Russia – The OM Blog by Heizer, Render, & Munson

OM in the News: Geopolitics and Supply Chains

“Supply chain managers today are thinking more about geopolitical risk than they are about any other risk,” writes The Wall Street Journal (May 3, 2024).

The Rubymar, a bulk carrier hit in a Houthi missile attack, sank in the Red Sea in March

Companies’ top supply chain concerns until recently were how to find a reliable source for products at the lowest cost. That led many to China with its cheap labor and unparalleled ecosystem of factories, parts suppliers and raw materials. Now many firms are prioritizing a supply chain that reduces their reliance on a single country or region.

Some of the changes were spurred by the Covid factory shutdowns in China and soaring prices for ocean shipping. The changes are being accelerated by more recent geopolitical shocks as countries such as China, Russia and Iran face off against the West.

The U.S. has also raised national security concerns about its dependence on China for technologies such as semiconductors that are key to computers, electric vehicles, robots and other goods. It has banned the export of some chips to China and is stimulating domestic manufacturing of chips with incentives for new factories that limit the use of raw materials from China. These new rules, regulations and tariffs complicate trade compliance efforts, especially for larger companies that sit atop a supply chain that can include hundreds of thousands of suppliers.

Companies are having to dig deeper into their supplier networks to identify raw materials and components that could be subject to steep tariff hikes or that could violate a growing number of regulations targeting countries such as Russia and China. VW was surprised when thousands of its Audi, Porsche, Bentley and Lamborghinis were recently held up at U.S. seaports. The cars contained a magnetic component sourced from a sub-supplier blacklisted because it is in China’s Xinjiang region, suspected of using Uyghur forced labor. “We really try, but this shows how challenging it is to really know everything that is happening in complex supply chains,” said VW.

Multinational companies cannot easily disentangle themselves from geopolitical risks. Russia is one of the world’s largest suppliers of metals such as aluminum, nickel and copper. China supplies about 75% of the rare-earths minerals that go into U.S. semiconductors.

Classroom discussion questions:

Why is it difficult for manufacturers to know details about their supply chains?
How does Table 11.3 in your Heizer/Render/Munson text relate to VW’s problem?

OM in the News: Maintenance Really Does Count

When Ural Airlines Flight 1383 to Siberia suffered a technical fault with its hydraulics a few months ago, the pilots decided to divert to a closer airport. Then they discovered the defect meant the aircraft was rapidly running out of fuel and needed to land quickly. The plane, with 165 people onboard, eventually made a successful emergency landing in a farm in southern Russia. The Airbus A320 jet remains there, fenced in and under security, with Ural agreeing to pay rent for a year to the land’s owner–and then harvesting the jet for parts.

The episode is among a surge in aviation-safety incidents recorded in Russia last year, and an indication of how Western sanctions are hindering the country’s ability to source spare parts and conduct proper maintenance, writes The Wall Street Journal (Feb.5, 2024). (See Chapter 17 in our text). Some 74 air safety incidents were logged in Russia last year, up from 36 in 2022. The data show an incident occurred 9.9 times in every 100,000 departures in 2023, compared with 5.0 in 2022 and 4.5 in 2019. The incidents include repeated instances of engines catching fire or becoming inoperative during a flight, rubber landing-gear tires bursting during landings, and malfunctioning flaps leading to diversions.

Sanctions imposed after Russia’s invasion of Ukraine have cut off that country’s access to Western aircraft manufacturers, banning the provision of spare parts, maintenance support, critical software updates and more. “The sanctions imposed on Russian airlines have significantly impeded the maintenance of aircraft airworthiness and their technical condition,” said one industry expert.

Russia is particularly exposed to shortages of landing gear and brakes, and has had to send aircraft to Iran for maintenance. And a lack of technological know-how in repairing wheels and separate issues with low-quality deicing chemicals have led to safety incidents. Meanwhile, a shortage of parts for simulators limit Russia’s ability to train new pilots and run required refresher courses.

