Geopolitics and Supply Chain Risk

Stephen DeAngelis

April 5, 2013

“All eyes are currently watching the deteriorating political situation in Egypt,” writes the team at Container magazine. “[The March 2013] civil riots in Port Said were, arguably, too close for comfort for those dependent on the Suez Canal. Although the arterial trade route is unlikely to close, the possibility cannot be ignored.” [“What if the Suez Canal was shut?” 24 March 2013] When it comes to supply chain disruptions, closure of the Suez Canal would cause a significant, if temporary, disruption. The article notes, “There is enough spare vessel capacity to absorb most of the shock of sailing from the Far East to Europe via the Cape of Good Hope simply by increasing vessel speeds, which means that closure of the Suez Canal tomorrow would not be a train smash.” However, until new routes were established and filled with sufficient capacity, “businesses in Europe dependent on goods from Asia, Australasia, the Indian Subcontinent, and Middle East would immediately be thrown into turmoil.”

In past posts, I’ve reported that even short disruptions can have significant impact on a businesses bottom line as well as its valuation. Although most recent disruptions have resulted from natural disasters or supplier problems, geopolitical risks cannot be ignored. Catherine Bolgar reports that it was the terrorist attacks in 2001 that first “opened many executives’ eyes to geopolitical risk.” [“Geopolitical Risk,” Supply Risk Insights, 12 November 2012] She continues:

“While terrorism presents a high-impact, low-frequency risk to supply chains, other kinds of geopolitical risks are much more likely to disrupt business. The term itself is a catch-all for exterior risks that aren’t caused by nature or by another company. Problems can run from the extreme of wars or coups to social unrest, expropriation or new parties ruling a government to embargoes, taxes, regulation and protectionism.”

Anne Marie Thurber, executive vice president and managing director for Zurich Insurance Group Ltd.’s credit and political risk business, told Bolgar, “Once a company’s operations cross borders and your processes are dependent on activities and persons outside your home country, you need to be more aware of geopolitical risk.” Bolgar notes that “geopolitical risks can arise quickly.” She points to the 2011 Arab Spring as one example of unexpected geopolitical turmoil that had widespread effects. The staff at SupplyChainBrain rhetorically asks, “What happens when we grow our supply chain footprint?” The answer is, “Lead times expand; the number of ‘nodes’ in our supply chains expand; and with that expansion the probability of a disruption, delay or error increases … and on and on.” [“The New Supply Chain Normal: Global Uncertainty, Complexity & Risk,” 16 March 2012] Geopolitical risks can affect each of those characteristics as surely as natural or manmade disasters. Bolgar provides another example. She writes:

“Export or import bans in the name of public safety also can arrive quickly, because authorities prefer to be wrong rather than sorry. In the space of two weeks in 2011, Spanish produce was nearly shut down as Germany banned Spanish cucumbers, which it blamed for a deadly E.coli outbreak. Other countries followed suit, some of them banning other vegetables as well. Russia banned all fresh vegetables from the entire European Union. The outbreak finally was traced to German bean sprouts.”

That example demonstrates how supply chain complexity can result in poor political choices being made and innocent parties being damaged. As Bolgar states it, “The extended nature of supply chains can obscure the risks. You can have dealings with a supplier in one country, not realizing that your supplier has factories in a number of other countries, some of which might not have stable governments.” Bolgar believes, however, that there are a few things that companies can do to help make them more resilient to geopolitical risks. The first thing involves being informed. She writes:

“Large multinational companies have teams of people that deal with government relations, including geopolitical risks. ‘It’s important to have local expertise physically monitoring everyday things going on in that country or region that could affect your company,’ especially new regulations, taxes or tariffs, says Celina Realuyo, assistant professor of national security affairs at the National Defense University in Washington. It’s important to remain even-handed in dealings, too, even when a regime seems well entrenched. Companies shouldn’t just make ties to the ruling party because ‘something like the Arab Spring happens, and they find they don’t know anybody,’ Dr. Realuyo says.”

