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An Unintended Interruption to the Global Supply Chain

The current outbreak of COVID-19 (the coronoavirus) will be a test of the global supply chain’s strength in the face of unintended interruptions, and can be a lesson on building-in supply-chain contingency plans.  As a result of COVID-19, many factories in China, which supply the bulk or all goods and components to many companies, have ramped down or temporarily shut down production due to workforce challenges and necessary quarantines of workers.  While disruptions in business and supply chains have already emerged, the full impact of the disruptions will likely not be seen for a few more weeks when companies may begin shutting down assembly and manufacturing plants as a result of a shortage of components from tier-two suppliers.  These disruptions will likely be felt through at least April due to logistics challenges and capacities.

Supply chains are made up of different tier suppliers – direct suppliers and tier-two suppliers.  Tier-two suppliers manufacture and supply components to direct suppliers who have contracts to supply goods to companies around the world.  One corporate data analytics firm has calculated that the Wuhan region of China, the epicenter of COVID-19, is home to direct suppliers for approximately 51,000 companies and tier-two suppliers relied on by at least 5 million companies.

Two noteworthy supply chain disruptions occurred during the aftermath of the 2010 earthquake in Fukushima, Japan and the 2002-2003 SARS epidemic.  The SARS epidemic did create a small hiccup in global financial markets – but in 2003, the GDP of China represented 4.31% of the world GDP, today, it represents about 16%

While some companies previously affected by supply chain disruptions created large inventories of critical components, many companies did not follow suit and are finding themselves in a predicament with the spread of COVID-19 in China.  For companies that did move to increase inventories, those may only last for a few weeks.  However, even when production increases, there will likely continue to be manufacturing delays as most goods are shipped to their destinations, a trip which takes about 30 days from China to the US or Europe.  Departures from Chinese ports have already decreased by 20%

Fashion companies are scrambling on multiple fronts: sales are taking a hit due to travel restrictions and store closures; and since China is the world’s largest garment producer, their supply chains are being affected.  Luxury fashion brands are taking major hits as COVID-19 is having a negative effect on luxury demand in China.  Companies such as Macys, which cater to a different consumer, also expect drops in international sales and import lags.  Brides may be in for a rude awakening this summer – many bridal gowns are produced in China and some factories producing them have been shut down.

Even if a company has its cutting and sewing done elsewhere, China, as the largest exporter of textiles and clothing in the world, is the source of many fabrics, trims, appliques, and cords which are needed to finish products.  Mid-market fashion brands tend to have more supply chain exposure to China than luxury brands.  Many fast-fashion companies have less exposure to China with more diverse supply bases in North Africa and Turkey.  The hope is that those companies can shift some manufacturing to mitigate against disruptions in China. Additionally, larger chains are likely better positioned that smaller stores to survive the risk to inventories.  Some, such as Kohl’s, have moved production of private brands, which account for about 40% of sales, outside of China, which gives the chain greater flexibility.

If a retailer follows a traditional two-season model, much of the stock for spring and summer was on its way to distribution centers before the virus hit.  Those companies may see a bigger hit in autumn and winter stock due to manufacturing delays.  If clothing arrives late for an intended season, it will need to be marked-down to be sold, thus delivering another blow to retailers.

With a focus and priority on the health and safety of employees, many companies are having employees work from home, which amounts to an inconvenience for most businesses other than the retail industry.  Retailers cannot maintain their level of output when there is a disruption in staff or store closures.  Some retailers are closing stores in China and reducing hours at those that remain open.  Restaurants that do remain open in China are experiencing substantial sales declines.  Yum brands rolled out “contactless delivery” in China, and pick up in store options, which has sustained some sales.  Contactless delivery consists of placing an order online, a courier calling the customer prior to delivery and waiting for the customer to arrive before placing food in agreed upon location.  The couriers, who are required to wear masks and disinfect their hands and delivery boxes after each delivery, then step back at least 10 feet before customers pick up the food.  Instore pick up is now done by placing food in packaging that avoids exposing food to viruses in the air.  Those food packages are then placed on pick up racks.

In the US, Many retailers, such as Walmart, are expecting negative financial hits in the first quarter.  Home Depot has cited apprehensions as it sources about 30% of its products from China and is concerned that uncertain consumers may delay big-ticket home improvement projects.  Microsoft and Apple already announced that quarterly sales would be lower than predicted due to COVID-19’s impact on supply chains.  Both Fiat Chrysler and Hundai announced temporary suspensions in production lines at plants in Serbia and Korea, respectively, due to inability to get parts from China as a result of COVID-19 manufacturing disruptions.

Other stores have seen upticks in demands for products like hand sanitizer and face masks and grocers’ sales remain strong (and even increased) as some consumers stock up on staples and turn to online ordering.  Costco’s website sold out of Kraft Macaroni & Cheese and Jif Peanut butter in the New York City Area and Amazon advised customers that same day grocery service may be delayed or limited. 

Even the FDA is on alert.  January, the FDA notified pharmaceutical companies that they must evaluate their entire supply chains manufactured in China.  The FDA expects that the COVID-19 will impact medical product supply chains which could lead to supplies and shortages of critical medical products in the US.  Drug manufacturers have already alerted the FDA to shortages related to a site affected by COVID-19. 

Contingency measures are expensive, large scale disruptions are rare and companies are judged on profits.  Therefore, many companies are driven towards offshoring, outsourcing and lean manufacturing – all measures which can lead to quick disruptions in supply-chains.  For companies who have taken contingency measures such as dual-source manufacturing and creation of inventories of necessary components, the impact of COVID-19 may be a test for those measures.

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Cristina L. Addy's picture

Cristina L. Addy is an Associate in the firm's Real Estate group. Her practice focuses on representing investors, developers, and lenders in connection with the acquisition, disposition, and financing of office, multifamily and retail properties. Cristina also has extensive experience representing tenants and landlords in office, retail, and industrial leasing transactions.

Prior to joining Goulston and Storrs, Cristina was an associate at an Am Law Top 50 U.S. law firm.

Co-authors

Andrew O’Connor's practice focuses primarily on securing and protecting clients' intellectual property rights. With extensive experience in matters concerning patents, design patents, trademarks, trade dress, false advertising, product disparagement, trade secrets and copyrights, Andrew devotes extensive strategic planning and skilled advocating both in and out of the courtroom in order to assist clients with successfully navigating the constantly evolving intellectual property law landscape. Andrew also prosecutes and manages the trademark portfolios of clients before the U.S. Patent and Trademark Office.

Andrew focuses on the broader goals of each client’s business model and overall brand, negotiating intellectual property license agreements, corporate mergers and intellectual property asset management projects for a broad array of companies, ranging from entrepreneurs, start-ups and laboratories to Blue Chip multi-national corporations. Andrew’s extensive experience in the pharmaceutical, medical device, retail and video gaming industries has produced consistent and successful implementation of each individual client’s specific goals and interests in highly sophisticated industries.