The deterioration of Russia’s aviation safety record is undoing decades of work by Russia’s airlines to modernize their fleets and turn around a reputation for questionable safety. That effort started in the early 2000s, when Russian airlines spent billions of dollars buying brand-new Boeing and Airbus jets to replace aging and less-reliable Soviet-era aircraft. The splurge left Russia with one of the biggest aircraft fleets in the world– a total of 1,031, most built by Airbus and Boeing. Russia’s total operational fleet is forecast to halve by 2026.

Classroom discussion questions:

What are the two types of maintenance issue that Russia airlines face?
How does Figure 17.2 (Overall System Reliability) apply in this case?

OM in the News: Finding an Airbag in Russia

Western sanctions brought Russia’s car industry to a screeching halt earlier this year, writes The Wall Street Journal (Nov. 1, 2022). As it restarts, it is emerging smaller, technologically backward and more isolated—a foreshadowing of what could be in store for the rest of the embattled Russian economy.

Within weeks of Russia’s invasion of Ukraine, most Western car companies curtailed operations in the country. Sanctions cut off the supply of parts and, one after another, Russian car plants stopped production, with car production down 97% compared with a year ago. But as some Russian plants are now reopening, the restart features cars that were a far cry from prewar models, lacking air bags, anti-lock braking-system sensors or electronic stability-control technology, an industry standard.

Russia’s biggest carmaker can’t find airbags

“Such key factors of a modern car as an automatic transmission, four-wheel drive and a modern engine— but these tasks can’t be solved quickly and require serious funding,” said the CEO of AvtoVAZ, maker of the iconic Russian Lada auto brand. Lada workers wrote that their plant couldn’t restart due to the lack of components. At the moment, Russia’s best car is only 40% Russian. The rest used to be imported from abroad.

The auto industry is shaping up to be an early test case for how successfully Russian industry can recover from the greatest shock to the country’s economy since the dissolution of the USSR. Russian executives are scouring other countries for missing Western components or trying to produce them at home, a process that can take years to master. Meanwhile, they are producing cars partly based on designs decades old.

The war is undoing decades of Western investment and know-how, heralding a period of adjustment ahead across industries. “The impact on the industry will be indicative of what awaits other sectors of the Russian economy: less technologically advanced products, poorer quality and a limited variety of goods,” said an expert in London.

To resume production of cars with anti-lock brake systems next year and electronic stability control by 2024, AvtoVAZ will need to develop its own homegrown technological capability. The development of an automatic transmission will cost about 30 billion rubles, while creating an all-wheel drive system for cars will cost another 20 billion rubles. Locked out of their main suppliers, like Bosch in Europe, Lada is turning instead to Chinese suppliers, but Chinese versions aren’t expected until next year.

Classroom discussion questions:

In Chapter 2 (see page 33) we list 6 reasons businesses globalize. How does each of these apply to the Russian auto industry today?
What should Lada do at this point?

OM in the News: Turning Offshoring into “Friend-Shoring”

As war and the pandemic expose the fragility of supply chains, the U.S. and its allies are pursuing a new kind of global trade, one that confines commerce to a circle of trusted nations. The shift, writes The Wall Street Journal (May 16, 2022), is called “friend-shoring.” The new strategy is a departure from economic globalization of recent decades, when businesses bought and made products where costs were low and free-trade policies made moving goods around the world cheaper and faster.

“Friend-shoring” is a chance to revamp supply chains to reduce reliance on autocratic nations and nonmarket economies

Now, the U.S. and allies in Europe, Asia and the Pacific are promoting and funding new production and trading channels for essential goods that run though friendly nations. This trend comes after a series of disruptions, including the pandemic, Russia’s invasion of Ukraine, and a trade war between the U.S. and China.

Promoters of friend-shoring see it as a chance to revamp global supply chains to reduce their reliance on countries such as China and Russia. They say it is a compromise between full-fledged globalization and isolationism, and between offshoring and domestic production. Such arrangements, says U.S. Treasury Secretary Janet Yellen, “would allow the U.S. to deepen ties with a group of countries sharing a set of norms and values about how to operate in the global economy.”

