As the World Turns, Supply Chains Spin

Tags: Latin America, Global Economy, Middle East, Asia, Global Logistics

Continental instability, national volatility, and economic vulnerability force shippers to confront their own global challenges.

Mobile phone manufacturer Nokia recently announced plans to shift smartphone assembly from Finland, Hungary, and Mexico to Asia, offering a telling example of how global companies are adapting their supply chains to variable trade winds. The Finnish company aims to refocus lower-value activities closer to component sources, thereby increasing supply chain responsiveness and reducing total landed logistics costs. Value-added assembly and logistics functions will remain largely in Europe.

"We are aligning our manufacturing strategy to increase competitiveness," says Nokia spokesperson Mona Kokkonen. "We need to optimize our manufacturing operations so we can collaborate more closely with suppliers and be more responsive to customers' needs."

Pulling jobs out of Finland couldn't have been an easy decision for the world's largest mobile phone maker, whose lineage in the country dates back to the 19th century. And while Nokia has stuck to the company line justifying its realignment, other factors were likely considered.

The company, ranked third in global smartphone production behind Samsung and Apple, has had its eye on Asia for some time. In 2011, it announced plans to open a new Vietnam factory, which will join existing operations in China, India, and Korea. Increasing demand among Asia's growing middle class for smartphone products may also be driving Nokia's decision.

The corporation's predicament is by no means unique. Other multinational companies in the United States and around the world have been equally influenced by changes in the global economy—contraction and isolationism in Asia, the Eurozone debt crisis, the South American enigma, and recurring political and social volatility in the Middle East and North Africa.

The importance of supply chain alignment—matching supply to demand signals, contingency planning and redundancy, and balancing go-to-market growth opportunities with supply-side sourcing needs—has only grown in scope. Global distribution networks must be fluid to accommodate unpredictability. Considering current world events, it's not difficult to understand why.

From a global perspective, China remains the red elephant in the corporate boardroom. The country's explosive economic growth from a primary offshore manufacturing destination to an emerging second-world export market has turned supply chains on end.

China managed to isolate itself, to a great degree, from the prolonged recession that gripped the United States. Government mandates to steer production output inward, and stimulate domestic consumption, infrastructure development, and industrial growth helped the country adjust when U.S. imports began to run dry, bringing greater balance to imports and exports.

Europe's more recent financial crisis, however, has had a greater sting. It became China's foremost trading partner, responsible for 25 percent of all exports. Now there is concern that Chinese economic contraction—natural or orchestrated—will have a major impact on smaller Asian countries that rely heavily on exports, especially to the mainland.

While U.S. companies are still heavily invested in China, machinations in play are slowly drawing interest to other boutique sourcing options.

"Higher wage rates along China's east coast, escalating fuel costs, and an ongoing shift in favor of fast, agile supply chains that avoid inventory carrying costs and enable quick responses to market conditions will yield two important results," says George Brown, CEO and co-founder of Blue Canyon Partners, a Chicago consultancy.

"First, more of China's manufacturing will move to the western part of the country, a remote region where labor costs remain relatively low and logistics infrastructure is less developed.

"Second, production will shift to other countries," Brown continues. "In some cases, it will move back to North America, which creates an opportunity for Mexico to capture business. In other cases, the shift will be to alternate low-cost Asian locations, such as Vietnam and Thailand."

Evolving Economies

This manufacturing migration has been occurring in China and elsewhere in Asia over the past few years, as countries slowly evolve their economies.

"China has a 50-year runway to get from third- to second-world, then another 50 years from second- to first-world—much like Hong Kong's transition from low-tech apparel to high-tech products, and now financial services," says David Morgan, CEO of Pleasanton, Calif.-based third-party logistics provider D.W. Morgan.

"Vietnam's low-cost labor is now highly regarded, and coastal Chinese cities such as Shenzhen and Shanghai have become second-world," he adds. "They want to consume want they are making."

Asia's transformation is also changing the way global companies look at export growth opportunities. It used to be a continent of 3.5 billion workers; now it has 3.5 billion consumers.

Some American supply chains that were previously weighted for import volumes are rebalancing as Asia's appetite for U.S.-sourced agriculture and consumer goods grows. And for the minority of wholesale and retail companies that have been allowed the privilege to sell into these markets, the potential is enormous.

