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In today's globalized world, regulatory complexity is one of the root causes to lacking supply chain performance. This article presents the sixth of eight root causes we defined for supply chains lagging behind their potential. You will find an overview of all root causes in the first post of our ten-part series. For more details, jump to the related article.
Every company faces its own construct of regulations: on an international level, for example, through EU directives or on a national-state level. Secondly, some regulations apply in the case of cross-border material flows, including, e.g., tariffs, but also trade restrictions. Current events such as the US trade policy or Brexit add an important factor to the already complex structures: uncertainty. Thirdly, for some sectors, specific regulations exist. GMP (good manufacturing practices) regulate the production and logistics of pharma products and medical devices in pharma and life sciences. Similar regulations exist in other sectors, such as food and beverages, aerospace and defense, and semiconductor. GMP is regulated in the US by the FDA (Food and Drug Administration). The WHO (World Health Organization) provides its version of GMP, which regulators and industry use in more than 100 countries.
How the effect of regulatory complexity on supply chains differs due to individual conditions
From a strategic perspective, regulatory framework conditions are to be named as an important factor for the choice of location. As a result, regional regulatory conditions affect the long-term strategic decisions of companies, which in turn influence supply chains.
From a tactical to operational perspective, a very differentiated approach is required when looking at the effect on the supply chain. The consequences depend decisively on the respective law and fluctuate depending on the industry and individual business situation. In addition, the outcome depends on how well a company or an entire supply chain has been able to prepare or has been designed for a regulatory change. Therefore, in the following, we will use examples to discuss what effect specific regulations can have on supply chains and examine the role of regulatory uncertainty.
Taxation & Duties
Former U.S. president Trump stated in a tweet that "trade wars are good and easy to win "as he imposed tariffs on about $360 billion of imports and other trade barriers for China in 2018. He aimed to reverse what he called "unfair trade practices." In the 2016 election year, Trump declared that he would "reverse" the deficit in U.S. goods trade with China. However, the goods trade deficit with China has increased since then, reaching $ 287 billion in the eleven months to November 2020 (according to Chinese data). Compared to the previous year, the deficit decreased in 2019 when U.S. companies switched to imports from countries like Vietnam but remained above the gap of $ 254 billion from 2016. One reason was the retaliatory tariffs imposed by Beijing on goods from the United States valued at around $ 110 billion. These only began to recover in the final months of 2020.
Furthermore, Beijing made a vow to import an ambitious $172 billion worth of U.S. goods in specific categories in 2020, but it had bought just 51% of that set goal through the end of November. The decrease in energy prices amid the pandemic and the problems with Boeing Co.'s planes played a part in that failure. The persistent deficit demonstrated how reliant companies are on China's vast manufacturing capacity, which was highlighted again by the pandemic. China was the only country capable of increasing output on a big enough scale to meet the rapidly growing demand for goods such as work-from-home computers and medical equipment. Eventually, Trump's trade war with China resulted in an even higher increase in Chinese exports.
Bloomberg chief Asia economist Chang Shu stated: "The fact that exports were little affected after four years of trade war speaks to the resilience of China's manufacturing capacity. However, the trade war has exposed China's vulnerability in certain bottleneck sectors such as high tech. "
Trump expected and encouraged US companies to transfer their production capacities from China back to America. A shift that did not happen. US direct investment into China increased 3.1% from 2016 to 2019 (Rhodium Group data). The former US president also claimed that tariffs boosted the US economy while causing China to face heavy economic losses. However, the economic impacts were minor on both sides.
"Compared with tariffs, an escalating conflict over technology is of more concern to China. Washington's sanctions and export restrictions have threatened the viability of leading technology companies such as Huawei Technologies Co. and microchip maker Semiconductor Manufacturing International Corp.
That is an existential threat to Beijing's plans for economic growth. So far, the impact of US actions has been to accelerate Beijing's drive for technological self-sufficiency. The issue has rocketed up the Communist Party's agenda, symbolized by a statement in December 2020 that increasing "strategic scientific and technological strength" is the most important economic task. "
In July 2021, 130 countries and jurisdictions have agreed on a global tax reform consisting of two pillars. The first pillar aims for a fairer distribution of profits and taxing rights among countries concerning multinational corporates, including digital companies. The idea is to re-allocate some taxing rights from the multinational's home countries to the markets where they have business activities and earn profits, regardless of whether firms have a physical presence. The second pillar will set a global minimum corporate tax rate to end competition between countries over corporate income tax rates.
