Why coronavirus is a dire threat to supply chains

As governments and health officials around the world struggle to contain the coronavirus outbreak, supply chain experts say the virus may pose an unprecedented challenge for the global technology industry, and one that may linger for months or longer.

The virus, which has infected more than 20,000 people in China according to the country's National Health Commission, has prompted quarantines and widespread travel restrictions in major high-tech manufacturing hubs. Wuhan, the city where the coronavirus outbreak originated, is home to 1,656 technology enterprises, including semiconductor suppliers and fiber-optic firms, according to an October analysis from the Milken Institute.

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Factory disruptions are already straining tech companies that source components from China, but supply chain experts warn that the full impact is hard to determine and could include long-lasting economic harm.

"I don't think we have a real precedent for this," said Yossi Sheffi, the director of MIT's Center for Transportation and Logistics, who has written at length about the ripple effects on supply chains following the 2011 earthquake and tsunami in Japan. "The only thing that I would compare it to is the 2008 financial crisis. I don't know if it will be that bad — but the thing is that nobody knows."

Sheffi told Protocol that the coronavirus may be far more disruptive than the natural disaster or other outbreaks like SARS or bird flu. The Chinese National Health Commission said 425 people had already died from the coronavirus, compared to 349 Chinese deaths during the SARS outbreak, according to the World Health Organization.

In the aftermath of the Japan quake, Sheffi said, companies took months to figure out what exactly was missing from their supply chains, and which products from intermediary sellers had been wiped out in the damage. Manufacturing for the world's products in tech and beyond is more concentrated in China than any other country, so it's unclear how broad and long-lasting the impact of canceled flights, forced work absences and shuttered factories will be.

The knock-on effects could last "potentially years, for sure months," Sheffi said. "There's a fear factor that exasperates everything."

Demand for delivery services is already starting to slacken. FedEx and UPS adjusted flight schedules to the Chinese mainland, as did many commercial airlines, which tend to carry a fair amount of the world's freight in their cargo holds.

Mirko Woitzik, a manager of risk intelligence, and Tim Yu, a risk intelligence analyst, both of Resilience360, a logistics risk-management company in which DHL is an investor, told Protocol that DHL wasn't experiencing many shipping delays out of Wuhan, mainly because few companies are looking to ship things out of the area. "There's not a lot of delays right now, there's just not a lot of volume," Woitzik said.

Crude oil prices have fallen sharply, as trucks and planes aren't being used to ship Chinese goods around the world. Cargo ships haven't yet taken as severe a hit, Sheffi said, primarily because it takes weeks to sail from Shanghai to Rotterdam. Shipping giant Maersk directed Protocol to a website it's running to show the effects of the coronavirus on its facilities. Other than in the Wuhan area, most ports will be resuming work this week, after Lunar New Year celebrations.

"It's an unprecedented event," Woitzik said of the dip in production, even when taking into account the recent holiday period. "We've never seen anything on this scale."

Common measures that companies take to safeguard their supply chains against disruptions are ineffective for the coronavirus outbreak, said Keely Croxton, a professor of logistics at Ohio State University. For example, large companies often have transportation redundancies, so if there are issues with cargo shipping they can resort to air freight. "In the case of coronavirus," she said, "that's not helping with planes being grounded."

Companies often carry business disruption insurance policies, but those usually have exceptions for pandemics, Croxton added.

Tech companies are likely to feel an outsized impact from factory closures in the Hubei province, where Wuhan is located. Woitzik and Yu said several LCD and OLED display manufacturers are based in the region, and companies are already experiencing delays. Asus on Feb. 3 announced a "temporary shortage" of its new ROG Phone II smartphone due to supply chain issues related to the coronavirus.

Companies have mentioned "coronavirus" in more than 70 regulatory filings submitted since late January, when the outbreak began spreading globally.

Tim Cook, in a Jan. 28 earnings report, said that Apple was working to mitigate the effects of the coronavirus on its business. Apple shuttered stores in China and gave itself a wider-than-usual range in its revenue guidance for next quarter, as the situation in China remained uncertain. Some analysts are expecting as much as a 10% drop in iPhone shipments as a result of the coronavirus. Apple wasn't immediately available to comment on the state of its supply chain.

For a massive company like Apple, trying to replace a supplier won't be easy. "Nobody else can take 100 million orders suddenly on Friday and start making them on Monday — that just doesn't happen," Sheffi said. Some operations can shift — Apple's main assembly partner Foxconn in particular has facilities in the Americas, where it could spin up production — but eventually those places will reach capacity. South Korean automaker Hyundai announced Feb. 4 that it was pausing production at home, citing a lack of available parts from China.

Disruptions will likely be worse due to global companies' embrace of a "lean supply chain" mentality over the last two decades, Croxton said. Businesses have prioritized reducing inventory in efforts to cut cost and waste in manufacturing, but that means less cushion during interruptions.

Sheffi advises companies to operate an "emergency management center" at all times, but especially amid crises like this. One centralized group within each company, he said, should start thinking about the business' most vulnerable suppliers, who could go out of business with a cut in orders. Companies also need to be thinking about whether other suppliers could fill in the gaps, and whether their competitors would go to the same suppliers.

Even if the coronavirus were to be cured tomorrow, effects would continue to be felt throughout out the supply chain, Yu argued. Companies will need to get back into factories and get them back up and running after bans are lifted in towns like Wuhan and Chongqing — and that won't happen overnight. Once everyone is producing again, a rush to use the same shipping suppliers could create a bottleneck. "It's a bit of a double-edged sword," Yu said.

Even if a company doesn't directly source parts from China, it may suffer from the manufacturing slowdown. Companies in China are struggling to get their raw materials into the country, so restarting manufacturing will be slow-going. While the supply chain can consist of several layers of companies, businesses may only have visibility into the top layer.

"You don't always know where your suppliers' suppliers are getting their raw materials," Stanley Griffis, the McConnell Professor of Business Administration at Michigan State University, told Protocol. And that opacity can lead to weaknesses companies didn't even know they had in their supply chain.

"We are all very intertwined," Griffis said.

Correction: An earlier version of this story contained inaccurate information about flights to the Chinese mainland. FedEx and UPS adjusted flight schedules, but did not stop flights. In addition, Resilience360 should have been described as a company in which DHL is an investor, not as a subsidiary of DHL. This story was updated on Feb. 6, 2020.