Efforts are already under way in industries including semiconductors and rare-earth metals, a crucial input for EVs and missiles. Private companies are joining the fray as well, moving to increase production in countries they see as carrying relatively low political and logistical risk. U.S. Trade Representative Katherine Tai said “it is essential to diversify supply sources for key goods to make sure that the next time there is a crisis, we don’t have the panic and the sense of desperation.”

Some businesses have already moved ahead in their friend-shoring practices. Apparel companies had to grapple with U.S. policies clamping down on cotton products from China’s Xinjiang region linked to forced labor. Then came the pandemic-induced congestion that resulted in skyrocketing of the time and cost of shipping from Asia. Apparel businesses’ favorite destinations are Central American countries such as Honduras, Guatemala and El Salvador. Gap is doubling the region’s share of its global production to 10% within the next year and eventually wants to raise it to 25%.

Classroom discussion questions:

What are the disadvantages of “friend-shoring”?
The advantages?

OM in the News: Four Million Dead Chickens

The horrific war in Ukraine has captured not only headlines for the past month, but our hearts and souls as well. Today’s blog wants to share our grief over the devastation and loss of lives in Ukraine, but also address the impact the war has had on global supply chains.

Piles of chicken corpses are spread across a farm property in Ukraine

“The war,” reports The Wall Street Journal (April 8, 2022), “has already disrupted Ukraine’s prodigious exports of wheat, sunflower oil and other produce, boosting global food costs.” It has also halted production at Europe’s largest poultry farm in a southern part of Ukraine that has experienced some of the heaviest fighting.

That facility, which exports about one billion eggs a year, is just one of several to have been hit in the region. The one farm has lost almost four million chickens to thirst and starvation since the war began. On March 1, Russian mortars took out the local power station, cutting all electricity and crashing the automated system that feeds and waters the farm’s chickens. The farm has 11 generators that need three tons of diesel a day, but fuel is no longer being delivered to the farm. With power rationed, the chickens began to die of thirst and starvation.

The chicken factory’s difficulties are emblematic of the broader impact Russia’s invasion is having on Ukraine’s agriculture sector. The industry not only plays a crucial role in feeding the world but also represents the biggest contributor of the country’s economy, raising the specter of a slow recovery if and when peace returns. Known as the breadbasket of Europe, Ukraine is also responsible for 10% of global wheat exports, 14% of corn exports and about half of the world’s sunflower oil.

Now, Ukraine’s agricultural industry is in turmoil. The war has closed ports, deprived farmers of fertilizer and fuel, destroyed equipment and displaced workers. That has resulted in soaring grain prices, piling pressure on developing economies already struggling with food-cost inflation. Global food prices hit a new record high in March, the U.N. said this week. Higher grain prices in particular also threaten a knock-on impact on beef and other meat as producers rely heavily on grain to feed livestock and poultry. The higher costs mean some of the largest food companies in the U.S. will likely continue to raise prices on consumers for products from cereal to deli meat.

Classroom discussion questions:

Will this war impact U.S. supply chains?
What will be the long-term effect of the invasion on global markets?

OM in the News: The End of Globalization?

“Russia’s invasion of Ukraine will reshape the world economy and further drive up inflation by prompting companies to pull back from their global supply chains,” BlackRock CEO Larry Fink has warned, reports The Financial Times (March 25, 2022). “The Russian invasion of Ukraine has put an end to the globalization we have experienced over the last three decades.”

While the immediate result had been Russia’s total isolation from capital markets, Fink predicted “companies and governments will also be looking more broadly at their dependencies on other nations. This may lead companies to onshore or nearshore more of their operations, resulting in a faster pull back from some countries. A large-scale reorientation of supply chains will inherently be inflationary.” He stated that “Mexico, Brazil, the U.S., or manufacturing hubs in Southeast Asia could stand to benefit.”

He further predicted that the Russian invasion would affect the transition to cleaner energy. Initially, the search for alternatives to Russian oil and natural gas “will inevitably slow the world’s progress toward net zero [emissions] in the near term.”

“Longer-term, I believe that recent events will actually accelerate the shift toward greener sources of energy” because higher prices for fossil fuels would make a broader range of renewables financially competitive. Though climate activists want investors to shun fossil fuels entirely, Fink rejected this approach. “BlackRock remains committed to helping clients navigate the energy transition. This includes continuing to work with hydrocarbon companies,” he stated. “To ensure the continuity of affordable energy prices during the transition, fossil fuels like natural gas will be important as a transition fuel.”

