Enhance toughness out of the trough, advices to auto industry on supply chain management        

After two years of downturn and deep adjustment, China's automotive industry had been expected to stabilize and recover in 2020. However, the sudden outbreak of the COVID-19 pandemic, a classic black swan event, disrupted this uptrend. The resulting supply disruption has gained widespread attention and will significantly impact the global automotive industry.

Given the industry's huge complexity, which involves multiple upstream and downstream enterprises, as well as the deep participation of Chinese companies in it, the overall impact of the pandemic on global automotive supply chains is only likely to appear in the coming months or later this year.

Impact of the pandemic on automotive industry supply chain: the pace of spare parts production and vehicle sales was disrupted, and the butterfly effect of the epidemic will gradually appear and spread across the global supply chain

Sales stagnant for a short time and market demand disrupted

The epidemic in China will have had a huge impact on auto market sales in the first quarter. Although the release of delayed demand is likely to bring something of a sales bounce once the epidemic is under control, we expect the market to decline continuously this year given the current level of customers and state of market development.

In addition, the epidemic will impact overall demand. OEMs will face multiple challenges to their production and marketing plans, as well as inventory management, due to the short-term sales suspension, release of pent-up demand, and changes in vehicle ordering, pickup and sales.

OEMs face difficulties in work resumption, and it will take time for production capacity to recover

Local governments in China have clearly stipulated the dates and application procedures for resuming work after the epidemic. Although many provinces and cities allowed enterprises to resume work on 10 February, most OEMs postponed their work resumptions to 15 February or later as personnel returned to work slowly due to restrictions on people's movement, and quarantine requirements. Higher health and safety requirements also posed huge challenges in arranging and managing production. It will take some time after the resumption of work for production capacity to recover. This will have had a substantial impact on production capacity and production plan implementation in the first quarter.

Disruption to spare parts suppliers poses several risks

The automotive industry supply chain is long and complex. Any issue in spare parts supply at any link will affect the whole chain.

The first focus should be on the short-term risk of spare parts supply disruption. According to the latest research from the China Association of Automobile Manufacturers, most OEMs and spare parts enterprises started work seven to 10 days later than in previous years, and needed more time for production capacity to recover after resuming work. Hubei Province, the epicenter of the epidemic, is one of China's largest automotive industry bases, with its nearly 12,000 spare parts enterprises accounting for 13 percent of the national total. Wuhan alone is home to half of the top 20 global spare parts suppliers. The suspension of production by key manufacturers threatens industry-wide supply disruption, and will affect downstream vehicle production.

The long-term impact of the epidemic on supply safety will be even more notable. The resulting work stoppages and short-term downturns in finished vehicle production and sales are bound to damage upstream second-, third- and fourth-tier small- and medium-sized spare parts suppliers. They will face greater cash flow and finance risks, threatening the longer-term supply safety of downstream enterprises.

Furthermore, sudden demand changes caused by supply disruption could lead to a butterfly effect. In response to limited production capacity at some upstream suppliers, some downstream enterprises could raise order quantities, start backup supplies or increase inventory to ensure their normal operation, which will lead to excess stock. Distorted demand information could be transmitted and exaggerated along the supply chain, creating a bullwhip effect throughout the chain and increasing the risks of upstream overcapacity, supply and demand mismatches and downstream overstocking of spare parts.

Logistics interruptions deepen risk of spare parts supply disruption

Affected by the epidemic, the logistics industry faces a grave shortage of transport capacity as well as severe disruption caused by road closures, traffic controls and mobility restrictions in provinces and cities. This creates practical problems, such as long-distance transportation disruption and unwarranted delays in the transportation of complete vehicles and spare parts, which could further deepen the risk of spare parts supply disruption.

The impact has spread to the global automotive industry supply chain, and could create supply substitution risk

Over nearly 30 years of development, China has become deeply embedded into the global automotive industry. The epidemic's extensive disruption to China's automotive supply chain could also pose risks to the global automotive industry chain. Some global auto companies have shut factories in South Korea or Japan temporarily due to supply disruptions in China, and some global spare parts manufacturers have issued global supply chain risk warnings. This makes it necessary to pay close attention to possible substitution and loosening risks from China's automotive industry supply disruption. However, there is no need to be too pessimistic. If the COVID-19 can be controlled promptly, enterprises can gradually resume production and supply. With its long-term advantages in technology, quality, price and production capacity accumulated over the past decade, China's automotive industry chain could suffer relatively limited industrial substitution.

Suggested short-term response: OEMs to play role of "chain masters" to strengthen visibility and coordination of upstream and downstream enterprises, resolve supply chain uncertainties, and cooperate to overcome difficulties

Over the short term, as "chain masters", OEMs need to zoom out to see the whole supply chain and industry from a macro perspective, improving the visibility and coordination of supply chains by strengthening support for upstream and downstream enterprises, as well as cooperating with the entire industry chain to overcome difficulties through proactive planning and monitoring of supply risks.

