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Exclusive interview with HBS professor Willy Shih: Global supply chain resilience issues to watch out for in 2023 and beyond

Judy Lin, DIGITIMES Asia, Taipei 0

Credit: DIGITIMES

As resilience has become as a critical keyword for global supply chain manufacturers, Harvard Business School professor Willy Shih, in a pre-event interview for the DIGITIMES Asia Supply Chain Summit, highlighted risks and opportunities when companies pursue resilience amid ongoing pandemic uncertainties, geopolitical tensions and sustainability regulatory changes.

Shih is the Robert and Jane Cizik Professor of Management Practice in Business Administration at Harvard Business School. He will be a keynote speaker at the Asia Supply Chain Summit to be held on September 27-28.

What should companies do to make themselves more resilient? Contrary to intuitive answers such as diversification and securing multiple sources of supplies, Shih shed light on four areas that call for more attention and warned that the world needs to be on alert for its over-dependency on sources that may be cut off for geopolitical reasons. There are also regulatory reforms that have not been on most people's radar but will have a great impact on their operations that need to be addressed as soon as possible.

The areas global supply chains need to work on their resilience include semiconductors, energy, regionalization and regulatory reforms, as well as China.

Semiconductors

A 2020 report by the Global Semiconductor Alliance and Accenture described the manufacturing of semiconductors as a 25,000-mile trek for all the components to complete the making of a chip.

Due to the complexity of the manufacturing process, the semiconductor industry is a highly sophisticated division of labor of global high-tech partnerships.

Taiwan's foundry manufacturers produce 63% of the semiconductors and almost 90% of the advanced chips (made by processing technology under 10nm nodes) for the world. If the US no longer had access to chips produced in Taiwan, the scenario would be scary, according to US secretary of commerce Gina Raimondo: "It's a deep and immediate recession. It's an inability to protect ourselves by making military equipment."

Raimondo's comment points to a possible invasion of Taiwan by China that could stop chip supply, but it will take several years for the US to rid of its worries because companies need two years to build a fab and need more time to adjust the machines to get a satisfying yield of chips.

The reshoring of chip production by the US and Europe is now in progress as those two economies both have Chips Act to subsidize chip production. However, before those investments start to bear fruit, companies need to take action to grapple with the fact that it is difficult to tell when the chip crunch will end, especially for automakers.

Shih's solution for solving chip crunch in the future is strategic partnerships and more transparent information sharing on true supply and demand.

Harvard Business School professor Willy Shih.  Credit: Willy Shih

Harvard Business School professor Willy Shih
Photo: Willy Shih

Though diversification and just-in-case extra inventory stock have been etched into the minds of people who suffered disruptions during the pandemic as a solution to improve resilience, the complexity of the resilience issue is far more than what people see on the surface, because there is a fundamental conflict of interests.

"Companies want to get more resilience by having diversity or multiple sources, but that would increase their costs," Shih said. "Now, the problem is that consumers don't necessarily want to pay more; the suppliers don't necessarily want you to have multiple sources either."

All the process development kits (PDKs) of foundry service companies such as TSMC, Samsung, UMC, and GlobalFoundries provide to their customers are partly to lock them in and make it not so easy to go to their competitors.

"If it is a commodity part, where you can have multiple sources, that means the manufacturers don't make as much money, so they're not going to have a lot of slack capacity," said Shih.

The advice Shih gives to the US automakers for securing a more stable chip supply is to build a more "partner-like" relationship with their suppliers, rather than the "transactional" relationships they have had for decades where they cancel orders more or less at will.

As the product life cycles with automotive components often can be five years, Shih advises automakers to engage in information sharing and long-term planning, and be able to give suppliers a truer indication of true demand, "such as have them be able to rely on you to absorb that demand." In verticals that lack such a kind of partnerships, companies often have to do their independent forecasts of demand and supply. "More information sharing will definitely help," said Shih.

Energy

The Russia-Ukraine war has drastically changed Europe, creating a challenge for those that have been deeply depending on Russia and are now trying to shift away. While Germany is struggling to find alternatives and cut dependence on gas imported from Russia, Demark presents to the world a significant example of energy independence.

Demark has transformed itself from a country that used to import 98% of its energy consumption during the two oil crises in the 1970s to one that has 80% of its energy produced domestically, in which 50% is renewable energy such as wind and solar, and biogas takes up 25% of their gas supply. They have significantly wound down dependence on coal and oil.

Shih shared his observation from his trip to Europe a week ago, a massive emergency pivot of energy policy. "They are very worried about next winter, as you know, they may not have enough natural gas."

"If you look at Taiwan's energy dependence, it is also importing 98% of the energy from abroad: 47% is oil, and 30% is coal, and have 15% of liquefied natural gas (LNG), while nuclear energy is 6.3%. But what if I am operating a fab and I don't have electricity? And you already had issues with water?"

Shih feels that rather than the "business as usual" mentality of Taiwanese citizens in the face of China's threat of invasion, "there are times when things are relatively apparent, you have the strategic vulnerabilities. You really shouldn't (be complacent)." Developing energy alternatives and conservation takes years, so it is important to take a comprehensive view and some planning for contingencies options in the face of less and less stable situations.

