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Dropping globalization is easier said than done

Mathilda Jordanova-Duda
May 26, 2020

Globalized supply chains have accelerated growth over the past decades but are proving fragile in the current pandemic. As companies assess the new risks emerging from globalization, safe supply is moving center stage.

Containers, aerial view
Image: Reuters/W. Rattay

Compressed air is a versatile product because it can be used to control machines, move postal packages, form plastic bottles — and, during the COVID-19 scare, safe lives.

The global outbreak of the coronavirus has led to a huge rise in demand for ventilators and brisk business for compressor makers such as Boge. The German midsize company, situated in Bielefeld, is manufactures specialized compressors for medical applications and is a main parts supplier for German ventilator maker Drägerwerke.

In the past two months, assembly lines at Boge have been operating virtually around the clock to make the key ventilator component, says Oliver Peters, Boge's chief financial officer. And so have the company's own suppliers in Asia, who are delivering vital motors for its compressors.

In the chaotic days when the virus broke out in China and quickly spread to other countries in the Far East, the company was lucky enough to be able to fall back on some domestic stockpiles, says Boge's purchasing manager, Olaf Kuhlmann, because "deliveries from Asia completely broke down."

"And while we were trying to secure supplies from other parts makers, we were realizing that the whole market in Europe was quickly drying up," he adds.

Boge gets the piping and frames for its compressors from manufacturers in Eastern Europe, while the cooling system is made in China as it involves a lot of manual work. Other components are manufactured in Italy, the first country in Europe that has completely shut down its industries amid the outbreak. 

Boge Kompressor company
Compressor maker Boge is currently rethinking its supply chains strategyImage: Boge

Cutting global reliance

While Boge sells its specialized medical compressors to the whole world, the globe is also the market from which it sources most of its components — a dependence the company is now rethinking.

Purchasing Manager Kuhlmann believes that it's becoming increasingly important for the company to "spread" supply chain risks by cutting its strong reliance on a single supplier, or one world region currently. Although the prices for its upstream products may be rising as a result, Kuhlmann says that "costs are not everything, availability is often more important."

Kuhlmann however cautions the strategy revamp isn't intended to throw the firm's long-lasting partnerships with suppliers overboard, and says stable business ties have their advantages, too.

"We're realizing that perceptions among the customers we are selling to are also changing. They're now putting a greater emphasis on quality and supply security, for which they are willing to pay more," he says.

The coronavirus outbreak, like no single incident before, has highlighted the need for lowering supply-side risks among German businesses. According to the country's machine-builders' association, VDMA, almost half of companies in the sector experienced significant or even grave production difficulties in April due to supply bottlenecks.

The Institute of the German Economy (IW) has recently made a calculation showing the extent to which the country's machine-building industry is intertwined with global supply chains and manufacturers abroad. The value added by foreign suppliers to €100,000 ($109,000) worth of German machinery is €28,200 on average, IW found.

Although more and more factories in China are reopening and production is rebounding, Michael Holz believes the genie of stronger diversification is out of the bottle in all industrialized countries. An economist with the Research Institute for Small and Medium-Sized Companies in Germany (IfM), he says production costs will rise as a result of the trend, which however mustn't necessarily mean companies are less competitive.

"[This is because] all competitors are facing similar challenges at the moment, and will have to come up with viable solutions," Holz argues.

Asia's cost advantage a myth?

Ronald Bogaschewsky, a professor for industrial economics at Würzburg University in Germany, shares this belief, asking if a return to pre-COVID-19 globalization is desirable, after all.

He argues supply chain risks are mounting with every dollar or euro purchasing managers are squeezing out in terms of lower costs. Already before COVID-19 broke out, globalized supply had been increasingly affected by natural disasters, political conflicts, production stoppages and the growing impact of climate change, he says. 

Bogaschewsky even claims low-cost production in Asia and elsewhere isn't that cheap anymore if transition costs are brought into the equation. By counting in logistics, government fees, costs for quality control and higher communication needs, the financial benefit of operating there was merely 5% cheaper, he calculates.

The Asian cost advantage would even turn negative if environmental degradation, human rights violations and the political costs of dealing with undemocratic regimes would be counted. Against this background, he calls on political leaders to ensure full cost transparency, and believes that state-controlled good governance incentives will "prompt companies to find the most efficient ways" of meeting them. 

Shenzen workers
Outsourcing production to faraway locations has its downsides, says BogaschewskiImage: Getty Images/K. Frayer

Haste makes waste

Current attempts by companies in Germany and elsewhere to diversify their upstream supplies have been tentative at best so far. It's not at all clear if many of them will really trade the cost advantage of globalized supply chains for more security after the virus crisis is over.

What could support the fledgling trend though are innovative technologies aiming to put future supply-risk assessment on a more scientific footing.

A landmark project called "Spaicer" was recently launched by the German Research Center for Artificial Intelligence (DFKI) — a corporate alliance embracing tech giants such as Microsoft, SAP and Google as well as many German industry leaders like Daimler, Airbus and MunichRe.

Spaicer is intended to use artificial intelligence (AI) to monitor global production risks and help companies find the best possible suppliers and production locations. Data regarding commodity prices, political developments and even the likely effects of future climate change is part of DFKI's analyses.

Bogaschewsky notes that common products like standardized screws are certainly not checked for where in the world they can be produced best. But more complex machinery components are more challenging to make and require thorough pre-production analysis, he adds.

"The [product's] performance must be precise not only once, but should be replicated a thousand times," Bogaschewsky says, and notes that establishing quality and reliability in a supply chain often takes two to three years.

At Boge in Bielefeld, Purchasing Manager Olaf Kuhlmann, therefore, has launched a certification process for likely candidates aiming to deliver parts and components to the compressor maker in future. The current pandemic is already separating the wheat from the chaff.

"Some suppliers are doing everything they can, while others are just waiting and seeing for a few weeks," he says — and some have only just begun to apply for an export license.