do

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Map the supply base. Only a small minority of companies have mapped their supply bases; especially to Tier 2 and below. While this may be surprising to some, incentives and systems need to be aligned to ensure that correct and complete information on suppliers is collected and maintained; ideally not as a separate system from the ordering and payment systems for Tier 1 suppliers.

Maintaining up-to-date maps is difficult due to the churn of suppliers, new products and especially mergers or acquisitions. Correct and complete contact information is even more challenging, as suppliers can change hands or personnel. Tier 2 is still more challenging, as Tier 1 suppliers may be reticent to share information about their suppliers (if they themselves know) and may frequently change suppliers.

As the pandemic unfolded, a clear understanding of from where each part or component is made, including Tiers 2 and above, and how to contact them was needed. This is needed for all suppliers, not just big ones, as spend does not always correlate with their ability to disrupt a manufacturer. This must be a complete exercise of mapping, with a change management process to keep things up-to-date. Traditionally, the cost of doing supply base mapping has deterred firms, but the increased availability of public data is reducing the cost and effort, as is the emergence of companies offering these services.

Update “general” playbooks for disruptions. While it is probably unreasonable to expect that individual firms had a playbook for a global pandemic, general disruption playbooks should be created and updated. As already noted, all firms with global supply bases have a high-probability of experiencing some 100-year event in their purview soon. When these do occur, responsibilities for data gathering, collection, analysis and dissemination are critical. The press, investors, internal stakeholders, non-disrupted suppliers and customers need to hear a consistent version of what effects the disruption has had on your supply chain. Also important but more often overlooked, is a plan to properly focus on the human side of the disruption.

Reduce extended payment terms levied on suppliers. While payment terms are not typically considered in a supply chain risk program, they should be. We have both argued that payment terms can accentuate risk not just to suppliers, but to buyers also, during disruptions. We have done so through on-going research that dynamically models disruptions, and a recent webinar.

While payment terms benefit the cash flow of buyers, they harm the cash flow of suppliers (who often have a higher cost of capital, and a weaker financial position). Banks have, of course, helped suppliers devise ways to get loans on future payables, but why create the need for this? Reduced payment terms can help suppliers weather the storms created by a disruption, leading to a healthier supply base on the other side.

Although everyone is struggling with cash flow at the moment, now may be a good time to ask why you force these terms on suppliers, and whether it may make more sense to pay immediately— possibly at a lower price. If the supplier's cost of capital is higher than the buyer's (as it often is), then there will be surplus to share. More robust supply chains will result. We do see examples of firms reducing payment terms during the crisis. Unilever recently announced it will reduce payment terms to “the most vulnerable small and medium-sized suppliers.” Discount retailer Aldi has even decided to pay small suppliers within five days.

Underlining public concern for the harm caused by extended payment terms, many countries have imposed strict rules on them. The European Union, for instance, sets 60 days as the default for the profit sector. In the Netherlands, legislation is even more restrictive, setting default payment terms at 30 days for all buying organisations, and never allowing large firms go beyond 60 days.

Change the way sourcing managers make decisions. As discussed in a recent article in the Harvard Business Review, too often procurement managers focus on cost reduction (or, most often: acquisition price) over all else. This is due its easy measurability and internal incentives.

Instead, a useful first step would be for buying firms to make efforts to include all relevant cost aspects (delays, deficiencies, etc.), and adopt a Total Cost of Ownership (TCO) perspective. We argue that this still does not capture all relevant sourcing aspects. One main problem, as one of us discussed some 15 years ago, is that TCO does not capture possible revenue-enhancing aspects of different sourcing alternatives.

A recent thought piece along these lines describes a new process global sourcing decision making; and a new name: Total Value Contribution, or TVC. The TVC process shifts the focus from cost to the much broader construct of value. Undervaluing suppliers' inherent risk, financial health, capacity, adaptability and loyalty can increase the pain when challenging times arrive. Unfortunately, (global) sourcing decisions as practiced today too often do undervalue these things; instead focusing on cost. The result is more fragile supply bases. TVC requires a change in incentives for those who select suppliers, and also requires structured cross-functional coordination. Now may be an opportune time to sell this process and incentive change to leadership.

Treat suppliers ethically. Most firms are under duress during this pandemic. Being fair with payment terms and making decisions based on TVC should contribute to more ethical relationships with suppliers. Beyond these specifics, consider the standards of ethical supply management conduct of the Institute for Supply Management. These standards state, for instance: “Supply management professionals must be aware of their organization's position […] in the supplier base and ensure that market power is not abused.” We feel principles and standards like these need to feature more prominently in the discussion about how procurement needs to respond to the current crisis.

Ethics are not a ‘luxury' item only applicable during the good times. It is exactly during hard times that buying firms should uphold their ethical standards versus suppliers; just like they would expect their customers to do the same. We expect they will be rewarded with loyalty as we emerge from the pandemic.

Things not to do

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Don't dramatically alter make versus buy decisions. This may be a time when firms consider bringing activities in-house to gain “control.” However, gaining control is not by itself a reason to bring something in-house. For example, while you could control the creation of remote meeting software by developing it in-house, that doesn't mean it’s a smart idea. The pandemic may be providing a clear illustration of the transaction costs (e.g., renegotiation) of engaging a third party versus manufacturing the component in-house. Still, for the right move to be to bring the activity in-house, considerations should always made via the sound logic of the level of asset specificity inherent in the activity, now and in the future.

Don't bring everything back home. In the early stages of the pandemic, when it appeared to be isolated to China, there was an increased call to bring some activities back home, due to the increased risks inherent in long supply chains (one of us co-wrote a piece for a D.C. think tank to that point, which discussed the fragility of “low road” supply chains created by typical sourcing decisions). While reshoring local production for local demand generally does reduce disruption and other risks, and the above “Do” recommendations will likely lead to more local sourcing, there are still plenty of things that should be globally sourced.

The global pandemic is, hopefully, an exceedingly rare event. It is an opportunity to reconsider how suppliers are chosen and managed. It is also an opportunity to gain support to prepare better for the next disruption, which will undoubtedly occur in some other form.

John V. Gray is a professor of operations and the associate director of the Center for Operational Excellence at the Fisher College of Business, The Ohio State University. He can be reached at [email protected].

Finn Wynstra is a professor of purchasing and supply management in the Department of Technology and Operations Management, Rotterdam School of Management, Erasmus University. He can be reached at [email protected].

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