In summary, we can state that the impact of taxation on global trade is smaller than expected. Through the introduction of global tax standards, the difference between countries w.r.t. tax rates will diminish. This will reduce the need to shape supply chains to gain tax advantages. For instance, in the pharma industry, the active ingredients carry the majority of the value of the finished products. Therefore, principal-based tax schemes were set up, with a principal company buying the active ingredient from the producing entity for a price close to production costs and selling it for a high price to the global formulation and packaging plants, resulting in a high profit at the principal entity. By placing the principal entity in a low-tax country, companies could save a lot of tax costs in the past. This advantage will decrease with a standardized global tax system.
Subsidies
Governments provide an average of $ 700 billion per year for agricultural support in the countries that produce two-thirds of the world's agriculture. Based on a World Bank report, 70% of subsidies support increased incomes in regards to market price support and production payments:
Agricultural subsidies result from the unique challenges in the sector, such as weather, climate, and unpredictable natural disasters. Simultaneously, agriculture plays an important role in global food security. Producers have to make expensive investments in equipment and labor before they can realize any profit. However, the trade-distorting effects of agricultural subsidies are tremendous: less developed countries complain about disproportional disadvantages because their governments cannot provide similar subsidies, leaving them unable to compete in the global market. "Communities say that foreign products, such as European milk, are flooding their markets, crippling local herders and farmers and leaving consumers vulnerable to price changes. " For the supply chain, this example shows the negative effect subsidies might have on local, fully functioning, and productive workflows that are being pushed out of the competition by imported, cheaper goods and the mere fact of less monetary support from an overall weaker economy in their respective country.
GMP
Good manufacturing practice (GMP) describes the minimum standard that a medicine manufacturer must meet in their production processes. In the US, the Food and Drug Association (FDA) is responsible for protecting public health and, therefore, is in control of the related processes and regulations. Since 2018 the FDA has significantly increased the number of foreign inspections and warning letters to human drug manufacturers. "This has put drug manufacturers and their supply chains under increased scrutiny, and at greater risk for potential compliance issues that can have dramatic effects on a company's business." The supply chain must prioritize a strong oversight of the regulatory changes at each stage of a product life cycle to avoid tremendous delays bringing a product to market. Furthermore, the FDA focuses on data integration during foreign inspections. It refers to the completeness, consistency, and accuracy of data at a production site.
Standardized, systematic production systems can help to ensure that all production sites of a company are GMP-compliant. A leading-practice production system consists of multiple pillars: Leadership & Ownership, Autonomous Maintenance, Preventive Maintenance, Problem Solving, Work Process Improvement, Health, Safety & Environment, Quality, Culture, Organization & People. The idea is to establish a culture of excellence and prevent operations from moving outside regulations to ensure high performance. Self-directed teams in operations take autonomous actions and drive results. Standard working processes are established as routines that are executed daily. The work processes go hand in hand with regulations like GMP.
How to realize fact-based decision making to improve the implementation of regulatory changes to preserve a healthy supply chain
To be on top of the fulfillment of regulatory requirements, two factors are essential: (1) Time, i.e., at what point of time a company or a supply chain becomes aware of a change and reacts to it, and (2) adaptability, i.e., the ability of companies and supply chains to react or adapt quickly to regulatory changes.
While the first factor of the absolute time span between the observation of a change and the corresponding action can only be influenced to a limited extent, for example, through early education mechanisms, companies can very well optimize themselves with regard to the second factor, adaptability to regulatory changes. The term supply chain resilience is closely linked to this challenge. This overarching term describes the resistance of supply chains to (disruptive) events of any kind. In our context, we understand these events in the sense of risks of a regulatory origin.
To build up a resistance to regulatory risks, understanding the various sources of risk in a supply chain is relevant. These are summarized in the following figure based on Martin Christopher:
Without digging too deeply into the various components, it becomes clear that the effect of regulations can impact different ways. For example, the delivery side can be interrupted or significantly more expensive. However, the situation is relevant when regulations affect demand (prohibition, tobacco tax, etc.).
