Just-in-time supply chains after the Covid-19 crisis
Global supply chains have received significant attention since the early days of the Covid-19 crisis (e.g. Baldwin and Evenett 2020). When China implemented the first lockdown anywhere in the world, the supply shock immediately hit European and American companies. The staggered shutdown and re-opening of manufacturing hubs around the world has multiplied supply chain issues in what Baldwin and Freeman (2020) have referred to as `supply chain contagion’. The general public turned their eyes to the global supply chain problem when it became apparent that medical equipment was affected, too.
Even before the Covid-19 crisis started, however, the business model of the highly coordinated and efficient international supply networks, which greatly enhanced the speed and vigour with which the supply shock hit, had come under pressure. An increasingly uncertain political environment at least since the Great Recession, as well as the looming effects of climate change, have prompted concerns about robustness, resilience and indeed about the very structure of such global supply chains.
Both empirical and conceptual guidance that can inform this debate is surprisingly rare and often derived from very focused industry studies. To make progress on both fronts, in a recent study (Pisch 2020), I use data for French manufacturers from 1997-2006 and present a comprehensive empirical characterisation of just-in-time (JIT) supply chains. I outline a novel theoretical framework that is consistent with the patterns in the data and use it to discuss potential long-term implications for supply chains in the post-Covid-19 world.
Just-in-time supply chains are regional and vertically integrated
JIT supply chains are the epitome of lean and highly coordinated production. Suppliers and customers along the value chain coordinate in such a way that any finished intermediate or final goods are immediately collected and processed further, rather than put on stock. This management paradigm – developed in the 1970s by Japanese car manufacturer Toyota (Ohno 1988) – relies heavily on the exchange of information: only when a downstream customer stage or factory communicates its precise orders to its upstream supplier does the latter commence production.
I measure the degree to which individual companies are embedded in such JIT supply chains using high-quality survey information for more than 3,000 French manufacturing firms for the period 1997 to 2006. In this data set, every company reports whether it sources from its suppliers, or delivers to its customers, in a JIT fashion. The richness of other confidential firm level information in France then allows me to compare JIT to non-JIT companies and their respective supply chains to draw a comprehensive picture of their organisational structure.
JIT supply chains are pervasive, important in the aggregate, and participants are large and productive
JIT supply chain management is a pervasive practice: even in industries like “wood and products of wood” or “non-metallic mineral products” about 30% of all companies report participation in JIT supply chains. About two thirds of firms in “motor vehicles” production are JIT intensive, which is the highest penetration in the sample. Moreover, JIT firms are substantially bigger and more productive than their more ‘traditional’ counterparts even within narrowly defined industries, which is consistent with the significant overhead costs required to run a JIT supply chain.
As a direct consequence of pervasiveness and bias towards large producers, JIT supply chain management practices are economically important in the aggregate. About two thirds of all French manufacturing workers are employed in JIT supply chains and roughly 60% of French international trade volume can be traced to JIT firms.
JIT supply chains are more regional and more vertically integrated
Using the near universe of international trade transactions, it is possible to locate suppliers and customers for all firms and compare the spatial structure of JIT and non-JIT chains. Figure 1 illustrates the main finding for Europe. First, all countries are grouped according to quintiles in the distance-to-France distribution. Then the JIT vs. non-JIT difference in firm level (log) trade volumes with each group is plotted and darker colours indicate larger differences (for further details, see Pisch 2020).
Figure 1 Spatial structure of supply chains in Europe
International trade in JIT supply chains is skewed towards proximate suppliers and customers, i.e. such production networks are more spatially concentrated compared to their `traditional’ counterparts. This pattern is economically important: In the sample, trade volumes fall by roughly 3.5 log points between the first and third quintile group of countries. The baseline estimates suggest that JIT supply chains have a distance gradient that is 0.35 log points steeper than that of non-JIT supply chains – a difference of first order magnitude.
