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Why Become Digital Today, When Digital Value Chains Are Heavily Disrupted?


Author: Lorenzo Veronesi

From Bad to Worse: When a Pandemic Turns Into a Global Supply Chain Crisis

During an August earnings call, the CEO of a global technology company raised the alarm about the global semiconductor shortage: "This is the worst I've seen it," the CEO said. "Everything from copper shortages to wafer starts to assembly to manpower, people, logistics, freight. Just about every aspect of it is challenged, too."

It's true that 2020 has left an indelible mark on business rules, creating a "next normal" of rapidly mutating demand, subverted work rules and supply uncertainty. While we're seeing some signs of recovery, the aftermath of the crisis is proving to be even more difficult for many companies. There is no end in sight to disruptions to "physical" processes — such as factory and supply chains — which are critical for revenue generation. The lack of key components such as chips is particularly difficult for even the most tightly organised companies. Despite all the efforts, the pandemic has impacted companies' physical operations and even with the vaccines, the uncertainty will continue into 2022 and perhaps beyond.

The automotive sector is a good case in point. While car factories were idling production during the worst period of 2020, high-margin orders shipped to the tech sector (such as datacentres, bitcoin mining and laptops) have "sidelined" the industry. Without the key components to complete the assembly processes, many OEMs have been unable to deliver and generate revenues. The industry is rapidly regrouping, though. Daimler has decided to embed more expensive chips in its cars (they generate more profit for the chip makers so they've been prioritised), while companies such as Hyundai and Bosch are aiming to leverage their industrial capacity to internalise chip production.

Reason Number 1: The Offer-Side Shock

The main reason for the disruption is the lack of production and delivery capacity from the semiconductor industry. Over the past few years, semiconductor companies have chosen not to boost their capacity as they have focused on making their operational structures as lean and right-sized as possible with global demand. Moreover, trans-Pacific geopolitical tensions have reduced the effectiveness of global trade structures and have led to a wait-and-see approach that has kept investments on hold. Given this, when the pandemic led to a 30%–50% forced capacity reduction, the semiconductor industry's ability to meet global demand was severely reduced. The industry is also facing skyrocketing commodity and raw material costs, for copper, steel, gold, aluminium and rare earth, for example. This has prevented many chip makers from holding significant levels of stock, and this has elongated delivery lead times.

Chip makers such as TSMC, Intel, Samsung and GlobalFoundries have announced they will increase production capacity by 20% to 100%, but this will take a few years to kick in due to the cost and complexity of production ramp-ups.

It's not just capacity, though. It's also about distribution capability. The restructuring of job markets due to the pandemic is creating labour shortages in factories and distribution and logistics centres. Higher energy prices are also impacting costs and adding further constraints on global freight logistics. From January to September 2021, due to the uptick in trade between China and Europe, the volume of traded containers nearly tripled, while freight capacity only rose by 2.5%. Vessel on-time rates dropped to just 23% from around 70% in late 2019, and overall freight prices have increased tenfold over the past year, according to the Shanghai Shipping Exchange. Add to this the growing issue of seaport congestion. Felixstowe port, for example, which handles 36% of freight container volumes in the UK, is rerouting some of its biggest ships away from the port due to lack of capacity. The Suez channel congestion exacerbated the global situation, putting a spanner in an already strained system.

Reason Number 2: The Demand-Side Shock

In addition to the delivery and supply problems, global economic growth expectations are strong and these will amplify the mismatch between supply and demand. The IMF, in its October 2021 World Outlook, forecasts 5.9% worldwide GDP growth in 2021, with rarely seen growth rates from the Advanced Economies panel (5.2%).

This recovery is characterised by stronger demand for high-tech consumer products and digital infrastructure equipment as home-bound consumer behaviour and lifestyles shift to high-tech products and streaming services for home entertainment. This has forced the tech sector to meet unprecedented demand. While the price of GPUs soared three- or fourfold, demand for zero latency in the lockdown- and livestream-fuelled online videogame industry has made the components a scarce commodity. At the same time, as droves of employees and students in local government, education, finance and banks (who mostly relied on desktop PCs) shift to home-based activities, demand for notebooks has soared. At the broader enterprise level, the need to build and manage modern cloud and network infrastructures has significantly raised the stakes for infrastructure equipment OEMs and component makers (of switches, routers and storage, for example) to maximise the level of service to their customers.

In general, we're seeing the transformation of global value chains, which are becoming more and more reliant on technology elements as products (from automobiles to white goods, machine goods and equipment) increasingly become connected and enhanced with digital services. Semiconductors contribute to 4% of a premium vehicle bill of material, and this is forecast to increase to 12% by 2025 and 20% by 2030. In other words, semiconductors have now become the crucial building blocks of modern digital economies.

When there is such a misalignment between demand and supply, it's not uncommon for companies across industries to decide to minimise their operational risk by simply hoarding key components. This means we're seeing a shift away from linear and super-optimised "just in time" models designed to maximise speed and quality of delivery and minimise overall costs. Many companies are now applying a "just in case" approach geared around the creation of inventory and supply network redundancies by anticipating orders to ensure operations execution and customer fulfilment despite supply chain disruptions.

Invest in Digital, but Try to Secure Long-Term Relationships with Reliable Technology Partners

It's very important to stress that even in the face of all these challenges in delivering digital products and setting up modern infrastructure, companies should continue to invest in digital technology. Digital companies may be impacted by semiconductor disruption, but the benefits from digital technologies and from digitally enabled business models outweigh the challenges.

IDC's Global Performance Index shows that companies that have digitally transformed and deployed digital technologies have historically delivered better business performance (revenue and profit margins) than their non-digital counterparts. It's therefore imperative for leading organisations to make sure they're not being left behind and that they don't fall victim to the "digital divide". Companies, from industry leaders to start-ups, should reinvent the way they trade to survive and stay relevant in the context of the broader industry transformation. Business challenges should not be an excuse for postponed technology investments, even when the increase in onboard software makes products susceptible to shorter technological life cycles and exposes companies to continuous operational risks. To realise this vision, it's essential to establish a secure and scalable digital infrastructure that enables process resilience and continuity.

In this journey, a reliable technology vendor partner is invaluable. Organisations that want to thrive in difficult and uncertain market conditions must work closely with their suppliers to ensure long-term continuity of digital projects and make sure the vendor has a global operational footprint, reducing the risk of sudden delivery interruptions due to technology procurement issues.

The ideal technology partner in this complex scenario must have deep insight into the main industry and market practices, trends and issues. It's important the company does not just rely on short-term forecasts from the customer side but that it acts proactively to address key issues. In particular, the provider should have in place a long-term business continuity plan — and an efficient mechanism to implement this. A solid financial foundation is a precondition because it will have invested time and money in preparing the plan. It also needs a resilient and robust supply network to tackle "black swan" incidents to ensure little or no disruption and quick recovery in the event of a major incident.

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