Risk, resilience, and 
rebalancing in global 
Value Chains

This article is a summary of
Mckinsey & Companies original report. To view the full report click here

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Mckinsey & Company Summary

From the August 2020 Issue

Summary

Intricate supplier networks that span the globe can deliver with great efficiency, but they may contain hidden vulnerabilities. Even before the COVID‐19 pandemic, a multitude of events in recent years temporarily disrupted production at many companies. Focusing on value chains that produce manufactured goods, this research explores their exposure to shocks, their vulnerabilities, and their expected financial losses. We also assess prospects for value chains to change their physical footprint

in response to risk and evaluate strategies to minimize the growing cost of disruptions.

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Key Points

1. Shocks that affect global production are growing more frequent and more severe

Companies face a range of hazards, from natural disasters to geopolitical uncertainties and cyberattacks on their digital systems. Global flows and networks offer more “surface area” for shocks to penetrate and damage to spread. Disruptions lasting a month or longer now occur every 3.7 years on average, and the financial toll associated with the most extreme events has been climbing. Shocks can be distinguished by whether they can be anticipated, how frequently they occur, the breadth of impact across industries and geographies, and the magnitude of impact on supply and demand.

2. Value chains are exposed to different types of shocks based on their geographic footprint, factors of production, and other variables

Those with the highest trade intensity and export concentration in a few countries are more exposed than others. They include some of the highest-value and most sought- after industries, such as communication equipment, computers and electronics, 

and semiconductors and components. Many labor-intensive value chains, such as apparel, are highly exposed to pandemics, heat stress, and flood risk. In contrast, food and beverage and fabricated metals have lower average exposure to shocks because they are among the least traded and most regionally oriented value chains

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3. Operational choices can heighten or lessen vulnerability to shocks.

Practices such as just-in-time production, sourcing from a single supplier, and relying on customized inputs with few substitutes amplify the disruption of external shocks and lengthen companies’ recovery times. Geographic concentration in supply networks can also be a vulnerability. Globally, we find 180 traded products (worth $134 billion in 2018) for which a single country accounts for the vast majority of exports.

4. Value chain disruptions cause substantial financial losses

Adjusted for the probability and frequency of disruptions, companies can expect to lose more than 40 percent of a year’s profits every decade on average. But
a single severe event that disrupts production for 100 days—something that happens every five to seven years on average—could erase almost a year’s earnings in some industries. Disruptions are costly to societies, too: after disasters claim lives and damage communities, production shutdowns can cause job losses and goods shortages. Resilience measures could more than pay off for companies, workers, and broader societies over the long term.

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Over the course of a decade, companies can expect disruptions to erase half of a year's worth of profits or more

In 2018 alone, the five most disruptive supply chain vents affected more than 2,000 sites worldwide, and factories took 22 to 29 weeks to recover

5. The interconnected nature of value chains limits the economic case for making large-scale changes in their physical location.

Value chains often span thousands of companies, and their configurations reflect specialization, access to consumer markets around the world, long-standing relationships, and economies of scale. Primarily labor-intensive value chains (such as apparel and furniture) have a strong economic rationale for shifting to new locations. Noneconomic pressures may prompt movement in others, such as pharmaceuticals. Considering both industry economics and national policy priorities, we estimate that 16 to 26 percent of global goods exports, worth $2.9 trillion to $4.6 trillion, could conceivably move to new countries over the next five years if companies restructure their supplier networks.

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Types of Shocks

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This analysis reveals four broad categories of shocks. Catastrophes are historically remarkable events that cause trillions of dollars in losses. Some are foreseeable and
have relatively long lead times, while others are unanticipated. Shocks that offer at least some degree of advance warning include financial crises, major military conflicts, and pandemics such as the one gripping the world today. Another set of catastrophes includes extreme weather, geophysical natural disasters, and major terrorist attacks. It may be possible to anticipate the frequency and magnitude of these events by looking at larger patterns and probabilities; hurricanes strike in the Gulf of Mexico every year, for example. But the manifestation of a specific event can strike with little to no warning. This includes some calamities that the world has avoided to date, such as a cyberattack on foundational global systems.

