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

OM in the News: The Shifting Supply Chain Winds

The world economy is undergoing significant changes as we shift from a global approach to one focused on regional and national production, reports Industry Week (Feb. 21, 2023). Demographic, geographic and political factors are reshaping our world and driving the change. Going forward, companies will need to continue to navigate supply chain disruptions, China risk, and concerns about capital outlays. The new model will not be defined by the globalization that dominated the last half-century. Here are four of the challenges the article presents:

The American China Crisis The post-COVID world has escalated tensions between the U.S. and China, with allies involved on both sides. Consumers still want the low-cost products they can get through the Chinese manufacturing value chain. But companies that ignore the post-China supply chain plan are putting their companies’ futures at risk with a clear and quantifiable situation.

Regional Industrial Labor and Skill Shortage Companies are looking to low-cost manufacturing zones in North America and Europe in an effort to move higher-value production to the region. Much of the shift to date has been items where a logistics penalty supported a more rapid move. Challenges exist for smaller commodity components with low margins, which are currently manufactured in China. These parts, mostly taken for granted, will likely stress supply chains in the near future. Purchasing teams need to regionalize their value chains. Mexico continues to shine as the heart of the North American low-cost manufacturing engine.

Shifts in the Semiconductor Industry The semiconductor life cycle has historically been cyclical, and this time is no exception. COVID drove a rapid expansion in consumer electronics, pulling this cycle ahead. Automotive companies suffered, but availability is temporarily increasing. However, with the shift to EVs requiring a growing number of semiconductors per vehicle, constraints will re-emerge. The U.S. has taken steps to engage allies and block further development of a Chinese semiconductor industry.

The War in Ukraine The Russian war in Ukraine continues to be a serious crisis with disruptions across Europe. Neon gas supplies remain tight, impacting semiconductor production. Companies should be evaluating a shift to military and government production if the Ukraine war breaks out to a larger conflict in Europe. There is a short window for companies to re-engineer value chains for risk mitigation.

The Industry Week article concludes that “2023 is an opportunity for companies to work together to restructure and regionalize their manufacturing value chains.”

Classroom discussion questions:

Why is Mexico a popular regional option?
What factors are impacting the China supply chain?

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: VW Rethinks Globalization

VW halts EV production in Germany as Ukraine crisis hits supplies

For years, Volkswagen thrived as a global company, building its cars all around the world. We illustrate the magnitude of this approach in Figure 8.4 (see page 350 in your text). But as war, health scares and trade disputes roll back decades of globalization, the firm is changing its manufacturing approaches to adapt. VW’s goal now, writes The Wall Street Journal (March 28, 2022), is to shore up access to components and raw materials and to shorten supply chains to make its regional businesses less dependent on faraway suppliers.

Without the vast home market of its U.S. competitors, VW long ago bet on international markets for growth. As the world’s second-largest car maker, VW benefited like few other companies from decades of post-Cold War detente, falling import tariffs and JIT supply chains. But can such a global business endure as supply chains are strained by the pandemic, the semiconductor shortage, rising raw-materials prices and new geopolitical fractures?

When Covid-19 shut China down at the beginning of 2020, components built there were suddenly missing from supply chains and VW’s factories in China and Europe stood idle. By the end of the year, VW produced 18% fewer vehicles than the year before. Then came the next crisis, with the world’s supply of semiconductors drying up, VW slashed production at its global factories in 2021, just as the industry was rebounding from pandemic lockdowns. VW production fell another 7% by the end of 2021.

Even isolated incidents have highlighted the fragility of a business woven across borders. A few months ago, a fire on a cargo ship destroyed nearly 4,000 of VW’s most expensive cars including Porsche, Bentley and Lamborghini on their way to the U.S. In February, when Russia invaded Ukraine, VW found itself without Ukrainian wiring harnesses, forcing it to halt production of electric vehicles at VW, Audi and Porsche, and stop production at its biggest German factory.

Ukraine and Covid production stoppages exposed how VW could no longer focus solely on obtaining the cheapest parts, however remote or scattered their producers. Now, VW is making the uninterrupted delivery of parts a priority over competitive pricing, and looking at dual sourcing of components, a practice that the industry gave up years ago in favor of single sourcing components and JIT delivery.

Classroom discussion questions:

What OM lessons has VW learned from the chip and wire harness shortage?
Why will VW invest over $7 billion in the U.S. in the next 5 years?

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?