I. Coordinate upstream and downstream enterprises to ensure clear information throughout supply chains
OEMs should cooperate with spare parts suppliers and dealers to open up information channels in the value chain and improve the transparency of supply and demand data. Timely and clear information on demand changes, production restrictions, and spare parts supply restrictions can help upstream and downstream enterprises accurately adjust production, reducing the risk of supply and demand mismatches and short-term fluctuations being amplified by information asymmetry.

II. Give dealers a bigger say and understand market needs
OEMs should adjust their dealer strategies, objectives and business policies, as well as give dealer a bigger voice and more influence in vehicle ordering and pickup to better understand front-end market demand through orders placed by dealers and make targeted adjustments based on real demand. This can also help dealers overcome difficulties, promote deep cooperation with OEMs, and enable more and better coordination of production and marketing plan adjustments.

III. Conduct multi-scenario supply and demand simulations, and adjust production and marketing plans
OEMs should reexamine front-end market demand and inventory, production capacity and upstream spare parts supply plans and restrictions, analyze market demand fluctuations, upstream spare parts supply plans, and production capacity recovery plans. The resulting information can be used to simulate multiple production and marketing scenarios, as well as develop plans to prioritize required and producible models for their most important markets.

IV. Flexibly adjust production arrangements, and achieve a controlled work resumption as soon as possible
Control is key to the resumption of OEMs' operations. Given the challenge of resuming all areas of operation, OEMs should strengthen epidemic prevention and health and safety management, and gradually resume production by adjusting production plans and capacity, their pace of production, and production line arrangements based on safety management requirements and the return of workers. They should focus on how to further enlarge the space available for production to provide flexible support for changes in output and marketing plans.

V. Quickly review and identify supply disruption risks, and launch supply chain backup and contingency plans
OEMs should work with their core first-tier spare parts suppliers to comprehensively investigate and evaluate upstream suppliers' short-term supply capability, identify risks and launch supply chain backup and contingency plans. In particular, OEMs need to rapidly confirm and finalize supply plans for key spare parts that come from the same production lines. They should also monitor quality to ensure the safety and quality of short-term spare parts supplies.

VI. Monitor long-term supply risks and support upstream suppliers
OEMs should assess the financial health of upstream suppliers, monitor long-term supply risks, and support important links of the supply chain when necessary. This can include assisting with the application of force majeure to deal with default risks, shortening payment periods, or providing financial support to ensure they can overcome difficulties together. Meanwhile, the suspension of production by some upstream suppliers of key spare parts could have a delayed impact on OEMs. They should screen key spare parts, trace upstream suppliers and check production plans, identify high-risk suppliers, as well as formulate and begin plans to replace suppliers where appropriate.

VII. Cooperate with logistics partners to ensure uninterrupted supply
Although automotive logistics has been relatively less affected by the epidemic than production, procurement and supply, OEMs still need to assess the stability and safety of their logistics networks, and formulate responses to short-term capacity limitations and delays. At the same time, OEMs need to work closely with 3PL to focus on allocating transport capacity and logistics resources, while identifying major risks in spare parts supply logistics and improving 3PL's coverage of spare parts supply. For imported spare parts, OEMs should heed risks in international transportation and customs clearance efficiency, making timely adjustments to transportation routes and customs clearance processes to ensure production is not affected by logistics interruptions.

Long-term response strategy: Establish a tenacious, flexible supply chain through capability orientation, technological empowerment and cooperation

Based on short-term adjustments and recovery, automotive enterprises should make long-term preparations: establish capability-oriented, strategic supply networks, promote smart manufacturing to improve flexibility, and build a resource network ecosystem for mutually beneficial cooperation. On one hand, a flexible supply chain helps improve agility; on the other, a firmer supply chain boosts enterprises' risk resistance capabilities. Future supply chains need to have both qualities.

First, establish a capability-oriented, strategic supply network

There is already competition across the automotive industry chain. The core value of a supply chain lies in its completion of product delivery and optimization of cost efficiency, and supply chain flexibility, agility and tenacity are key to future industry competition. Therefore, automotive enterprises need to develop strategy-oriented network layouts to enable dynamic, flexible configurations in response to changes in external markets, customer needs and the industry ecosystem, achieving the optimal allocation of supply capabilities and industrial chain resources. By improving supply quality, providing superior customer services and enhancing supply continuity at the lowest possible cost, enterprises can build secure yet flexible supply capabilities.

