Supply chain implications of the Russia-Ukraine conflict

The interconnectedness of economies and businesses has both exacerbated the growing supply chain crisis and to some extent masked it. According to Dun & Bradstreet, there are fewer than 15,000 Tier 1 suppliers in Russia. Dig a little deeper, however, and there are 7.6 million Tier 2 supplier relationships with Russian entities globally.³ More than 374,000 businesses—90% of which are in the United States— rely on Russian suppliers. Now consider that in Deloitte’s most recent annual survey of chief procurement officers, while 70% believed they had good visibility into risks in their Tier 1 suppliers, only 15% had the same confidence about Tier 2 and beyond.

Manage the risks now

While many of the changes required to current global supply chain design and operating practice will most likely take years to implement, there are actions that can be taken right away.

• Ensure risk management frameworks and systems are in place. Most organizations were not prepared to respond to the COVID-19 pandemic. While it was common to state there was no playbook for COVID-19, the reality is that most organizations did not have any playbook at all. Hence, make sure that the proper risk management tools are in place for the crisis that the war in Ukraine has given rise to. That means focusing on risks in the extended supplier network and in relation to the supply and inflationary pressures on key commodities.
• Use technology to understand risks in Tier 2 and beyond. On the surface, Russia is not as critical to complex global supply chains as other nations, such as China. However, the picture is much different when you look beyond direct suppliers. Visibility is one of the core pillars of a resilient supply chain—and it should extend to the entire network. The aforementioned Deloitte survey of chief procurement officers indicates that relatively few companies (26%) felt that they could predict risks in their Tier 1 supplier base, let alone anticipate issues in their upstream suppliers. To get a better grip on where risks lie, consider implementing “control towers” powered by artificial intelligence/machine learning and advanced analytics to provide right-time data visibility, proactive alerts, prescriptive insights, and self-driving execution. Control towers can identify suppliers and/or commodities that pose elevated risk levels in both your direct supplier base and within the extended supply network (i.e., your supplier’s suppliers).
• Understand and activate alternate sources of supply. For companies that have multisourced key inputs, it is important to move quickly to activate secondary supplier relationships and secure additional critical inventory and capacity. At the same time, companies must take care in choosing alternate sourcing locations for key commodities, as doing so can increase industry reliance on supplier hubs that are already concentrated.
• Consider onshoring and “friend-shoring.”Coming out of the COVID-19 pandemic there was already momentum building to reshape global supply chains with a more regional, if not local, structure. The Ukraine conflict and the spotlight that it has put on important global commodities will accelerate that movement. Bringing supply chains home can offer governments and companies more control and remove the volatility of foreign dependence. But onshoring isn’t always possible. Some products and services, such as semiconductors, either cannot be produced domestically because natural resources or expertise is not available, or because the market for those products and services isn’t large enough to support multiple competing sources of supply. “Friend-shoring,” or the reorchestration of critical supply chains by swapping risky foreign suppliers with close allies and partners may offer a pragmatic solution.
  
• Update inventory policy and planning parameters for critical materials. For the past couple of decades companies have been implementing practices to reduce inventory across the supply chain, setting a level of safety stock to buffer normal demand and supply variability. COVID-19 was a wake-up call that these traditional inventory buffers are insufficient when a crisis hits. Establishing a policy for “strategic stock” of critical materials should be an essential component of a company’s overall inventory policy. Some companies had already taken action to mitigate the risks of the Russia-Ukraine conflict. For example, the largest companies in the semiconductor industry had increased stockpiles of palladium and neon, two critical elements in semiconductor production that are highly reliant on supply sources in Russia. Unfortunately, many companies had not anticipated these supply-side risks and are now exposed with lean, and potentially insufficient, inventory to manage through a prolonged period of disruption. Being short just one component, such as a wiring harness made in Ukraine, can stop production of an automobile.
  
• Understand the impact of commodity inflation in supplier and customer contracts. The impact of the Russia-Ukraine conflict was quickly felt by sharp increases across several commodities—oil and natural gas, metal commodities, and agricultural commodities. Resilient organizations will proactively drive down their costs to reflect changes in commodity prices, while working thoughtfully with suppliers who may be struggling themselves, to be well positioned for whichever market conditions greet them in the “next normal.” Revisit customer pricing where possible. The rising cost of fuel is most often recovered through a fuel surcharge that is built into freight terms. However, the implications of rising commodity costs in product profitability and customer pricing may be less obvious. It is, therefore, important to understand the implications of inflation on product and customer costs and develop strategies to maintain profitability.
  
• Monitor logistics constraints and costs. The Ukraine conflict is disrupting traditional supply routes, emphasizing the need for logistics flexibility in the design of global supply chains. Even prior to the conflict, most companies were managing their way through complex logistics challenges such as port congestion, container shortages, long lead times, and record-high ocean freight rates. With this conflict we are seeing additional disruption. Rising oil prices are putting additional inflationary pressure across freight modes. Ocean shipping in the Black Sea has become increasingly challenging, air-freight availability and lanes are changing as flights need to be rerouted around closed air space over Russia and Ukraine, and freight trains that were moving goods from China to Europe through Russia, Ukraine, or Belarus may no longer be available.
  
• Increase focus on cybersecurity risk monitoring, within your own operations and with key suppliers. Supply chains are rapidly becoming digital, thanks to smart factories, smart distribution centers, and the growth of the Internet of Things where almost every modern device has an IP address. For years, countries and companies have been investing in cybersecurity. However, this conflict has illustrated how digital attacks are now part of modern warfare. State-sponsored and organized attacks have reinforced the critical need for cybersecurity and the resilience of the systems and automation that we are increasingly reliant on.
• Prepare for disruption in operations in the conflict region. The data suggests that there are not a lot of international organizations with operations directly in the highly disrupted regions in Ukraine. However, over the first few weeks of this conflict, we have seen a number of multinational corporations in energy, mining, agriculture, health care, and consumer products industries make tough decisions regarding whether to stop, scale-back, or continue operations in Russia and Ukraine. For those companies continuing operations in Russia and Ukraine, it will be critical to focus on the safety of the workforce and to prepare for significant disruption to logistics infrastructure and other supply chain partners.
• Conduct global scenario planning. The world hopes that this conflict will come to an acceptable conclusion quickly. However, the duration and magnitude of this crisis is uncertain, as are implications for commodity costs and availability of supply, and the implications of further potential sanctions and government intervention. Companies should assess scenarios, based on the nature of their exposure to this conflict, to determine the best medium to longer–term course of action.

Successful leaders will take decisive action to respond to the immediate risks of this crisis and to stabilize their supply chain. They will also embrace the long-term view, recognizing that this crisis is most likely to elevate the importance of many of the fundamental and structural changes to global supply chains that were already being accelerated as we emerge from the COVID-19 pandemic.