All four types of shocks can disrupt operations and supply chains, often for prolonged periods

Exposure

Some of these vulnerabilities are inherent to a given industry; the perishability of food and agricultural products, for example, means that the associated value chains are vulnerable to delivery delays and spoilage. Industries with unpredictable, seasonal, and cyclical demand also face particular challenges. Makers of electronics must adapt to relatively short product life cycles, and they cannot afford to miss spikes in consumer spending during limited holiday windows.

An organization’s supply chain operations can be a source of vulnerability or resilience, depending on its effectiveness in monitoring risk, implementing mitigation strategies, and establishing business continuity plans.

Other vulnerabilities are the consequence of intentional decisions, such as how much inventory a company chooses to carry, the complexity of its product portfolio, the number of unique SKUs in its supply chain, and the amount of debt or insurance it carries.8 Changing these decisions can reduce—or increase—vulnerability to shocks.

McKinsey's Financial Impact Modelling

We built representative income statements and balance sheets for hypothetical companies in 13 different industries, using actual data from the 25 largest public companies in each. This enables us to see how they fare financially when under duress.

We explore two scenarios involving severe and prolonged shocks:
 

  • Scenario 1. A complete manufacturing shutdown lasting 100 days that affects raw material delivery and key inputs but not distribution channels and logistics. In this scenario, companies can still deliver goods to market. But once their safety stock is depleted, their revenue is hit.
     

  • Scenario 2. The same as above, but in this case, distribution channels are also affected, meaning that companies cannot sell their products even if they have inventory available.

Our choice to model a 100-day disruption is based on an extensive review of historical events. In 2018 alone, the five most disruptive supply chain events affected more than 2,000 sites worldwide, and factories took 22 to 29 weeks to recover.11
 

Our scenarios show that a single prolonged production-only shock would wipe out between 30 and 50 percent of one year’s EBITDA for companies in most industries. An event that disrupts distribution channels as well would push the losses sharply higher for some.

Having calculated the damage associated with one particularly severe and prolonged disruption, we then estimated the bottom-line impact that companies can expect over the course of a decade, based on probabilities. We combined the expected frequency of value chain disruptions of different lengths with the financial impact experienced by companies in different industries. On average, companies can expect losses equal to almost 45 percent of one year’s profits over the course of a decade (Exhibit E5). This is equal to seven percentage points of decline on average. We make no assessment of the extent to which the cost of these disruptions has already been priced into valuations.

These are not distant future risks; they are current, ongoing patterns.

On top of those losses, there is an additional risk of permanently losing market share to competitors that are able to sustain operations or recover faster, not to mention the cost of rebuilding damaged physical assets. However, these expected losses should be weighed in the context of the additional profits that companies are able to achieve with highly efficient and far-reaching supply chains.

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Conclusion

The economic turmoil caused by the pandemic has exposed many vulnerabilities in supply chains and raised doubts about globalization. Managers everywhere should use this crisis to take a fresh look at their supply networks, take steps to understand their vulnerabilities, and then take actions to improve robustness. They can’t and shouldn’t totally back away from globalization; doing so will leave a void that others—companies that don’t abandon globalization—will gladly and quickly fill. Instead, leaders should find ways to make their businesses work better and give themselves an advantage. It’s time to adopt a new vision suitable to the realities of the new era—one that still leverages the capabilities that reside around the world but also improves resilience and reduces the risks from future disruptions that are certain to occur.

Strengthen supply chain risk management and improve end-to-end transparency

 

Global manufacturing has only just begun to adopt a range of technologies, such as analytics and artificial intelligence, the Internet of Things, advanced robotics, and digital platforms. Companies now have access to new solutions for running scenarios, assessing trade-offs, improving transparency, accelerating responses, and even changing the economics of production

Minimize exposure to shocks
 

Targeted measures taken before an event occurs can mitigate the impact of a shock or speed time to recovery.18 As more physical assets are digitized, for example, companies will need to step up investment in cybersecurity tools and teams. 

When a shock does hit, companies need the ability to respond quickly
 

The shift to just-in-time and lean production systems has helped companies improve efficiency and reduce their need for working capital. But now they may need to strikea different balance between just-in-time and “just in case.”  Companies must gain the ability to reroute components and flex production dynamically across sites can keep production going in the wake of a shock. This requires robust digital systems as well as the analytics muscle to run scenarios based on different responses