Working with corrupt regimes sometimes can’t be avoided (except by avoiding a country altogether). Royal Dutch Shell, for example, found itself in the unenvious position of having to deal with the Syrian regime after the civil conflict in that country started. [“Business needs a world view of its own,” by Michael Skapinker, Financial Times, 27 October 2011] Skapinker pointed out that “Shell has a joint venture with a company controlled by a regime that has recently killed an estimated 3,000 of its citizens.” As companies expand internationally, they are going to be confronted time and again with such circumstances and need to have thought through how they are going to respond. Bolgar reports that companies need to be aware of regime stability, economic trends, changes in laws, and so forth. Geopolitical risks are particularly important if suppliers are state-owned companies. The second action that companies can take to make themselves more resilient is to ensure that neutral venues are specified for any arbitration that may arise. Otherwise, Bolgar claims, a company could suffer a “death by a thousand cuts.” She explains:

“Expropriation is generally illegal when governments don’t pay fair compensation. But armies rarely march in and take over foreign-owned factories these days — except in Venezuela and Bolivia. Instead, some governments favor a more subtle tactic, creeping expropriation, says Dan Riordan, chief executive officer, Zurich Global Corporate in North America. Using new rules and regulations that deprive investors of their rights or that make operations so costly as to eliminate any prospect for profitability, ‘it has the cumulative effect of being the same thing’ as expropriation, he says. When entering a country, it’s important to arrange in advance to have arbitration in a neutral venue to settle disputes. If the arbitration panel decides in favor of the company against the host country, whether it’s outright or creeping expropriation, and if the government doesn’t pay, then insurance may pay it, he says. Otherwise, ‘companies could be waiting a very long time to be paid.'”

A third activity that companies can engage in to make themselves more resilient is identifying supply chain vulnerabilities. Many supply chain analysts suggest that supply chain mapping and conducting “what if” exercises are good ways to identify potential vulnerabilities. Only after vulnerabilities have been identified can they be addressed. Bolgar explains:

“Major companies try to build in redundancy among suppliers, but a multitude of sources simply doesn’t exist for some precious metals. For example, China produces 97% of rare earth elements, which are increasingly used in high-tech products. And only a couple of companies are able to take the raw metals and process them to the purity that manufacturers need. South Africa produces 75% of the world’s platinum, Bolivia has about half the world’s lithium and the Democratic Republic of Congo produces 51% of the world’s cobalt.”

In such circumstances, increasing stockpiles may be the only alternative to building in redundancy. As more companies have recognized the potential for single point disruption, research has increased into developing acceptable alternatives for hard-to-obtain resources. Rare metals are not the only resource that can create problems. An automotive example involves cyclododecatriene (CDT) or one of the materials made from it — PA-12 (nylon-12). In March 2012, an explosion in an Evonik Industries AG plant in Marl, Germany, disrupted the primary supply of CDT, which is used to make fuel and brake lines. The disruption caused a scramble in the industry to mitigate the consequences of the explosion (see my post entitled Supply Chain Disruption: The Reason is the Resin). Amos Guiora, professor of law at the S.J. Quinney College of Law at the University of Utah in Salt Lake City, told Bolgar, “Sometimes you need to engage in R&D and consider and plan alternatives. … If you say alternatives are way too expensive, and down the road something happens, it might not look so expensive. How much do you want to be dependent on problematic or at-risk regimes?”

The final activity organizations need to master, Bolgar claims, is learning to communicate quickly and effectively when trouble hits. She explains:

“If your company ends up in the middle of an uprising or even just a political firestorm, you need to get your message out quickly. Dr. Guiora described a company whose disaster plan included meeting an hour after a disaster to discuss a press release, with another two hours to write and approve the statement for release well ahead of the evening news. In an age of Twitter and social media, that’s way too slow. ‘Time after time we see how poorly corporations do in the middle of an event,’ he says. ‘CEOs need to prepare themselves for tough press conferences.’ Delays only hurt the message.”

Robert Ritchie, professor of risk management at the University of Central Lancashire in the U.K., told Bolgar, “It’s difficult to find shelter from many geopolitical risks.” In places where risks are high, Ritchie insists that rewards can also be high. That’s because most companies aren’t willing to take on the kinds of risks that come with operations in politically tumultuous regions. “There are certain areas where most companies fear to tread,” he told Bolgar, “but if you look, there are always some companies willing to go there, knowing the risk.” Back in 1709, Alexander Pope wrote, “For Fools rush in where Angels fear to tread.” By being well informed, you need not be a fool when treading in regions where geopolitical risks are high.