Coronavirus and supply chains

COVID-19 impact: Understanding the importance of supply chains

Business professor explains how supply chains may be affected during a pandemic

As the coronavirus threatens health and upends daily life throughout the world, UofSC Today is turning to our faculty to help us make sense of it all. While no one can predict exactly what will happen in the coming weeks and months, our faculty can help us ask the right questions and put important context around emerging events.

Mark Ferguson is the Dewey H. Johnson Professor of Operations and Supply Chain in the Darla Moore School of Business. We asked him to help us understand the importance of supply chains and how they may be affected during a pandemic.

What is an essential element we need to understand surrounding supply chains?

The two most essential elements of supply chains are sourcing lead-times and the amount of variability in the supply or demand. Reducing both of these allows firms to run very lean and efficiently, without the need for a lot of safety stock or capacity. The overall environment we have seen for the last 10 years has experienced significant reductions in each of these elements, so the amount of buffer, or “just-in-case” stock, in the worldwide supply chains has been greatly reduced.

When you experience a sudden shock to the system, as we are seeing today for many products, there is very little extra slack in the supply chains to respond to such shocks, at least in the short term.    

Of all the items that could be in demand in a pandemic, what makes a product (such as toilet paper) tip the scale?

The supply chain for toilet paper is a good example of a (normally) low-variability environment. I expect there are three things that have added variability, leading to the worldwide shortages we have seen for this item.

First, there actually has been an increase in demand for domestic toilet paper, the type you buy for your household. As a significant portion of the population has shifted from spending days at school or work, they have shifted their usage from a commercial setting to a domestic setting. The supply chains for commercial customers (offices, factories, schools, etc.) are very different than the supply chain for domestic customers, and the two types of products cannot be easily substituted. Thus, there has been an increase in overall demand for domestic toilet paper, whose plants were already operating at around 95 percent of full capacity.

Second, it is completely rational for an individual to increase their average purchase quantity when you observe periodic unavailability. This is an increase in variability on the supply side, which leads to the customer needing to hold extra safety stock of the product.  For example, if I go shopping every week and toilet paper is always available, then I may only buy enough to last until my next replenishment opportunity, which is a week away.  As soon as I observe that it is not always available, I should increase the amount I hold in inventory, just in case I’m not able to resupply at the next opportunity.  This causes an increase in the variability on the demand side, that propagates up the supply chain and leads to even more inefficiencies. This is a well-known phenomenon in supply chains known as the bullwhip effect.    

Third, and this one has been well-covered in the popular press, is that some customers may be hoarding, or buying out an entire store’s supply. I’ve read explanations for this type of behavior that have to do with human psychology. The argument goes that when people are under stress for reasons outside of their control, they often react through ways that they feel they can control. Thus, I can’t completely control whether I catch the virus but I can make sure I’m not one of the people who runs out of toilet paper.

When you experience a sudden shock to the system, as we are seeing today for many products, there is very little extra slack in the supply chains to respond to such shocks, at least in the short term.   

Mark Ferguson, professor, management science, Darla Moore School of Business

What do you see as a teachable opportunity with the universal pandemic affecting supply and demand? What may be a take-away involving supply chains?

I hope that nations learn from this crisis that we need to think more about the resiliency of supply chains. We experienced something similar on the financial side during the financial crisis of 2008. The lack of monetary liquidity during the 2008 crisis showed that we did not have enough cash buffer in the worldwide systems to keep the payment systems going. Since supply chains depend on the regular payment for products between transacting partners, along with short-term loans and credits, the transfer of money goes in the reverse direction of the flow of goods. Because of new regulatory policies enacted after the 2008 crisis that require higher capital reserves (more buffer) and frequent stress-testing, along with the central banks of the world acting as last-case buffers, the financial system has (so far) not broken down as much in the current crisis.

Under the current crisis, we are seeing systematic breakdowns in the forward flow of products, including life-or-death products such as medical supplies. This is partly because we do not have the equivalent of a national-level stress test for the resiliency of the supply chains for critical products. We also lack a central organization that helps facilitate supply and demand imbalances, the way the financial system does. For example, Bank A may have excess cash reserves but, just due to the randomness of demand, Bank B may be short of their required reserves. In the U.S., the Federal Reserve helps alleviate these types of imbalances by providing a platform for Bank A to temporarily lend to Bank B. We don’t really have anything equivalent if one organization has an excess supply of a critical item such as respirators while other organizations are in critical need. I’m not sure what this should look like but maybe we need a national chair of critical supply chains.    

Many people's fears have to do with disrupted supply chains. Describe what could happen if global supply chains got broken?

I think we are living through a mild version of this right now (in early April), given the widespread shortages of critical medical supplies and some grocery store shelves being emptied. A scary scenario for a more extreme case would be everyday life recently in places such as Venezuela, where there have been extreme shortages of even the most basic of goods. In such scenarios, you often see social systems break down along with huge inefficiencies, because many people spend their entire days just trying to procure their necessities.     

As far as the pandemic affecting agriculture, it seems as if there is plenty of food being grown and produced, yet there are many steps involved in getting that food to the consumer. What do you anticipate happening with the food supply chain? What signs or factors would you look at to get a better understanding of what is coming in the next few weeks or months?

Having grown up on a farm, I worry about our food supply chain a lot. On one hand, migrant farm workers often live in very tight and less-sanitary conditions, which is not a good recipe for avoiding infection. On the other hand, we have not observed the virus spreading as much in rural communities, so there is hope that the numbers of these critical members of the food supply chain will not be significantly reduced. In my opinion, it is easier to find new employees for the other parts of the food supply chain (such as distribution, trucking and grocery workers) than it is to find alternative employees willing to actually harvest the crops. This is especially true for fresh produce and fruits. If we run short of healthy food to eat, our natural resistances to viruses will go down and the infection risk will increase. We should be doing more, on a national level, to protect and ensure this critical resource.

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