In network layout, enterprises need to break through the traditional model of produce delivery as the core, manufacturing as the axis, and function oriented. Instead, they should go beyond the traditional boundaries and change elements of network layout from physical node to capacity oriented. Specifically speaking, the future network layout is not the physical node layout of the supply chain in the tradition sense, but re-decompose and combine the entire automotive supply chain from a capability perspective. The physical node is only the carrier of a series of capabilities, and the node layout is the physical manifestation of the capability layout, but capability changes are different from node changes. Under this strategy, the configuration of network capabilities is the core of the network layout planning. Enterprises need to sort out all resource capabilities required for end-to-end delivery, realize the modular combination and allocation of capabilities, and pay attention to the definition and establishment of pivotal capabilities, so as to reconfigure network capabilities.

Second, establish backup capability and strengthen risk management

The nature of risk is difficult to predict. Traditional risk management is event-driven and involves summarizing all potential risks in exhaustive detail to formulate countermeasures for the most likely eventualities. This requires heavy investment and makes it difficult for enterprises to effectively respond to low-probability, black swan events such as the COVID-19 outbreak. Therefore, in a capability-oriented supply network layout, establishing a backup supply chain is an effective way for enterprises to improve their risk resistance.

The core concept is putting one or more auxiliary supply chain networks in place underneath an existing master supply network, which can help enterprises smoothly weather a crisis. In one example, an enterprise-level internet equipment supplier established assembly nodes in different regions that in combination matched its core assembly capacity. In the event of a major crisis such as an earthquake, tsunami or other force majeure event that is difficult to predict based on traditional probability analysis, each node has considerable assembly capacity and can immediately start cross-regional emergency supply to avoid supply disruption. Another example is a Japanese automotive enterprise that standardized and redeployed spare parts supply after the 2011 earthquake, giving multiple supply nodes equivalent spare parts production capacity to enhance its overall supply chain risk resistance.

At the same time, OEMs and core first-tier suppliers should use digital tools to manage upstream supplier risks, ensuring their timely control and analysis, and improving the responsiveness and professionalism of risk management.

Third, promote smart manufacturing and improve supply chain flexibility

Businesses should actively promote Industry 4.0 to achieve smart manufacturing and enhance the flexibility of their production and supply, especially in R&D and spare parts standardization. To better deal with hidden supply risks, they can at the same time optimize overall processes to achieve flexible production and supply chains. For example, a US luxury car brand with a workshop in China can support flexible production of seven types of cars using Industry 4.0, enabling quick switches in production. Moreover, the brand's factories in other countries including Argentina, Poland, Thailand, and Brazil, have also transformed towards unified templates, designs, production process and technology. If any serious problems occur in one region, factories in other regions can provide quick support.

Fourth, increase upstream and downstream supply chain coordination, promote mutually beneficial, long-term development, and establish an ecosystem of automotive industry resources

At the operating level, OEMs, upstream and downstream enterprises need to cooperate more in R&D, planning, and supply chain operation, especially on how to establish upstream and downstream information sharing using digital tools to enhance visibility and multi-party collaboration.

Strategically, OEMs need to re-consider how they cooperate and strategize with upstream and downstream businesses, rebuilding mutually beneficial cooperative relationships, and creating trust, with dealers and suppliers. Meanwhile, OEMs should proactively build ecosystems of automotive industry resources to strengthen coordination, and establish industry alliances. Compared with company-based supply chain management, this enables businesses to shoulder risks together in a crisis by sharing resources, including supplies and funding, which can make a huge contribution to the recovery of an individual enterprise's supply chain. After a fire in one of its supplier's factories in 1997, a Japanese automaker faced a 98 percent shortage of brake fluid valves and an estimated two-week production halt. The company promptly called on other suppliers. Although these suppliers had never produced the required spare parts before, more than 200 of them were able to manufacture enough brake fluid valves that met the automaker's requirements in just one week through close coordination and rapid R&D. The Japanese automaker was able to do this because it cooperated with a supplier alliance, creating a culture of mutual assistance—"when difficulties arise with one party, aid will come from multiple sources". It was able to weather this supply chain storm and maintain a highly flexible, rapid response capability even though in normal conditions it used an exclusive supplier.

Conclusion

When a crisis occurs, it is important to also focus on the future, including changes in thinking on supply chain risk management and business continuity.

The COVID-19 outbreak at the start of 2020 has been a huge shock to the entire automotive industry. Regardless of how severe the situation becomes, Deloitte believes businesses will win this "war" against the epidemic, overcoming difficulties through proactive responses, deep cooperation and mutual assistance, with support from government and industry. On the road to recovery, businesses can further promote modernization, establish resistant, flexible supply chains, and strengthen cooperation and alliances, while continuously promoting integration with the automotive industry worldwide and contributing to its bright future in China.