The Pros and Cons of Decoupling, De-risking and Diversification of Supply Chains

Globalization, which became very popular in the 1990s and lifted many countries from poverty, has been on decline over the past five years. In its place, bilateral trade agreements, de-risking, decoupling and self-reliance have been on the rise. This sea change has mainly been due to: major shocks as a result of the Covid pandemic, ongoing conflicts between major countries, energy risks, trade wars, natural disasters, and war. Regardless of their size, companies are reassessing their global supply chain strategies.

Diversification of the supply chain is good and has great benefits, but it also comes with potential risks.

What are the benefits of supply chain risk diversification?

In a nutshell, the main advantages of supply chain risk diversification are minimizing potential supply chain-related disruptions, having more negotiating power, improved resilience, and access to new markets. One of the primary advantages of decoupling is the ability to diversify risks. Heavily relying on a single sourcing location can leave businesses vulnerable to disruptions, whether they are geopolitical, environmental, or economic. By diversifying suppliers across different regions, companies can reduce the impact of localized disruptions.

According to the Reshoring Institute, the disruptions caused by the Covid pandemic prompted 33% of U.S. and European companies to reevaluate their supply chain strategies. Reduced dependency on a single logistics route or shipping company, minimizing the impact of disruptions like port closures or transportation challenge, is also a major benefit of risk diversification.

What are the impacts of decoupling in the supply chain?

One of the biggest impacts of decoupling in the supply chain is that it helps minimize the impact of unexpected events. The World Economic Forum (WEF) reported that 85% of global supply chains were disrupted by the Covid pandemic in some form. Trade wars, local conflicts and potential health emergencies highlight the vulnerability of supply chains that are heavily dependent on a single source. Spreading production across multiple countries or regions can mitigate the risk of production halts due to unexpected events.

A report by Deloitte highlights that 33% of supply chain professionals consider enhancing supply chain resilience their top priority. A diversified supply chain can enhance overall supply chain resilience. During the times of crisis and disruptions companies can remain operational by having alternative suppliers or manufacturing facilities. This adaptability is crucial for minimizing downtime and maintaining customer satisfaction.

Reducing dependence on a single supplier can boost a company’s negotiating power.

Competition among suppliers can lead to improved pricing and contractual terms, and increase profitability. Research by McKinsey indicates that companies with diversified supplier bases often have stronger negotiating positions, leading to an average cost reduction of 10% to 20%.

Exploring new sourcing options can open doors to new markets and trade opportunities. This expansion can be particularly advantageous for businesses looking to tap into emerging economies or strategically position themselves in growing markets. Companies that diversify their sourcing locations often discover new market opportunities, leading to increased volumes.

Diversification of the supply chain comes with some potential disadvantages.

One of the biggest disadvantages of diversification in the supply chain is cost.

Spending on travel, managing various regions, and managing multiple supply chains across different countries can be costly. Each country’s regulations are different. The underlying logistics regulations, political stability and compliance are biggest challenges. A few years ago, this would also increase freight costs, but today, almost all major ports in Asia are commonly rated. A study by PwC found that 66% of surveyed executives anticipate higher supply chain costs as a result of diversifying away from China.

Managing a decentralized supply chain is more complex than dealing with single supplier or country of origin. Coordinating operations, ensuring quality control, and monitoring compliance across multiple regions can be challenging and may require a significant allocation of resources. According to the World Bank, managing a decentralized supply chain can increase administrative and coordination costs by up to 25%. Companies will deal with multiple origins and multiple suppliers, and will spend more time which otherwise could have been used elsewhere.

Keeping standardized quality when dealing with multiple regions is another disadvantage.

Different regions will have different standards and regulations. Ensuring consistent product quality and compliance with local regulations can be a complex endeavor, potentially leading to quality control challenges, which may result in defective materials, loss of customers, profits, and deterioration of the overall business.

Another disadvantage is to be able to maintain enough inventory levels in multiple locations to meet ever-changing demand. Overstocking or understocking can lead to increased carrying costs or missed sales opportunities. A report by the Inventory Optimization Institute reveals that maintaining inventory in multiple locations can increase carrying costs by 5% to 10%.

Companies will also lose the advantage of economies of scale when they diversify.

Dealing with fewer suppliers has the advantage of economies of scale which results in cost efficiencies. Decoupling can result in a loss of these economies of scale, potentially leading to higher production costs. Research by the Institute for Supply Chain Management indicates that decentralized supply chains can reduce economies of scale, leading to a 15% to 20% increase in production costs.

Where did the volumes go? Below are some transpacific eastbound stats, from Datamyne, which illustrate the clear volume shift and countries that are chipping away volumes from China.

Many importers still rely on China heavily due to superb infrastructure, know how, and easy access to a qualified work force. China is losing volumes in its coastal cities, but its inland locations where labor and cost of living is cheaper are increasing their output. Since the start of 2018, exports from 15 of China’s central and western provinces have skyrocketed 94% as factory production expanded beyond the Pearl and Yangtze River deltas that have driven China’s industrial economy (per the Wall Street Journal). Infrastructure, ease of doing business, and capacity are still the biggest issues in alternative regions.

A shift is obvious. With a global recession on the horizon, once the world’s economies are back to normal, we will see whether the current trends will continue.