As shown in the "Energy Transformation Whitepaper" released by Taiwan's Ministry of Economic Affairs (MOEA) in 2020, the energy supply from Taiwan's nuclear plants in 2018 declined 28% from the 2000 level, due to the government's policy to phase out nuclear plants by 2025.

The fact that Taiwan is isolated as an island and could not plug into a greater grid or energy hubs like the ones in the EU during times of emergency is also a critical vulnerability in terms of resilience.

Although Taiwan sees what happens in Japan and worries about the safety of nuclear power plants, Shih does not rule nuclear out as an alternative that Taiwan can consider providing a stable and relatively cheap supply of energy. "There's a lot of innovation going on, and compact modular reactors, which are designed to be less costly to build and safer." Shih said Microsoft founder Bill Gates has been supporting some of that with his investments.

"You know, a problem with wind and solar, is that those sources are variable. I was flying into Amsterdam a week and a half ago, I was looking at all the offshore wind farms, and none of the turbines were turning, there was no wind," Shih said. "Taiwan needs to start planning for where it is going. I understand the reservation around nuclear, but what other options do you have?" Since Taiwan imports 98% of its energy, a prolonged blockade by China would definitely threaten the stability of Taiwan's power supply.

Regionalization and regulatory changes

Regulatory changes for the purpose of cutting greenhouse emissions to comply with COP26's goals of net-zero carbon emission by 2050 and ESG standards are pushing for the transformation of long-chain production to short-chain, or regionalization.

Starting in January 2023, there are new rules issued by the International Maritime Organization for ocean shipping to push for full sector decarbonization. Every individual ship will be graded, based on how much deadweight tonnage, how much cargo they carry, how far they sailed the previous year, what kind of fuel they used, and therefore, how much less greenhouse gases they produced.

From 2023 until 2030, ships will be graded on a scale from A to E. Those graded D will have three years to get back into compliance, and those graded E will have one year. Otherwise, they will have to be removed from service or need to be scrapped. Importantly, the targets get 2% tougher every year.

"One person I talked to in the industry said 70% of the ships would not be compliant after one year," Shih said, gving an example to illustrate the severity of the issue. If ship companies change the fuel to biofuel or LNG, it would be more expensive, and it needs lots of fuel to travel long distance with heavy loads of goods. If ships decide to slow steam to cut emissions, it takes more days to reach the destination and there will be extra costs. People will find that shipping goods long distance may not make too much sense, depending on the value.

"So, I think it's going to push for more of that kind of regionalization, independent of the politics, but just because of shipping costs. The other thing is, if you have to start thinking about Scope 3 emissions, which has a huge carbon footprint, people in Europe already are taking a broader perspective by analyzing product life cycles," said Shih.

As Europe raises carbon pricing, they're trying to avoid a situation where companies have offshore production in places with lower standards. All that carbon reporting is going to become much more important because it will impose carbon border adjustment duties on products in areas with lower environmental standards.

Carbon capture and storage will be important for industries such as steel or cement, which account for 6% of global CO2 emissions. Automation will be applied to help cut labor cost for producing those products in regions where wages are high.

China

The heavy-handed way China has managed pandemic controls has disrupted supply chains and global logistics. Recently, Sichuan and other Chinese provinces imposed power cuts that shocked the notebook manufacturers there.

Economic slowdowns, job losses amid company layoffs, and real-estate financing bubble bursts are likely to have an impact on demands in the world's second largest economy.

There are, of course, geopolitical issues to watch out too. Friend-shoring, CHIP-4, and the export restrictions that prohibit equipment and electronic design automation (EDA) software from being shipped to China are interpreted by Global Times, a state media of China, as "decoupling attempts." Companies that depend heavily on China's assembly workers and were relatively unscathed previously in the US-China trade war are actually taking actions to cut their exposure to risks now - a glaring sign of caution.

The fact that Apple is trying to nudge its suppliers to India and Vietnam recently is an important development that the world should monitor closely for its implications, says Nicholas Thompson, CEO of the Atlantic Magazine in his daily video streaming, describing what Apple's latest move means for the "Great Cold War between the US and China" as the most interesting thing in tech."When Apple has to do it, and they are so tied to this China manufacturing, that is very telling," said Shih. "In some sense, we may have just lived through the golden age of globalization. But the world is changing, so we have to deal with it."

But Shih also said he is not writing China off yet. "Carving China out of supply chains risks ignoring the strong production capabilities in the country that will be hard to replicate elsewhere," he writes in an article contributed to the Hinrich Foundation, a Singapore thinktank. "Yet the biggest risk to China is what China does to itself," Shih said.

Should people prepare for the possibility of decoupling? "I think we need to think about it more aggressively, that is the lesson from Ukraine," said Shih, adding that Germany, which has thrived through trade and shared dependency, was caught unprepared when the biggest land war since World War Two neared their doorstep. They didn't have enough LNG import facilities. They were too dependent on Russia for gas and for many things.

"Frankly, I have lots of friends in Taiwan, my biggest worry about Taiwan is the 'business as usual complacency,'" said Shih. "Actually, one day you will look at the time that you spent preparing, you might regret you did not start earlier than you should. So my big worry is complacency."

(Editor's note: Willy Shih is one of the guest speakers at DIGITIMES Asia's Supply Chain Summit to be held in Taipei on September 27 and 28. You can register here.)

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