Walmart has increased its stake in China with a controlling interest in e-commerce Web site Yihaodian. Amazon is making a similar play in India, thanks to the government's recent decision to liberalize its foreign investment policies. Nokia is also well aware of this reality, especially as it looks to be more competitive in the smartphone market.

But cultural and regulatory barriers to entry still exist. Only multinationals with clout—and intellectual collateral—can even fathom the notion of penetrating the Chinese market.

"India is most receptive to bringing in products to build its infrastructure, whereas China will bring products in to copy them," says Morgan.

Then there are transportation and logistics concerns. Amazon's entry into India is largely predicated on fulfilling back-end support for the country's fledgling e-commerce industry—which, in the long run, may pay huge dividends.

3PLs and forwarders are less inclined to broker services to local trucking companies and warehouses for obvious security, cost, and customer service concerns. Instead, many are investing in worker training and putting their own assets on the ground as an added measure of assurance and insurance. When the retail rush eventually peaks, the clever proprietors selling their transportation assets and logistics tools will ultimately strike gold.

Europe Confronts Change

Developments in Asia resulting from North America's lingering recession and the Eurozone debt crisis are circling back to Western economies such as Germany. From an air cargo perspective, China has become a challenge for Frankfurt-based airline Lufthansa Cargo. The country's increasing isolationism and economic contraction has precipitated a noticeable change in freight flows.

"China is our biggest headache at the moment," says Nils Haupt, director of communications, Lufthansa Cargo. "This market has declined sharply for Europe and Germany. We saw significant freight decreases during the last four months of 2011. A lot more capacity is going to China, so demand and yields have dropped."

Unlike other European countries, Germany has managed to deflect recessionary effects by stimulating private investment, cutting taxes, growing jobs while reducing labor hours—its unemployment rate is at a record low—and expanding non-EU exports. The rest of the story on the continent is far less favorable.

"Europe's economic environment is forcing people to look outside," says Morgan. "As Asia rises, Europe is falling because of economic policies. Governments either enable or discourage the right environment, and many in Europe aren't allowing for potential growth."

For Eastern Europe and Russia, this characterization is an understatement. Russia remains a monolith in terms of economic policy. Countries in the Eastern Bloc have long been touted as the next hot region for offshore investment. That has yet to become reality.

"If Eastern European governments would loosen up regulations, they'd unlock the ability for people to engage in the economic mainstream," Morgan says. "Eastern Europe's residents will ultimately become consumers because there are so many people. It's on the same path as Southeast Asia."

Elsewhere in the Eurozone, there is far more uncertainty, which places pressure on U.S. businesses operating there to either act or stay the course. In terms of competition for manufacturing and distribution, decision-making is ultimately contingent on the type of activity and the requisite skill set and value attached to certain verticals and products. Nokia, for example, pushed low-value, labor-intensive jobs to Asia while keeping value-added aspects of its smartphone assembly operations in Europe.

"It makes sense for a phone maker such as Nokia to locate assembly closer to manufacturing or component supply," says Grant Opperman, president and chief strategy officer, D.W. Morgan. "On the other hand, companies making high-end goods are concerned with where their engineering talent is, regardless of economic conditions.

"For biotechnology, that base may be in the United Kingdom or France, so companies will be reluctant to chase dollars around the globe," he says. "It's a decision you can't make with a broad brush stroke."

Political, social, and economic stability have now become premiums in terms of site selection due diligence, raising new questions that were previously unthinkable. For example, within Europe's various economic microclimates, France is the most natural distribution point. But cultural and labor restrictions make it a difficult place to do business. The same considerations hold true for countries that have progressive economic policies.

"We operate in Switzerland, but not because of its factories," says Morgan. "In Asia, Singapore and Hong Kong are comparable examples. Objectively, it doesn't make sense to manufacture in those countries. But when you factor in stability, tax structure, accounting standards, and management talent, you can accept less optimal manufacturing costs for certain products and verticals."

South American Speculation

While Asia is still the primary concern for globe-trotting U.S. companies and European countries separating themselves from the Eurozone crisis, South America remains the unanswered question, eliciting optimism and doubt, depending on perspective.

