Politics, natural disasters, and a pandemic are among the events that have reshaped supply chains over the past several years, revealing their vulnerabilities. With volatility expected to continue, companies can find themselves at risk due to overexposure to particular regions or countries.

China remains integral to global supply chains, but foreign companies need to understand their current risk exposure — both upstream and downstream — and take the right measures to de-risk their supply chains. Next, they need to prepare a Plan B, particularly in the event geopolitical tensions worsen, especially in sensitive sectors.

Strategies to reduce risk exposure to China’s domestic market

Given the size of China’s domestic market and the fact there is no simple substitute for the country's export sector, it is difficult for foreign companies to fully decouple from it. However, global companies are adopting several key strategies to reduce their exposure. The most common strategy is the "China + 1" approach. This is a strategy that companies are increasingly using to spread risk across regions. It refers to a business model where companies maintain their operations in China while also expanding into one additional country, thereby diversifying their supply chain.

Five moves to limit supply chain risk in volatile times

We have identified a series of “no-regret moves” that companies and financial institutions can take to de-risk their global supply chains. In our experience, there is no single template for companies to follow. Options not only differ by sector, but are influenced by a company’s geographical footprint, market, and organizational structure.

Understand your geopolitical risk exposure

Many companies are managing conventional risk effectively but have not yet experienced significant geopolitical risks. Firms should conduct a review of products, components, or materials, as well as key shipment hubs, to understand how a geopolitical event might impact revenues, such as an extended supply disruption or a significant cost increase.

Firms must also assign responsibility to a dedicated risk owner or team that will monitor and drive risk management, rather than simply conducting one-time risk reviews. As horizontal risks, in particular, can cut across multiple business lines, such as merchandising and logistics, a holistic view toward risk exposure is critical in order to achieve a truly robust and accurate assessment of risk.

Decide which products need alternative suppliers

Companies need to next agree on the level of exposure they are prepared to accept at a product and component level. China is likely the lowest-cost option already, so developing alternative suppliers, such as ones in India or Indonesia, will be more expensive. It therefore makes sense to utilize alternative suppliers for select products rather than the entire portfolio.

To make this decision, firms need data-driven insight into a greater number of variables than is typically available. Leading companies are only just starting to track the physical location of suppliers via digital control towers, for instance. Translating these insights into a financial impact at the product level will improve decision-making on which products need alternative suppliers.

Choose markets for relocation

Companies then need to assess the alternative markets and suppliers available to them. The optimal mix depends on a range of inputs, including but not limited to costs, supplier availability, and incentives. There is no single template for success, as a company’s capabilities, footprint, and customers will shape and impact its decisions.

• Operating costs: The playbook for assessing operating costs, such as labor, logistics, and raw materials, is well understood. However, structurally higher inflation globally and the wide differences between countries will complicate calculations.
• Business environment: Companies need to consider the depth of the local supply chain in new markets. ESG standards are also rightly higher today, so firms need to exhaustively qualify new suppliers to avoid complications later.
• Public subsidies and incentives: Governments around the world are offering compelling packages to attract manufacturing investment. However, these packages can be complex, so companies should be cautious of being locked into unfavorable deals.
• Reshoring and automation: Reshoring is still in its infancy, but it is accelerating thanks to government support. There is also a greater mix of automation in the production process to help offset labor costs and productivity.
• Supplier relationships: Smart organizations can also work with their suppliers to reduce risk by encouraging them and their suppliers to diversify their own supply base, such as by sharing risk and providing a safe market.

Ensure regular checks on new suppliers

Companies that switch to markets outside of China must ensure that the new suppliers they employ are meeting their contractual obligations. In some cases, companies have discovered that the new suppliers are simply rebranding products imported from China, or relying more heavily on Chinese component parts than originally agreed, thereby negating the company’s original de-risking initiative.

Optimize inventory and cash flows

Many companies have also responded to uncertainties by building up their inventory. This inventory is expensive to buy, maintain, and monitor. It directly impacts a firm’s financial health and is not a sustainable option in the long term. Most companies are now looking for ways to improve their resilience while also reducing the stock they hold.

Developing alternative suppliers or markets less prone to disruption is a first step. Companies may also choose to change their stock keeping unit (SKU) inventory mix to avoid over- or under-stocking specific products. Better communication with suppliers, or negotiating contracts with suppliers to ensure they supply on demand rather than contingency, also are options.

Focusing on resilience and trust in supply chain

The new global supply chain has created challenges and opportunities for companies. Switching from a methodology that is mainly based on cost efficiency to one focusing on resilience and trust is a critical step for companies seeking to reduce their exposure to geopolitical risks.