However, it is difficult to predict the impact of future regulations. Therefore, an efficient way to arm yourself against regulatory disruptions is to build a resilient supply chain. Corresponding starting points are structured around the four main aspects (1) Supply Chain (re)engineering, (2) Supply Chain Collaboration, (3) Supply Chain Risk Management, and (4) Agility:
The operational implementation of a resilient supply chain to optimally adapt to regulatory changes requires numerous operational tasks. Transparency, SC Intelligence, Collaborative Planning are relevant concepts. The conscious anchoring of resilience goals in these daily tasks is a core aspect that can be implemented using consistently linked tools - ranging from analysis to implementation of measures.
We can find a historical example of Supply Chain resilience in the Nokia & Ericsson case study: The story begins on the evening of March 17th, 2000, with a thunderstorm over Albuquerque, in central New Mexico. A lightning bolt hit a power line, which caused a fluctuation in the power supply, resulting in a fire in a furnace in a nearby semiconductor plant owned by Dutch firm Phillips Electronics NV. In minutes, the fire was brought under control, but it destroyed eight trays containing enough silicon wafers for thousands of mobile phones. The damage to the factory from smoke and water was much more extensive than the fire itself, contaminating its entire stock of millions of chips. The suppliers immediately prioritized customers according to the value of their business. Between them, Nokia and Ericsson accounted for 40 percent of the plant's output of the vital radio frequency chips, so these companies were put at the top of the supplier's list.
On March 20th, over in Finland, Nokia's event management systems indicated that something was amiss. Orders were not coming through as expected, so a components purchasing manager telephoned the supplier, who informed him that there had been a fire in the plant, which was likely to disrupt production for around a week. Nokia was not unduly alarmed but dispatched engineers to New Mexico to investigate the situation. Philips was refusing to allow visitors to inspect the damaged facility.
Having been unable to investigate the problem further, Nokia staff increased monitoring of incoming supplies from weekly to daily checks. It became clear soon afterward that the problem was so serious that supplies would be disrupted for months. At the highest levels, the pressure was brought to bear between Nokia and its supplier to ensure that all other Philips plants were commissioned to use any additional capacity to meet Nokia's requirements. In addition, Nokia immediately sent representatives out to its other suppliers in the US and Japan to secure priority status for all available chips supplies and persuade them to ramp up production as quickly as possible. Because Nokia was such an important customer, the suppliers obliged a lead-time of less than one week. Nokia also set about reconfiguring its products to take slightly different chips from other sources.
Ericsson had also found out about the fire soon after it occurred, but having been assured by the suppliers that the fire was unlikely to cause a major problem, had not acted further until early April. By then, Nokia had already moved to secure its supplies, and unlike the quick-acting Finns, Ericsson had no alternative sources of supply. Some years earlier, it had decided on single-source key components to simplify its supply chains as a cost reduction measure. Ericsson lost an estimated €400m in new product sales as a result of the fire. An insurance claim would later offset some of the direct losses. Nevertheless, Ericsson was forced to cease manufacturing mobile phones. In contrast, Nokia claimed it could maintain production levels throughout, cementing its position as the global market leader.
This case study does clearly show how important it is always to be one step ahead of change. A hands-on mentality through every business function, lightning-fast reaction, sometimes with the necessary urgency, can make the difference in gaining transparency and crucial advantage to your competitors. It also gives you the ability to steer suppliers and retain an edge in competition and production. The right mindset and foresight combined with intelligent technical solutions will minimize the risk of regulatory complexity and positively influence your supply chain performance gap.
An initial step in improving a supply chain's resilience is to create a supply chain digital twin, representing the supply chain network and mirroring daily operations through data from transactional and planning systems. Our AIOplatform can be used to build a supply chain digital twin.
AIOinsights maps the supply chain network, visualizes material, information, and financial flows, and highlights potential risks related to changes in regulations. AIOintelligence helps to simulate regulations changes and identify parts of the supply chain that might be incompliant and need to be adjusted. AIOimpact then provides implementation support for the required adjustments by tracking all implementation steps and activities and monitoring progress and results.
The upcoming article of our ten-part series in the root causes of the supply chain performance gap will give an insight into sustainability requirements: stay tuned!
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