In the face of disruptive events

As of the day this post is being written, a virus has been spreading globally. Details of the virus (SARS-CoV-2) and it’s spread (nCoV-19) are being discussed across the globe. There is much in the way of fear, and fear-inspired reactions. Visit any airport, and note the number of people wearing what amounts to ineffectual face masks. All the while, doctors are trying to get common sense messages out about prevention and preparation. Don’t travel if you are sick. Wash your hands, effectively, with soap and water. And so on.

This isn’t a post about Coronavirus though. This is about the disruptive impact, near, and longer term, of this on, well, everything.

In HPC, many companies work in a just-in-time build mode. Keep inventory levels down to reduce risk of being stuck with unsellable parts. Avoid holding inventory on the books as much as possible. Within HPC, many of these parts are made in China specifically to keep unit costs down.

Outside of HPC, again, quite a bit of manufacturing is being done within China. I don’t have specific figures, but one could find them with detailed research and analysis.

One might ask, how could a virus impact manufacturing?

It turns out, that this can be a substantial effect. Using chinese resources for manufacturing arises in most cases due to a combination of lower costs. Costs of labor in China are often small fractions of what a manufacturer would pay elsewhere. The chinese government appears to work on encouraging businesses to manufacture in China, and has engineered some of their import/export rules, taxes, tariffs, to make this economically favorable. Cost of capital is lower in China.

All of these things together, reduce the financial burden upon a manufacturer to move their operations to China. Especially for those manufacturers in markets with tight margins, where unit costs are relatively low. Like electronics, among numerous others.

Companies aggregating these components from chinese ODMs into larger “value” sellable product thus become dependent upon the manufacturing portion, the supply chain, in order to schedule builds, set availability, and calculate their own internal unit costs.

This isn’t just HPC. This is everything.

Supply chains have spread globally. While, generally, there is nothing wrong with that in theory, there are a number of impacts upon companies and their customers (not to mention employees), which all line up under the rubric of opportunity cost. That is, what is the economic value of an alternative choice.

I’ve actually written about this several times. Back in the early 2010s, there was flooding in Thailand. This flooding wiped out a substantial amount of hard disk manufacturing capacity. This impacted my former companies’ ability to ship storage product cost effectively. This in turn reduced our revenue, and in longer term ripple effects, likely impacted our longer term survivability.

In 2011, there was a significant earthquake and tsunami in Japan. As I wrote then, this had significant impacts upon my company and many others in HPC, and tech in general.

In 2017 some market conditions conspired to provide insufficient manufacturing volume in Flash and SSDs. I wrote about this then. It was already too late for my company at that point. I could not salvage or sell what remained, and another shock would simply push us over the edge again.

Finally, in 2019, I synthesized these thoughts into another post. Here I posited that

This has downstream impacts upon product offerings, as you can’t build systems to gain revenue, without parts you can’t get. Or if your cost models are blown up as parts costs increase dramatically. Which directly impacts your bottom line, and if you increase prices to offset your costs, your top line.

All of this. From global supply chains. To take advantage of lower cost geos.

The fundamental question is, is the risk to the supply chain, to the bottom and top line, actually worth the cost difference? Put another way … if the supply in question were to go to zero for an unknown extended period of time, larger than a single fiscal year, what would this do to your product, revenue, profitability?

While I was specifically talking about HPC at the time, disruptive events have emerged in the form of the virus. The question I asked then seems quite prescient now.

Side effects of inability to manufacture and ship products are high prices and little inventory … shortages in other words. These are being postulated as starting to show up in market within the next month or two.

And again, this is not just HPC. This is everything.

Why this is important.

A theoretical risk to a company producing and supplying product, directly impacting top line revenue, and company fundamentals has been demonstrated to be … well … not simply theoretical. Long supply chains, non-diversity in manufacturing geos, etc. These are real, now measurable risks. There are policy impacts, such as leveraging war powers act in the US to increase manufacturing of critical components. Part of the problem is that much manufacturing has left the US, so the loss of experience and knowledge associated with that will be problematic to booting up this capability.

The risks aren’t theoretical. They are real. You can quantify them by analyzing corporate data, now. They will have an impact upon top line revenue, bottom line results.

The only question is, will companies learn from this? We can automate manufacturing so that labor doesn’t factor in so significantly. We can make sure laws and taxes work to encourage manufacturing here in the US, though this is often subject to political whims of those in (temporary) power.

Overall, the question is whether or not this will encourage a rethinking of how companies do their manufacturing and supply chain risk management. I suspect a number have been quietly working on exactly this due to changes in tax policy in the US over the last several years. I expect that many just got a kick in the proverbial pants to do this sooner rather than later.

Time will tell, but this is not likely to be the only disruptive event. Nor is it a black swan. A good company will prepare for that, and be able to survive during disruption.

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