In one of his first comments on cryptocurrencies, Fink drew attention to the Ukraine war’s “potential impact on accelerating digital currencies . . . A global digital payment system, thoughtfully designed, can enhance the settlement of international transactions while reducing the risk of money laundering and corruption.”

Classroom discussion questions:

Why would the U.S. benefit from a global supply chain reorientation?
What has been the impact on global supply chains from the invasion?

OM in the News: Russia, Ukraine, and Commodity Supply Chains

40-50% of all exports of neon come from Russia and Ukraine. Neon is a critical raw material for chip manufacturing.

Russia and Ukraine are both important grain exporters, accounting for 1/3 of the world’s traded wheat. The invasion of Ukraine has cast a pall over the commodities sector because it has also made it impossible to ignore the geopolitical faultlines for key raw materials.

The conflict itself and sanctions on Russia are causing disruption in a number of markets, reports Financial Times (March 3, 2022). The rising cost of energy has important ripple effects in other commodity markets, including for the cost of fertilizer. On top of that, firms are growing increasingly worried about the way that many raw materials have the potential to be used as weapons of foreign policy — especially in a new cold war.

For the past 3 decades, commodities have been one of the most striking examples of globalization. And markets themselves have been built around the expectation of open global supply. But two events have changed the world. The pandemic highlighted the perils of relying on a handful of countries or companies, which had led to severe supply chain disruptions. Now from grains to energy to metals, Russia’s invasion of Ukraine has served as a reminder of how some countries wield considerable influence over raw material supplies thanks to their large market share of vital commodities. As well as being Europe’s main supplier of gas (it accounts for 40% of the EU’s consumption), Russia is also dominant in the markets for neon, oil, wheat, aluminium, and palladium.

The short-term response to the war has been to increase stockpiles of important raw materials. In the long-run, it is forcing industry to consider alternative supply chains that can bypass the conflict that is building between Russia and the west.

As businesses and governments cut costs in their supply chains and made them more efficient, they became more reliant on certain producers, leaving them vulnerable to sudden disruption in product flows. But perhaps one of the more worrying effects of the war in Ukraine has been the impact on grains and food prices. The conflict comes at a time when food prices are already high, the result of poor harvests around the world.

Classroom discussion questions:

What could the U.S. do to alleviate stresses on oil and gas supply chains?
What is the U.S. position on supply chains from China?

OM in the News: Ukraine and Supply Chains

Russia’s invasion of Ukraine is piling new troubles onto the world’s already battered supply chains, reports The Wall Street Journal (Feb. 28, 2022). The fighting has shut down car factories in Germany that rely on made-in-Ukraine components and hit supplies for the steel industry as far as Japan. It has severed airways and land routes that had become crucial since the pandemic began gumming up sea trade.

Trucks are waiting six hours to enter Poland from Ukraine.

The conflict is also bottling up Ukraine and Russia’s vast commodity exports, sending the price of oil, natural gas, and wheat rocketing. Shipping from Ukrainian ports, an important corridor for grain, metal and Russian oil shipments to the rest of the world, has all but ceased. The decision by European nations to close their airspace to Russia will increase the cost of flying cargo from Europe to Asia, potentially making some routes commercially unviable.

If Russia cuts off supply of its products, it will hit supply chains that rely on components and little-known commodities from Russia such as neon gas and palladium, important ingredients to make semiconductors.

The car industry, which has long relied on extended cross-border supply chains, was among the first to feel the blow of the fresh economic dislocations. Leoni, which makes wire systems in Ukraine that it ships to European auto makers, last week shut its factories in Ukraine and sent 7,000 employees home. VW, no longer getting wiring systems produced in Ukraine, stopped production at factories that are most critical in its push into EVs..

Countries including the U.K., Poland and Bulgaria have banned Russian airlines from their airspace, and several freight forwarders have suspended services to and from Ukraine. Further airspace closures or airline-specific restrictions could cause delays, reductions in capacity and rate increases. Shipping giants FedEx and UPS suspended shipments into Russia, having earlier stopped doing so into Ukraine.

