The range of supply chain risks is daunting in an increasingly globalized economy. They comprise extreme weather and other natural disasters, to man-made threats, including geo-political and pandemic crises, factory fires/explosions, and labor strikes. Add to that list “Zombie Factories” as described in a cover story in yesterday’s Sunday Business section of the The New York Times: “The Zombie Factories That Stalk China’s Economy” (Michael Schuman).
Zombie factories are companies that the Chinese government keeps “limping along in a kind of march of the undead.” To protect jobs and plants, the government and its state-owned banks keep money-losing businesses— so-called zombie factories—on life support with restructured loans and credit. They do this to maintain social stability or to back struggling factories deemed important to the economy, according to the article.
To be fair, supplier financial risk is not a new risk category for supply chain risk management practitioners. And the Chinese zombie companies discussed specifically in the New York Times piece are limited to the beleaguered cement industry which has only a regional supply chain impact. However, it is reasonable to assume that the government policy of propping up struggling suppliers includes companies that are sub-tier partners to global OEMs/brands.
While the government policy of intervening financially to ensure uninterrupted production at struggling factories may be viewed as a positive for downstream companies—an added fail safe against financial failure—the experts believe this policy will ultimately prolong the economic downturn. A study of China’s labor market by the International Monetary Fund referenced in the article indicates that from a long-term economic perspective, China would be better off downsizing or closing struggling factories and shifting resources away from less proactive parts of the economy. A more forceful strategy to enact pro-market reforms is recommended.
There are two key implications of zombie factories to downstream customers. First, if zombie factories live in your supply chain sub-tier, it is unlikely that the health of the business is transparently reported. As a result, it might be impossible to detect any financial risk. As pressure to more aggressively pursue pro-market reforms mounts, zombie factories may be shuttered with little warning. The impact may reverberate if the shuttered supplier is key sole supplier of a particular component or part.
As alluded to above, the effect may be less direct and more systemic. The health of the China economy is important on many levels to the larger OEM/brands. Zombie factories will ultimately be a drag to the Chinese economy. According to the article, by pumping up growth and labor with fresh credit and stimulus, the government might temporarily revive some factories, but also exacerbate the economy’s problems of excess capacity and high debt and that the accumulating debt will ironically kills jobs.
It is wise to assess your supply chain exposure to Chinese factories. In addition to zombie factories, China is also dealing with massive stock (market capitalization) upheaval, and a pending regulatory/compliance crack down as a result of the August 12th Tianjin chemical explosions. The first step is mapping your supply chain to achieve basic supply chain visibility. Until you know who your suppliers are and how they are connected, you can’t start the important work of proactively mitigating supply chain risk.