Part 2: The Infrastructure Bill and decoupled supply chains

Editor’s note: This is Part 2 of a three-part look at infrastructure in the U.S. by Geoffrey Garrett, Dean of the USC Marshall School of Business, and Nick Vyas, Academic Director of MS in Global Supply Chain Management and an Associate Professor of Data Science and Operations at the Marshall School of Business.

Click here to read Part 1.

Click here to read Part 3.

Among the many things COVID has upended is the belief that supply chains are driven chiefly by demand. The acute shortage of essential supplies, lifesaving drugs and equipment during the early days of the pandemic underscored the key deficiency in the global supply chain network’s that feed our markets.

It was the “single-node/long string” structure of supply-chain networks, built on the promise of cheaper, faster, better product that proved to be the fatal flaw. In emphasizing efficiency and cost above everything else, modern supply chains have been often built with scant regard to the foundational principles of resiliency, sustainability and the mitigation of geopolitical risks. No surprise, therefore, that critical supply chains – from lifesaving equipment and medicines to semiconductors— have time and again floundered under pressure.

Where the chips may fall

This past February, a global chip shortage brought car production in three states to a halt. Governors of Michigan, Indiana, Ohio, Kentucky, Kansas, South Carolina, Alabama and Missouri wrote to President Biden to urge global semiconductor and wafer companies to expand production and “temporarily re-allocate a modest portion of their current production to auto-grade wafer production,” reported Reuters.

The world was then in the grips of a chip famine, which has since abated, but not before having created a situation that will cost the automotive sector over $10 billion and affect the production of 3.9 million vehicles, according to consultants Alix Partners.

A look inside the shortage provides a window into the bigger structural problem with contemporary supply chains. The chip famine started to build up in July last year when, spooked by lockdown restrictions, carmakers in the US and elsewhere scaled back their procurement of semiconductors. This prompted chip manufacturers – the vast majority of whom are based outside the US – to re-direct their production lines to the then-booming electronics industry (largely outside the U.S.) that was benefiting from the pandemic-induced dramatic growth in remote work. Thus, the sheer disregard of basic redundancy and risk management principles, a classic trait of the cheaper-better-faster mindset, caused the shortage of auto-grade chips.

From a larger perspective, it hasn’t helped that America’s share of global semiconductor fabrication has declined from 37 percent in 1990 to a meagre 12 percent today. As notably, more than 75 percent of semiconductor fabrication now takes place in Asia. While we’re on the subject, China’s share of chip manufacturing trajectory is the mirror image, going from zero to close to 30 percent in the same period. But on the demand side, the U.S. remains king (Figure 1).

Figure 1: U.S. Semiconductor Industry Market Share. Source: Semiconductor Industry Association, 2020 State of the U.S. Semiconductor Industry Report.

The bipartisan infrastructure bill’s substantial allocation of $85 billion for enhancing the country’s EV charging infrastructure will inevitably boost demand for auto-grade semiconductors, which are key for the powertrain and essential firmware of electric cars. The $65 billion broadband internet funding will also help increase demand. But leadership in semiconductor usage means that manufacturing needs to be located close to demand centers.

The U.S. Innovation and Competition Act that was recently passed by the Senate seeks to amend this situation with $52 billion of approved funding for domestic semiconductor manufacturing. The Bipartisan Infrastructure plan, however, left out the ambitious $566 billion proposed for manufacturing and R&D, and it is not clear whether manufacturing and innovation get any part of the Democrat’s $3.5 trillion blueprint that they plan to advance alongside the bipartisan deal. This could cost us dearly in the arena of the global supply chain.

Decoupling of global supply chains

Single-node/long-string supply chain networks have failed with alarming regularity and cascading global impact, whether it was in the aftermath of the 2011 Fukushima disaster that impacted the production chemicals and electronics worldwide; or the recent blockage of traffic across Egypt’s Suez Canal that sent the oil prices soaring across international markets. These events continue to serve as reminders that supply chains need to be more consumer-centric and geographically closer to demand centers.

