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Reshaping global supply chains: the shift towards greater resilience

Global supply chains are going through fundamental change, and this has been cast into sharp relief by COVID-19.

According to Swiss Re Institute's latest sigma, De-risking global supply chains: Rebalancing to strengthen resilience, the pandemic is accelerating a number of trends that were already evident.

In some cases, disruption to transport and trade tested the structure and composition of these supply chains to breaking point. But while the causes are varied and production costs may increase, we expect to see greater resilience and flexibility as a result.

This period of transformation is likely to last about five years, and it will see an increased role for the insurance sector. This will cover assessing new risk profiles, helping to calibrate markets, and ensuring the most appropriate forms of cover are made available.

Looking at the premiums required to provide adequate additional cover during this time, we estimate a market value of around USD 63 billion.

China: Pivoting from export to domestic consumption

In Swiss Re Institute's latest sigma, we examine these changes, what’s influencing them, and their wider implications. Among the changes to global supply chains (GSCs) will be relocation and reshoring of production, mostly out of China, with important implications for the global economy and insurance industry.

Since the 2008 global financial crisis, China has been nurturing its domestic market in an attempt to reduce its dependency on exports. Growing this market means raising the income levels of many people – in effect, creating a much larger affluent middle class. For people to have more disposable income, they need higher rates of pay. This will have some economic consequences – increased labour costs cause an overall rise in production costs, making Chinese firms less competitive.

“While issues like COVID-19, or the US-China trade war, get a lot of attention, the reality is there has been a gradual change taking place for some time,” says Irina Fan, Head of Insurance Market Analysis at the Swiss Re Institute. “Countries like Vietnam, Cambodia, Malaysia, Thailand, the Philippines, Mexico and others – they are all competing for a share of the market.”

Monthly labour costs in China are more than double that of Vietnam, Fan says, illustrating the extent to which these naturally occurring differentials were already changing the global manufacturing landscape.

Approximately 20-30% of China’s current manufacturing capacity is expected to gravitate elsewhere over the next five years. Where it will settle is difficult to accurately predict, but it’s likely to involve a mix of locations. Much is likely to move to the other emerging Asian economies already mentioned. Some will head closer to the domestic markets of the manufacturing brands in question. 

Reshoring: A balance of cost and benefit

Global supply chains as we currently think of them are a consequence of low-cost, high-efficiency models. Even though automation and AI now offer increased manufacturing capabilities at a lower cost, the higher wages and greater compliance requirements of developed economies will mean that reshoring will always be a relatively higher-cost undertaking.

As Fan explains: “When you produce in a market where you know the labour cost is the lowest, you are able to make cheaper-priced products. But if you move away from the most cost-efficient solution for whatever reason, you will experience efficiency loss. Those higher costs will be reflected elsewhere, perhaps in the purchase price of your products.”

But rather than being seen as a problem, this could be regarded as the cost of improved supply chain resilience.

Where to source clothing and textiles is something businesses tend to look at from a purely economic perspective – the lowest cost and best quality will deliver the keenest prices and highest margins.

But the pandemic has shown how some goods – and the sectors producing them – have an importance that goes far beyond economic factors alone. “In March of this year, more than 50 countries had measures in place to restrict trade in medical supplies, in order to give priority to their domestic market,” Fan says.

Medical supplies, communications and pharmaceuticals are the other sectors most likely to be considered too strategically important to not be reshored, the sigma analysis finds. There may also be politically driven decisions to create more jobs in a given domestic market by reshoring some manufacturing and production capacity.

As part of a diversified supply chain such changes will help to add layers of resilience and avoid the potential downsides of putting every egg in one basket. This landscape is not without challenges of its own, however. The political will to create more jobs may be laudable. But if it comes hand-in-hand with a desire for protectionism it could all too easily stifle international trade.

Transparency: A new era and new risks

If the current trends around diversification continue, we anticipate the next five years will be characterised by the creation of parallel supply chains. Some of the production exodus from China will be good news for its near-neighbours, who are already vying for a greater share of the market.

Some will be nearshored – for some US businesses, production in Mexico offers lower costs combined with geographic advantages. A similar phenomenon already exists in Europe, where several central and eastern countries are manufacturing hubs for brands based in higher-cost western European countries.

Regardless of the specifics of such changes, data transparency is the key for supply chain risk assessment. Consider the automotive sector, where there are many OEM businesses producing components – brake pads, windscreen wipers, suspension struts and more. The vehicle brand will have visibility of everything in Tier 1 of their supply chain. Beyond that, visibility diminishes very quickly.

Not knowing who is supplying those Tier 1 partners makes reliable risk assessment challenging. What if a parts supplier starts sourcing components from someone new – what risk could that represent elsewhere in the chain? As Fan explains: “It is important to really understand who the distribution or supplier partners are, and how they might be interrelated, so that you know where the risks are.”

Opportunities for insurers

Changes are already underway across global supply chains – some of them fundamental to our understanding of risk and how to cover it. Insurers will need to appraise themselves of these changes and their consequences. Similarly, their clients, the end customers, need to understand the chain of consequences that accompanies changes in their supply chains.

There are enormous opportunities for insurers, not just in terms of the cover that will be required, but in assisting their clients to make better-informed decisions. There are data analysis tools available that can compare information from multiple sources and help create a richer, more detailed assessment of risk.

One of the approaches Swiss Re takes is to blend external data with submissions and disclosures from business right across a supply chain. This can reveal connections, dependencies, and other potentially risk-altering factors that might otherwise remain unseen. “We have the technology and expertise that helps risk managers better see their underlying risks, by making those risks more transparent and easier to identify, such as key shared suppliers, critical ports of import-export and geographic areas of high risk.” says Fan.

With these insights, insurers can develop solutions to pro-actively mitigate losses. It also means insurers can start to create products that are better tailored to the needs of particular customers, in turn adding to the value the insurance sector can offer during this period of change.

These issues are discussed in-depth in the De-risking global supply chains: Rebalancing to strengthen resilience sigma, which you can download here.

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Publication sigma 6 / 2020

De-risking global supply chains​