The disruption to transportation is worsening by the day. At least 22 tankers are clogging the Kerch Strait, a key Russian-controlled waterway, because ports are closed. Greece, which operates up to a quarter of the global tanker fleet, is urging shipowners to pull their vessels from Russian and Ukrainian waters in the Black Sea.

Classroom discussion questions:

What are the main OM issues arising from this conflict?
Can the decision tree illustrated in Supp. 11’s Example S1 be applied here?

OM in the News: As Ice Melts, Shippers Look to Arctic Route

An Sovcomflot icebreaking supply vessel moored in Murmansk, Russia.

As we note our discussion of Transportation Mode Analysis (Example S4) in Supplement 11 (Supply Chain Management Analytics), speed of transportation is critical.

So it is no surprise, writes The Wall Street Journal (June 6, 2019), that Arctic routes are drawing greater attention as the global climate warms and polar ice recedes, potentially opening new paths between Asia and Europe. The mostly frozen Northern Sea Route (NSR) seaway is considered a likely commercial lane because it already is used in warmer seasons to move part of Russia’s extensive energy exports. Russia is promoting the lane as the shortest distance to ship containers from Asia to Europe, and a possible rival for routes that now take ships through the Suez Canal.

Russian shipping giant Sovcomflot tankers crossed the NSR more than 100 times last year, handling crude exports from Gazprom’s port oil facility in northern Russia. Crude tankers account for about 45% of ship traffic on the NSR. “The driver for transportation economy is basically distance, and the NSR cuts sailing time by around 20% compared to the route across the Suez,” says the CEO of Sovcomflot. “Cargo will always find the fastest way to move.”

Denmark’s A.P. Moller-Maersk, the world’s largest container ship operator, sent a small container vessel across the NSR last summer from Vladivostok to St. Petersburg. The Venta Maersk saved more than 10 days of sailing time compared with travel via the Suez.

Classroom discussion questions:

What country will lose out if the NSR is successful more months?
Is the time it takes to ship from China to the U.S. becoming an issue for suppliers?

OM in the News: In Russia, McDonald’s Serves Local Fries and a Side of Realpolitik

A new potato-processing plant is working to produce french fries to McDonald’s exacting specifications.

McDonald’s became a leading ambassador of American culture after opening its first restaurant in Moscow in the twilight of the Soviet Union, writes The Wall Street Journal (Nov. 8, 2018). Now, as Russia-U.S. tensions rise and pro-Kremlin politicians call to close the U.S. chain, management is taking a new tack: Go Russian. This year, the company boosted the share of Russian suppliers its restaurants use to 98%. McDonald’s has succeeded world-wide in part by finding local suppliers wherever its restaurants operate, shortening supply chains.

The local focus appears to be paying off. The number of McDonald’s restaurants in Russia grew 6% this year. The firm sees Russia as a high-growth market able to offset the saturated U.S. market. The company opened its first restaurant on Pushkin Square in 1990, where it served 30,000 hungry Soviet Muscovites on its first day.

U.S.-Russian ties have frayed in recent years. The first shots against McDonald’s were fired in 2014 after the U.S. sanctioned Russia following Moscow’s annexation of Crimea. Russian authorities at the time closed 12 restaurants nationwide, including the Moscow flagship, and subjected hundreds of others to snap health inspections. The temporary closures had little effect on sales, but management used them as an opportunity to refurbish restaurant interiors and start digitizing processes.

After that experience, McDonald’s focused on boosting purchases from local producers for almost everything it served. Critically, McDonald’s signed a contract to buy its french fries from a Russian producer—a first in its almost 30-year history. The agreement ends one of McDonald’s most fraught endeavors here: finding the right supplier to reliably deliver fries up to the company’s standards. And McDonald’s advertising strategy is focused on getting the word out. Delivery trucks are painted with a large “98%,” signifying the company’s share of local suppliers.

Classroom discussion questions:

What makes the Russian supply chain so difficult for the firm?
Why are the French fries an issue?