However, deglobalization of supply chain networks is neither possible nor right, for the good reason that globalization is strongly linked to economic efficiency and prosperity. Today, economies are far more interconnected and interdependent than ever before, and that is helping lift millions out of poverty and improving living standards across the world while expanding choice and quality for consumers everywhere.

So how do we minimize the vulnerabilities inevitably generated by globalization, while maximizing the sustainability and reliability of supply chains?  This can be done through “decoupling.” The idea is borrowed from the field of inventory management, where decoupling plays an interesting and useful role in a distribution network. A decoupling point, established close to the operational zone, acts as both a strategic distribution hub and a safety buffer that protects the supply chain network from demand shocks.
 
Used to connect global supply chain networks, decoupling points or decoupling nodes perform the same role. This ensures that operations in other parts of the world are not adversely affected by isolated problems in one place, thus mitigating the risk to the overall supply chain.
 
The functioning of a decoupled supply chain is more resilient and dependable. During a crisis emanating from any particular point in the network, it can swiftly tap into diverse supply chain clusters and keep the business running. For example, a customer base can be divided into different regions with each region having its own supply chain network that is independent and at the same time interdependent within other network clusters. In the event of a global crisis like COVID-19, regional decoupling nodes can help organizations react and effectively redistribute production and sourcing to unaffected areas.

The emerging global supply chain structure, therefore, will likely comprise a network of decoupled, consumer-centric supply chain clusters that will be, by design, less vulnerable to end-to-end disruptions.

It’s a brave new world

Today’s geopolitical chessboard is different and more complex than it was back in the 1930s when FDR opened the American economy to the world. The New Deal raised America’s imports from the advanced economies of the West and helped the country acquire a hallowed soft power that it maintained through the Cold War.
Events in the last two decades - particularly the financial crises of 2001 and 2008, the trade conflict of the last few years and the ongoing economic and health crisis caused by the pandemic - have collectively put us in a position where erstwhile emerging economies are now considered our economic rivals.

A successful infrastructure policy needs to, therefore, work well on several fronts, not only to strengthen America’s economic and technological leadership but also to re-establish our position as a prime advocate of freedom and fairness, ethical values and environmentally sustainable practices in global trade and commerce.

Specifically, a more balanced policy must involve the strengthening of trade agreements with those democracies in Europe, Asia and Africa that share American values and economic principles. This becomes even more imperative as China’s Belt and Road Initiative (BRI) continues to gather steam with an ostensible aim to realign supply chain networks and trade relations to the country’s benefit.
 
Trade agreements forged through the infrastructure policy could potentially include the Trade Facilitation Agreement “plus” disciplines, infrastructure investments for priority imports and exports – including principles for ethical lending practices, and trusted partner country criteria. This way businesses in those areas could be connected to create greater supply chain synergies, more port-to-port cooperation agreements, and increase use of digital tools to increase supply chain security and efficiency.

The final part of this three-part series will explore how the intelligent supply chains of the future will calibrate the balance between trade, resiliency, and environmental sustainability.

About the authors:
Geoffrey Garrett, Ph.D. is Dean, Robert R. Dockson Dean’s Chair in Business Administration, and Professor of Management and Organization at the USC Marshall School of Business. He became Dean of the Marshall School in 2020, having previously served as Dean of the Wharton School of the University of Pennsylvania for six years

Nick Vyas, Ed.D. is a Randall R. Kendrick Global Supply Chain Institute’s founding Executive Director, Academic Director of MS in Global Supply Chain Management and an Associate Professor of Data Science and Operations at the Marshall School of Business. He is a fellow at the American Society of Quality (ASQ) and serves as a Chair-Elect for Lean Division for ASQ.

Click here to read more on global supply chain management from Nick Vyas.

And, click here to listen to Nick Vyas on The Rebound Podcast, hosted by SCMR Editorial Director Bob Trebilcock and ASCM CEO Abe Eshkenazi.