"South America, and Brazil in particular, is a very big focus for Lufthansa Cargo," says Haupt. "We have begun two weekly flights to Manaus in the Amazon jungle, which has a free trade zone, in addition to existing service to São Paulo and Curitiba."

Haupt views Brazil as a strong market for both imports and exports, specifically for the high-tech and automotive industries. With the country poised to host both the 2014 World Cup and 2016 Summer Olympics, infrastructure development will be a necessity. Lufthansa will experience increasing competition from cargo carriers such as Emirates, which has direct flights from Frankfurt to São Paulo.

"At the moment, it's a good market for air cargo," says Haupt.

Others are less convinced. Morgan acknowledges that Brazil is the powerhouse of the South American market, with an abundant workforce and energy resources. But its biggest impediments are bureaucracy and a prohibitive regulatory environment. These concerns are magnified throughout the continent.

"South America is not ready to play in the global economy," says Morgan. "It's insular, with hidden economies, and you can't easily ship across single borders. Countries don't want to play together to advance their own self-interests."

Opperman offers a telling example of the difficulties companies encounter when trying to ship freight across geographical and political barriers in South America. "To ship products from Brazil to countries such as Chile, Uruguay, or Argentina, it's easier to send it to Miami, then transport it back south," he says.

Whether or not this sentiment holds true, it's clear that South America's predicament mirrors that of Europe's financial crisis, where individual countries are competing against the failures of the bloc to raise their own self-interests.

Brazil is the obvious leader. Chile and Colombia—with its recent U.S. Free Trade Agreement and connections to China—have similarly separated from the field.

But in the short-term, most attention will migrate north to the Panama Canal Zone—where U.S. East and Gulf Coast interests have been busy developing infrastructure to accommodate New Panamax vessels—and, ultimately, Mexico.

U.S. companies considering nearshoring opportunities can't ignore Mexico's proximity to major domestic markets. And in spite of recurring border violence in Monterrey and Juárez, businesses are simply moving farther south, where transportation connections, technology infrastructure, and cultural assimilation continue to slowly improve.

Continental Rifts, Supply Chain Shifts

The same can't be said for stability in the Middle East and North Africa. The region holds little manufacturing and sourcing appeal for global companies. Distribution capabilities have quickly evolved in the Arabian Peninsula, largely to serve consumption demand in its many tourist oases.

Current tension in the area, however, has raised fears among oil shippers that important trade corridors such as the Suez Canal could be shut down. While freight moving between Asia and Europe would be similarly disrupted, the greater concern is how re-routing tankers around the Cape of Good Hope might influence global fuel prices.

"Fuel prices have increased over the past year, and the current political issues in Iran and the Strait of Hormuz have created uncertainty," says Haupt. "Fuel represents approximately 25 percent of our total costs, and it's difficult to cover that with fuel surcharges. Shippers and freight forwarders are looking closely at these increases."

Along with fuel consumption and costs, lack of consistency in security and environmental standards pose an obstacle for shippers. "We still don't have harmonized legislation on a global scale," Haupt notes.

This variability provides a backdrop for even more global economic change as China's middle class—and India's and Brazil's, to lesser degrees—continues to expand over the next decade.

"More manufacturing capacity will be oriented toward meeting such demand," says George Brown. "Significant changes in logistics patterns will emerge to connect to these new demand centers, and as existing factories shift their attention and new sources emerge to serve demand in the West."

This means sourcing, manufacturing, contract manufacturing, and selling locations will continue to be moving targets—and so will distribution networks that flex to new supply and demand patterns.

Nokia closed down a smartphone factory in Bochum, Germany, in 2008 because it was building a new facility in Jucu, Romania. Its reason was that production would be moved to more competitive plants in Europe. Yet before the company's most recent European closures in Finland and Hungary, the Jucu factory was downsized as well—after three years of operation.

A statement former General Electric CEO Jack Welch made during a television interview in 1998 puts this all in perspective. When asked for his outlook on the coming year, Welch replied: "Ideally, you'd have every plant you own on a barge to move with currencies and changes in the economy. You can't do that, but the job of a company is to be agile and to capitalize on these opportunities."

As global economic trends continue to shift, shippers will have to adapt their supply chains accordingly.