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McKinsey’s analysis of value chain disruptions reveals vulnerability, opportunity

August 27, 2020
By: Mark Skinner

Crystal ball forecasts and predictions are growing about the long term impact of the pandemic on U.S. manufacturing, trade and overall global supply chains. The abruptness of the shutdowns within so many countries’ economies, the resulting scarcities of goods, and millions of furloughs and pink slips has generated cause for economic analysts, policy wonks and consumers to study the effect of disruption on global value chains. Increasing occurrence and severity of natural disasters as climate change accelerates along with a growing numbers of cyberattacks adds to the anxiety and attention about just how resilient production systems might really need to become. Risk, resilience and rebalancing in global value chains, a new report from the McKinsey Global Institute, sheds some light on the complex issue, confirming disruption is a growing concern for corporate leaders.

Preparing to withstand any of the various types of man-made, economic or natural shocks a company may experience is becoming a regular part of business. Relocating entire production systems or elements of a resource or supply chain is only a small part of the equation for most industries.

McKinsey’s analysis found disruptions to global value chains are much more common than one might expect. “Disruptions exceeding 100 days occur in global value chains every five to seven years on average.” Disruptions lasting a month of longer occur every 3.7 years.

The impact is costly to every firm’s bottom line. “Companies can expect to lose 42% of a year’s profits every decade” from unexpected shocks somewhere in their value chain.  

And there is every reason to expect disruptions to become more frequent, even though it was the extreme rareness of a pandemic like COVID-19 on the relative heels of the severe 2008 recession that has brought the topic of economic disruption to the popular press.  

The growing frequency of acute climatic events such as hurricanes, floods and wildfires is the most visible cause for concern (40 weather events caused more than $1 billion in damages each, the authors point out), but the report highlights other risks for value chains in many global industries.

For example, the report points out that 80 percent of global trade involves nations with declining political stability scores from the World Bank – and a full 29 percent of global trade involved countries in the bottom half of political stability in 2018. That figure is up from 16 percent in 2000.

The risk to disruption varies by type of shock and the character of the industry affected. McKinsey groups industries within four categories for its analysis: global innovations, labor-intensive, regional processing, and resource-intensive.  The global innovators (e.g., chemical, pharmaceuticals, advanced manufacturing, communications) are most vulnerable to large scale cyberattacks and trade disputes. Labor- and resource-intensive industries are most vulnerable to natural disasters.  Computers, communication equipment, semiconductors and related components are singled out for their vulnerability to geophysical events because of their “capital intensity and footprint in geographies prone to natural disasters,” such as earthquakes and volcanic activity.

Across all industries, McKinsey estimates the potential for up to one-quarter of global export/trade production to shift to new countries over the next five years.  This figure is highly concentrated in a few industries.  For instance, the analysis suggested “up to 60 percent of global pharma exports could shift to different countries due to economic and noneconomic factors.” COVID-19 is helping to trigger this potential realignment in production systems as political leaders decried national vulnerability to health treatments when realizing China and India exported large shares of key drugs and medicines.

Other sectors, such as automotive manufacturing, have developed more regionalized production systems in closer proximity to their consumer markets. As a result, they are less likely to see significant shifts in value chains from disruptions.

The analysis suggests “COVID appears to be increasing regionalization trends, the growth of digitization and focus on proximity to consumers.” 

“Companies are basing location decisions, in all but the most labor intensive industries, increasingly on highly skilled talent, supplier ecosystems, infrastructure, business environment, and IP protection—but also are regionalizing production closer to growth markets. “

As the U.S. remains one of the largest markets for many goods and services, there may be economic opportunity resulting in some locations and some industries across the country. Federal, state and regional policymakers may see benefits from increasing investments toward strengthening the competitiveness of your existing manufacturing base, improving connections to local supply chain components, and supporting new product development, process innovation and technological advancement.

Risk, resilience and rebalancing in global value chains is available here.