How social distancing disrupts supply-chains

What the virus spread has revealed is that it is difficult to predict where it might emerge next and with what ferocity.

How social distancing disrupts supply-chains
A globalised world, with air travel and deep, cross-linked supply chains, meant that the virus was able to spread out quickly.

What has surprised the world about the new coronavirus, SARS CoV-2, is how quickly it engulfed the globe, and how the unlikeliest of places emerged as hotspots for the epidemic. Starting in a deep interior region of China, it quickly spread across the world and became an epidemic in places that one would not have imagined having a link with the original location. A globalised world, with air travel and deep, cross-linked supply chains, meant that the virus was able to spread out quickly. It took root in a few places (even as it was quickly contained in Singapore), finding fertile ground in Iran and Italy. The jury is out on whether this can be safely contained in other places, like the US, Europe, the UK, and India, where outbreaks are just starting.

What the virus spread has revealed is that it is difficult to predict where it might emerge next, and with what ferocity. Containment strategies—from community immunity to social distancing—are being drawn and debated across the world. As the containment strategies start to coalesce largely around social distancing, it is beginning to have an unanticipated impact on many supply chains. Many corporate houses have banned travel and events, and work-from-home is the new reality. Even housing societies, and individuals are beginning to keep away from unnecessary contact.

We look at a few types of supply chains to assess the impact of social-distancing. It is difficult to predict how the shock flows through the system—the location and impact of the disruption will only be known over a period of time, via the many linkages that exist. We present a framework to think about the effects on various types of supply chains.

Time perishables: Supply chains that involve perishables face the highest risk immediately. In the time-related supply chains, the world is witnessing a significant drop in bookings—indeed, even large-scale cancellations—at airlines, hotels, restaurants, movie-halls, etc. Airports and retail outlets are facing a significant fall in footfall, leading to some airports demanding a higher fee from passengers. Time-related perishability is very difficult to do away with, especially if the asset is owned and cannot be closed down—fully or partially. In the case of leases, the pain from lack of revenues gets pushed up a level, to the landlord or the lessor. Consumer prices may come down in such sectors, but the lack of demand is not due to an inability to spend, but the unwillingness to do so—lower prices will not overcome the need for social-distancing.

The flip-side of time-related perishability is the time available at hand for doctors, paramedics, etc. Their time and availability being finite, there will be a massive surge in its value. Similarly, teachers, etc, who are suddenly free, with schools and tuition classes shut, will find their time being valued less, and this could lead to loss of salaries and business incomes. This equation will play across organisations and supply chains where some skills will be highly-valued, and some will simply not be required.

Freshness-perishables: Freshness-related perishable products are typically food products, dairy, flowers, etc. Here, the markets are generally well-balanced in terms of supply and demand. As India knows very well, even small changes in the demand-supply equation send prices scurrying in either direction (refer onion, pulses, and sugar prices over the last few years). Hence, every year, the government gets active, trying to balance the demand-supply by either opening or closing the export (or import) market. As footfall at restaurants reduces, and the marginal consumer demand drops, India is already witnessing a cascading effect on agricultural commodity prices.

As the rabi harvest comes to the market over the next few weeks, the softness in prices may continue. The most dramatic fall has already been witnessed in the case of crude—as production continued unabated, even while demand from airlines for the final refined product eased, the most immediate impact was felt in the price of crude. As offices, malls, and schools across the country start to encourage people to work from home or stay there, the demand-supply equations of power production could get challenged. This will either make the marginal producers unviable or require the shuttering of the base-load producing plants. Any commodity in which marginal pricing applies, and which typically remains tightly balanced, could see a sudden price movement.

Inventoriable: For some items, an inventory can be created for a short period, to smoothen out consumption. This includes non-perishable groceries—the fight for food, toilet paper, and sanitisers across the world shows a panic reaction in inventorying consumables. This could lead to sudden stock-outs, and surges in prices of goods that are seen to be in demand. This blip is going to be a short-one—eventually, only so much consumption of a product is possible. As the crisis abates, or countries go into lockdown, there will be a round of demand shocks—the same prices which shot up would find no support.

Deferred or denied consumption: Items that are not of immediate use, or simply inaccessible because of lockdowns, will see deferred, or denied consumption. Over the last year, India witnessed how disruptive deferred consumption can be. The entire auto industry went through a massive slowdown in volumes as customers deferred purchases for a wide variety of reasons, including the upcoming BS-VI regulations. Such deferment led to sharp bull-whip effects across the value chain, disrupting various ancillary production units, and impacting the non-tenured (or contract) workers the most.

Changed consumption: As travel is replaced by telecommunication, eating or shopping out is substituted by e-commerce, and entertainment with movies online, there will be a dramatic rise in the requirement of broadband capacity. In most countries, data is priced on an all-you-can-eat model. Hence, the marginal cost to consumers may not be as high (if the pricing model continues to remain the same). However, the infrastructure of delivery will require significant upkeep and investments—as the large work-from-home options clogging the internet are indicating.

What will surprise us are not the issues that we have already discussed, but something that, suddenly, will be found to be the lynchpin holding the entire edifice together. At my government accommodation in Lutyens’ Delhi (in a previous avatar), what caused the biggest stress was when the fellow did not report at 6 AM to turn on the motor to get the water up to the tanks. Such critical levers holding the local and global economy together will be exposed.

With luck and perseverance, we will have the ability to solve these issues in the long-term, and improvise effectively in the short-term while the virus roams.

This is the first of a two-part series

The writer is Head, Strategy and New Initiatives, Axis Bank. Views are personal

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First published on: 20-03-2020 at 06:00 IST