February 11, 2020
The human toll of the coronavirus ravaging China is significant. Tens of thousands are already infected, with over 1,000 already dead — and this number is certain to increase.
I’m not a medical expert, nor am I a political expert on China, so I’m unable to understand exactly the details of the virus other than what is being reported. I am, however, an expert on Chinese consumer products manufacturing and supply chain as I worked in China in manufacturing on the ground for 10 years. I’m also the CEO and founder of a VC-backed startup that is focused on building a modern and flexible manufacturing supply chain, with our current focus on Chinese manufacturing.
Supply chains are brittle and inflexible, which is the problem we are working on solving at The/Studio. The current and widespread inflexibility of supply chains is going to be the catalyst that pulls the world into a global recession. Before I get ahead of myself let me describe the overall situation, and where I think the coronavirus is leading us.
The predictions that I’ve read are that the coronavirus will reduce China’s GDP from 6% to 5% in Q1 and will shave off .5% of US GDP in Q1. I’m not an economist, but from my on-the-ground information in China, I feel that these numbers are vastly understated. It’s highly unlikely that China doesn’t dip into recession in Q1 and I don’t see how the impact to the US and other countries won’t be more severe given the interconnectedness of our global economy, especially supply chains.
American media’s high-level narrative is that there is a fast spreading disease in China, but it pales in comparison to the severity of the flu. There’s nearly no mention of the economic impact of the virus. And at first, even I started to buy into this narrative — things will be bad, but not that bad. As I started to dig deeper, however, I’m shocked at the delta between what is being reported and reality per my team’s perspective from China.
This year Chinese New Year fell on January 25th. As is normal in China, some factories started to close as early as January 15th. Because we are running a flexible supply chain composed of microfactories, we were able to keep our factories open until the 24th and some even worked through Chinese New Year.
Airfreight services were supposed to restart on January 29th which would begin the supply chain reopening from Chinese New Year. Our office, like many offices, was going to restart on January 31st, with most factories and other offices resuming work between January 31st and February 3rd.
On January 27th news started to trickle into our China operations that air freight services would not start on the 29th, but instead would start on the 31st as a precaution to the coronavirus. Each day, more bad news started to accumulate. The government was requesting that offices not resume work until February 3rd. A few days later, we found that offices could not be open until February 10th. Schools would be shut down until February 17th and some as late as March 2nd. Our factory partners, who were supposed to begin operations from January 31st to February 3rd, began telling us that the government was instructing them to reopen at the earliest on the 10th or later, with some even ordered to stay closed until the 17th.
Up until a few days ago, we assumed that our office would reopen on the 10th. However, we took the government’s guidance that unless necessary companies were advised to have their employees work from home, and we have now pushed our opening date to February 17th.
In the meantime, I began talking to other factories so that we would have backups for our existing partners. Larger factories last week began to tell me that if they were lucky, they could start on March 15th. I’ve also been talking to my friends that are running supply chains out of China — everything from small e-commerce businesses to multibillion dollar supply chains. The consensus is clear: almost nobody is expecting their factories to start work until February 17th, with larger factories not expecting to come online until March 15th.
The first big test of our supply chain was today, February 10th. Approximately 25% of our manufacturing capacity was able to start today and we anticipate that 50% of our capacity will be online by February 14th, with 100% of our capacity to be online by February 17th. No matter what, our company will definitely lose money in the short run. But we are the lucky ones.
Our manufacturing thesis is around creating a micro-rapid-flexible supply chain, so it’s much easier for us to get factories up and running again. Our factories understand how to operate under changing conditions and because our entire supply chain is managed in software it’s easy for our team to work remotely from home with those factories. In fact, we’ve even adjusted our supply chain to be able to do quality control and shipping all from the safety of our team’s homes.
But the larger the factory and supply chain, the longer the restart date is going to be pushed back. Factories are already saying that optimistically they cannot resume production until March 15th. I’ve spoken to factories that have staff located only 10KM away from the factory, and they cannot get to work because roads are blocked. Workers are scared to return to the factory — and workers that do come back are sometimes being denied entrance into the cities where their factories are, then being placed in 14 day mandatory quarantines.
This is why larger factories are hoping that a best case scenario sees their operations starting on March 15th. However, I’m skeptical that even this will happen. They might turn on the lights on March 15th, but the complicated thing about supply chains are that they are precisely that, “chains” of dependencies. When factories do start they are going to be short on raw materials, they are going to be severely backlogged, and so are their partner factories that help them with other parts of the assembly. A factory requires 100% of the raw material components and assembly partners to complete a product. Having just 99.9% of their supply chain intact will disrupt production as if none of it was online.
One startling fact I’ve encountered as we try to balance our supply chain is almost all factories are uncertain about their future in the short term. We have reached out to other factories to diversify our supply chain in the case that some of our factories are under capacity or are unable to come online. We’ve so far contacted over 5000 factories, around 10% have replied back to us and literally only 3 have expressed the ability to support us within the next 14 days.
Nobody seems to be connecting the dots for how this is going to create a global recession. Already, there is isolated news that Hyundai has shut down production for two weeks because they can’t import parts from China. Toyota is closing down their plant in China until at least February 17th (more than two weeks later than planned). Foxconn (think iPhones) was not approved to open their factory as expected on February 10th. This all speaks to deep supply chain problems that we are just starting to see emerge. Even if the situation starts to improve quickly, the backlog will make things worse in the short term before they get better.
Chinese companies are being instructed that they need to continue to pay salaries. But how long can companies continue to function when they have to pay the full fare of running a business with no income coming in? I’m already hearing about companies having to lay staff off or work illegally just to pay the bills. If companies go out of business or are under capacity, it will create a domino effect where upmarket factories are going to have to scramble to find new partners, which will only drive up costs and/or reduce efficiency of these factories.
This is also not accounting for prolonged reduced consumption in China which is already stretching into one month. People aren’t traveling, eating out, shopping, et cetera. The ingredients are all there for a recession.
Aside from WWII, the world has never faced this sort of supply chain disruption, and given that our world is so much more interconnected I’d argue that this is the world’s worse supply chain disruption.
I do believe that China will recover in the short term. But I’m not optimistic that recovery will really start until April 1st and I could see a scenario where the recovery does not start until 2021.
We chose China as the place to start our micro-rapid-flexible supply chain because we believe that is the most dynamic manufacturing ecosystem on Earth. No other country would be able to be as flexible with their supply chain as China is. In fact, it’s a miracle that China is still able to feed its entire population and largely keep inflation down despite this crisis. It’s a true testament to their supply chain.
But despite our company being built around flexibility in this versatile supply chain ecosystem, even we’re facing extreme challenges. We’ve been unable to successfully onboard new factories and we’ve been unsuccessful in finding new factories outside of China to support our business.
The supply chain that The/Studio is advocating for everyday is one that is connected digitally and is completely transparent. Companies should be able to scale up production from 10 pieces to 10 million pieces effortlessly, they should be able to shift their supply chain seamlessly across geographies and scale up production rapidly to meet demand — and respond, with as little pain as possible, to disasters like this. We’re not there yet, but the coronavirus is one more indication why we need to be.
In the meantime, I’m wishing China a quick recovery. Having lived there for ten years, it’s a country near to my heart — and I think the Chinese people have shown an incredible amount of bravery and fortitude this year, and I’m confident they will prevail against the coronavirus.