Challenges to the successful operation of the global supply chain have always existed.  Natural disasters, wars, and political upheavals in the past have all caused interruptions to varying degrees. However, the sheer scale of the COVID-19 pandemic has caused a sudden and widespread systematic disruption of the global supply chain.

In the past, your company may have been able to survive the break of a single link in your supply chain, but it is much more challenging now.  Much like the intense strain on the healthcare system due to so many people falling sick at the same time, entire swaths of the global supply chain beginning in China will degrade over the coming months.  Few companies (domestic or foreign) have the sufficient capital or inventory cushion necessary to survive long-term breaks in the supply chain.

Further, with so many elements of the supply chain degrading in China, once companies around the world start to realize the enormity of this crisis, they will all simultaneously try to find solutions and will consume what modest capacity exists in functioning companies.  While many companies do maintain some existing capacity to facilitate production and customer orders, that capacity is not infinitely elastic, and with the coming months many companies will see that capacity entirely consumed.

It is also important to understand that the shift over the last half century from an inventory-based system to a “just in time” approach exacerbates these problems.  In the mid-20th century, manufacturers stocked component parts in warehouses they owned and could easily access.  Today, most companies order parts and inventory on an as-needed basis, with the products arriving at the factory right before production.  This method leaves no cushion for delivery delays.  “Just in time” was the brainchild of financial analysts to save money for companies by eliminating inventory.  Unfortunately, they didn’t foresee the potential risks.

How COVID-19 Fractured the Chinese Supply Chain

The COVID-19 outbreak could not have come at a worse time for the Chinese supply chain.  The virus began to take hold in early January 2020, at about the same time as the Chinese New Year celebration, when literally hundreds of millions of people leave their factory jobs and travel to visit family and friends within and outside of China.  Chinese factories located in cities like Wuhan, the Pearl River Delta and Shanghai are often staffed by younger workers whose hometowns are hundreds, if not thousands, of miles away.  These factories shut down for the New Year celebration and workers crowd themselves onto public transit to travel home to spend time with their families and friends.

Due to concerns over contagion of the virus, the Chinese government forced many factories to extend the holiday shutdowns for an extra week or two, which then stretched on much longer than expected.  Workers found themselves stranded in complete lockdown in their distant hometowns.  Others able to travel locally were denied the opportunity to return to their factory jobs.  Needing a source of income, workers found alternate employment, and are unlikely to ever return to their factory jobs.

In a typical year, Chinese factories anticipate a loss of 10% to 15% of their workforce after each New Year’s celebration, as many workers decide to find work closer to home.  In 2020, that figure is likely to be closer to 40% due to the complicating factors of quarantines and lockdowns.  Even if the factories can find people to replace their diminished workforce, those new employees will need to be trained, which leads to production bottlenecks.  Factories will be racing to get finished products out the door to fulfill orders and get paid.  With almost half of the workforce being new hires, quality suffers.

On top of all of this, many Chinese companies are in desperate need of cash.  Benefits to workers are limited; thus, both companies and workers alike often survive paycheck-to-paycheck.  Having missed several weeks of payments from customers when they were unable to ship due to quarantine, Chinese companies are anxious to restart production.  However, that brings us to the next problem in the chain — COVID-19 seeped out of China and spread across the world.

COVID-19 swept into Europe, closing down many local economies and shuttering purchasers of Chinese component parts.  Just as the Chinese factories were starting back up, they found that their buyers were shut down, could not accept shipments, and could not pay for them.  This was the death knell for countless Chinese factories.  Then, six weeks later, COVID-19 struck America, and things got even worse.

Past Solutions to Solving Supply Chain Disruptions Will Not Work

If you or your company experienced disruptions to your supply chain in the past, perhaps you attempted to assist your supplier by purchasing additional inventory, increasing the price you paid, easing payment terms, or investing in the company.  These strategies assumed that (1) your company had extra working capital available, and (2) your supplier’s issues were only temporary.  But now, due to the effects of the COVID-19 pandemic, it is likely that your own company is experiencing or will experience cash flow or other capital issues, and the duration of this interruption will stretch on for months, if not years.  There are a variety of legal strategies that you might consider implementing as the supply chain breaks down.