Companies Diversifying Sourcing But Worry About Higher Costs, Experts Say

Market and geopolitical risk analysts said everything has gone wrong, undermining supply chain reliability over the last several years, and businesses are creating redundancy but are still anxious about the additional costs that entails.

Martina Bozadzhieva, chief research officer at market intelligence firm FrontierView, said during a webinar Aug. 30 on supply chain strategies that companies have had the "realization that a lot of supply chains are really concentrated," and that a number of them have a single point of failure.

Bozadzhieva ticked through the stressors that caused this realization -- the U.S.-China trade war, the COVID-19 pandemic, the war in Ukraine, shipping cost spikes, the ship stuck in the Suez Canal. "Anything and everything that could have gone wrong, really has gone wrong," she said.

Her firm surveyed companies with global supply chains in June, and asked them how they thought their supply chains would change over the next five years. More than 70% said they are moving toward regionalization, with 45% saying they were moving production to the U.S. and 35% saying they were moving to Mexico.

"For political reasons, for ethical reasons, for financial reasons, [supply chain management] is higher on the agenda for a number of stakeholders," she said.

She said before the chaos of the last several years, companies had a China-plus-one approach, but now it's an effort to diversify away from China.

"Very clearly, Mexico’s a winner in this process," she said, though Brazil and India also topped the list of countries that could be attractive for sourcing in the survey.

Despite these trends, a substantial minority of respondents said they were unsure if localization is a good long term strategy. More than 70% said they worried about how much more expensive it is to diversify supply chains, and they also said they're more complex to manage.

She said when sourcing is more expensive, that is "either going to mean more compressed margins," or the prices of goods will go up, fueling inflation.

Cvete Koneska, head of Dragonfly Advisory, a subsidiary of Fiscal Note, noted that the EU will require a corporate sustainability due diligence standard for about 55,000 companies, and it's likely to enter into force by 2026. Fiscal Note hosted the webinar.

"Due diligence is becoming more difficult and more costly," she said. "It’s not going to be sufficient anymore to say: Well, all our suppliers signed onto our code of conduct."

Bozadzhieva said players earlier in the supply chain are finding their customers are trying to force them to diversify and reduce their exposure to geopolitical risk.

"Their customers are demanding to see a lot more information about how they’re handling risk," she said. She said it's not always economically feasible to diversify for these suppliers, but if they are able to source goods in times of crisis, it's a competitive advantage. In the worst of the supply chain shocks, "if you could get the product [to customers] on time, you could charge whatever you wanted."

Koneska said when her clients talk about the downsides of sourcing from China, they talk about both the higher tariffs and the Uyghur Forced Labor Prevention Act. Regulatory constraints and costs "are often seen in conjunction."

She said she believes both the Section 301 tariffs and UFLPA are designed to be disincentives to importing goods from China or with Chinese inputs.

Bozadzhieva said only companies in sensitive technologies are pulling out of the Chinese market, but others do say: "You have to make sure your supply chain is not exposed within a shadow of a doubt to Xinjiang."

She said that in the past, when multinationals might have turned to China as a default for more manufacturing investment, Southeast Asia is now more attractive. "Even the economic situation in China itself is making China less attractive for additional FDI," she added.

China's economy as a whole is in the doldrums, with local governments' debt overhangs, high youth unemployment, an aging workforce and government intervention in business.