By Proxima

21 Feb 2020

Covid-19 is not only going to change how we view risk in our suppliers, it may also change how government thinks about buying, writes Proxima

Concern started to walk through some corporate board rooms about a fortnight ago.

Initially, Covid-19 did not have much impact. Chinese factories traditionally shut for the New Year holiday during the planet’s biggest human exodus. More than four hundred million people cross the country to reach relatives, so slightly extending the New Year did not make much difference.  

One week before the press started to comment about it, however, the boardrooms of some large corporates started to worry about possible disruption to their supply base.

One week later it was becoming clearer that the extension was not a matter of days but of weeks, with an indeterminate end, dependent on the rate of viral infection. Not surprisingly, this was going to affect supply chains.  In particular, the trade-off for just-in-time manufacturing was going to become apparent.  In pursuing a path of keeping stocks (and hence locked up working capital) to a minimum, with components being delivered at the last possible minute prior to being incorporated in production, business is vulnerable to any hiccup in a supply chain that wasn't designed for holding much stock.  And this is exactly what some of the country’s largest companies were becoming aware of.

There have been warnings where similar pressures were placed on the supply chain, but the lessons were not learnt. In 2011, the Japanese tsunami knocked out a number of supply chains because factories were inundated, which meant that a part was not produced, which eventually meant no cars. 

The first lesson was to take a greater interest in your suppliers and how they operate. 

The second lesson was there is a point of weakness in having much of your supply base reliant on a particular geography you may not easily be able to see the black or grey swan ‘event’ which could affect such an area.  Post SARS epidemic of 2003, it was not inconceivable what one possible problem might be.  It is clear that neither lesson was learnt.

Just like big business, few departments will have systematically surveyed which of their suppliers will be materially adversely affected by a Chinese economic closure. 

What the effect on government departments will be is unknown.  That is the point. 

Just like big business, few departments will have systematically surveyed which of their suppliers will be materially adversely affected by a Chinese economic closure.  There are some instances where the lens used to survey suppliers is good, especially with regards to diversity, SMEs, or slavery.  Surveys have, unfortunately, proved to be less good about providing a lens into the operational risks suppliers face in their own supply chains, outside legal obligations.   This is a tough challenge – who knows what they should be asking for in a world of unknown unknowns and known unknowns – but the consequence of this virus saga may be slightly different to an obvious future desire to reduce reliance on one geography.

In the private sector, innovation orientated companies in industries such as pharma are leading  charge away from using big suppliers and moving towards mid-sized alternatives.  Large suppliers to big business and government are often so large that they struggle to move fast enough, so rarely if ever are they at the forefront of innovation.  Instead, the businesses in pursuit of innovation from their suppliers are more keen to deal with the most likely innovators -  the entrepreneurial mid-sized corporations.  A by-product of this decision to pursue innovation is that there is less likelihood of having all one’s eggs in one basket.

If we recognize that the commercial world may have reached a point where it is exceptionally difficult to see into the supply chain of key suppliers to sufficient depth to truly see particular geographic or other systematic operational risks, then it is possible that the answer may be to move to deconsolidate some of the supply base.  This goes against much of the trend of the last 20 years where there has been pressure to consolidate suppliers in pursuit of leverage and – presumably – better terms.  In turn, that has led, in many instances, to suppliers rationalising themselves and we end up with fewer, slower moving participants in many key industries.

Perhaps the real consequence of Covid-19 for organisations is that it is going to encourage some business to start to make a more deliberate decision to pursue a less risky supply base, working with more responsive mid-sized suppliers, any one of whom the business is less reliant on.  Central government faces the same option. 

If government is keen to manage risk and encourage innovation, hot pursuit of mid-sized entrepreneurial businesses may be a good outcome.  Interestingly the counter to conventional thinking is that in services, there are significant diseconomies of scale, and as government is a keen user of services it may even see costs fall as a result.


You can download Proxima's report on the Capability Crisis in government here. 


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