Finally, data on industrial activities and international intra-firm trade of firms and their affiliates can be used to understand which stages of a value chain are retained within the boundaries of the (multinational) firm. I show that French firms in JIT supply chains – compared to their ‘traditional’ counterparts – are significantly more likely to source any given intermediate in-house, both domestically and abroad. The difference in organisational structure accounts for a substantial share of the overall variation.
Explaining the structure of JIT supply chains
Consider a segment of a supply chain where a single upstream supplier manufactures an intermediate that is shipped to a downstream buyer firm, which in turn uses it to produce its own output. In an uncertain world, both companies are continually hit by shocks, i.e. unexpected changes in their environments. In a sequential supply setting like this, it is paramount for the two firms to make adaptation decisions in a coordinated way, since otherwise costly inventories are needed to ensure smooth operation.
If the supply chain operates under a `traditional’ regime, little or no downstream information is shared with the upstream stages (‘make-to-stock’ paradigm) and the supplier’s ability to coordinate its adaptation decisions with the buyer firm is limited. In JIT supply chains, by contrast, production is predicated on a downstream demand signal, which is shared between the supplier and the customer in real time, and which facilitates a reduction in inventory holding costs.
This positive effect of JIT is stronger whenever the two plants are close to each other. Otherwise, shipping intermediates takes too long and demand conditions have changed when the input arrives. Moreover, vertically integrated production networks benefit disproportionally as well, since the supplier has strong incentives to make efficient use of demand information and thus maximise profits of the entire supply chain. The empirical findings outlines above are therefore rationalised by means of organisational complementarities: JIT is more effective for regional and multinational production.1
Global supply networks post-Covid-19
What can we learn about the long-term impact of Covid-19 on global supply chains? A potential impact of the crisis is a change in the distribution of (perceived) uncertainty. Covid-19 may by itself be – or hopefully is – a black swan event, but it highlights that pandemic events are ever more likely to happen in a globalised world. Moreover, by its disruptive nature, the crisis has drawn attention to other types of shocks associated with, for example, climate change.
The conceptual framework predicts that all supply networks, regardless of their organisational structure or management, will see an increase in inventory holdings to cushion a larger number of, and more intense blows. Crucially, however, the additional costs created are in fact lower – rather than higher – for JIT supply chains. The reason is that with diligent information sharing and coordination along the value chain managing those additional inventories is cheaper. Contrary to popular perception perhaps (and in accordance with a recent column by Miroudot (2020)), highly coordinated JIT supply networks are not predicted to recede, on the contrary.
This realisation has important implications for international trade and capital flows. Since there is a complementarity between spatial proximity of business partners and JIT supply chain management, international trade may experience a force pushing towards more regionalisation.2 This effect is driven by resilience and robustness considerations in supply chains, however, which are entirely disconnected from a protectionist stance. Moreover, since multinational production facilitates JIT supply chains, any increase in uncertainty benefits large, multinational conglomerates at the expense of smaller companies. At least in the manufacturing sector, therefore, FDI flows may be less negatively impacted by restrictions on international capital flows that have been put in place in the (recent) past.
Ohno, T (1988), Toyota Production System: Beyond Large-Scale Production, Productivity Press.
Pisch, F (2020), “Managing Global Production: Theory and Evidence from Just-in-Time Supply Chains”, CEP Discussion Paper 1689.
1 To lend further credibility to the framework, several empirical tests based on further predictions from the model are conducted. The fact that JIT supply chains are more regional and more vertically integrated can be traced to transactions of intermediates with high inventory costs and high downstream demand volatility. Moreover, if downstream firms have market power and can therefore push inventory holdings on upstream suppliers with contractual penalties (as in the automotive industry), JIT supply chains are more regional, but less vertically integrated.
2 An interesting question currently debated is whether there will be increased re-shoring of activities from China to Europe or North America. The conceptual framework predicts a deepening of local supply networks and to the extent that this will happen in China, too, it is more likely that intercontinental trade will shift towards final goods or components closer to the finished product.