Willy Shih: To Get Smarter About Your Supply Chain, Start With First Principles

If the past few years—and the historic inflation we’re in the midst of—has taught any lasting lesson it is that if you want to know where the global economy and your business may be headed, you need to deeply understand global supply chains, starting with your own.

For my money, there’s no one smarter on the topic than Harvard Business School’s Willy Shih, who has a gifted professor’s ability to demystify complex systems and a pragmatic streak rooted in his long, pre-HBS career running factories. He now sits on the board of publicly-traded Flex, Inc.

I first met professor Shih more than a decade ago during a visit to HBS just after the publication of his way-ahead-of-its-time book Producing Prosperity: Why America Needs a Manufacturing Renaissance (HBR Press, 2012). Over the ensuing decade—and especially during the pandemic era—he’s become among the world’s most-quoted supply chain experts, cited routinely by nearly every business publication you can think of and routinely brought in by government agencies and companies alike for advice.

June 7^th & 8^th, Shih will be one of the keynotes at our ACCD-Corporate Board Member Director’s Forum in Boston, leading a session on how public-company directors can ask sharper questions of management.

For Shih, that all starts first-principle questions—ie, where do we get what we need to do the things we do, how does it get where it needs to go, what could go wrong, what would that mean, and what’s the plan if something does go wrong?

He says you’d be surprised—he certainly is—how often CEOs and directors at even very sophisticated manufacturing companies don’t really understand some of these fundamentals of their business. In the following conversation (edited for length and clarity), Shih talks about how directors and C-Suite executives can get smarter, faster about their supply base, what stands in the way of that and why the great reshoring revolution may prove to be a lot harder than anyone thinks right now:

You focus a lot on first principles around supply chain. What are some of the key questions that people need to be asking to be better at understanding not just their supply chain, but how supply chains work in general? How do you as a board member work to think this through and help other board members?

Well, the first thing to understand is really the structure of your supply chain. Every company, every sector is different because of where you draw on those resources and capabilities, right? And especially in today’s globalized world where we have, you know, supply chains and value networks that span the world, understanding where all those value-adding steps are taking place seems obvious, but oftentimes it’s not easy, especially when you have a deep tiering in supply chains where you have multiple tiers of suppliers, feeding suppliers, ultimately feeding the companies who supply you.

There are some industries where those tiers may be as many as nine deep, and it is very challenging to even understand who all those suppliers are, and therefore, who all your vulnerabilities are. Just think about the math. Let’s say you have 400 tier 1 suppliers, and let’s say each one of those has 50 or 70 suppliers feeding them. By the time you get two tiers out, it’s really hard to understand where those players are.

Now, on top of kind of the combinatorial problem, there’s also a proprietary problem where a lot of those suppliers don’t want you to know who their suppliers are just because they don’t want to be disintermediated. So, now, how are you going to figure out where all your vulnerabilities are? So that’s the big challenge.

Are you surprised at how often operators, manufacturers, who are supposed to be steeped in this don’t actually have the kind of visibility they need to be smarter about where their supply chains are going?

The biggest area where the pandemic has highlighted that kind of exposure from lack of understanding has been in the logistics side. The reason I say that is you can compare different firms. Some did very well during the pandemic and some did not so well. I would argue that the ones who did well majored in understanding the logistics, majored in really making sure they had visibility all the way across, up and down their supply chain.

Sometimes these are the very large importers. The largest importers in the country are Walmart, Home Depot, Lowe’s, Ashley Furniture, Target, companies like that. They have people on the ground in China. I’m on the board of a company and we have operations on the ground in China, and I understood how the China manufacturing model works, with migrant workers living in dormitories on the factory site.

So, if you understand how that model works, then you see a shock, like a lockdown in some city, you say, “My workers aren’t going to be able to get back to the factory,” Then you can put all these pieces together. Or when you see so-called blank sailings on the Transpac, which means they’re taking out capacity, or you see a queue of ships waiting to unload, then you understand immediately that those things are taking capacity out of the system and it’s likely to impact you.

People who had their ear to the ground and were paying attention on a daily basis, they had a headstart on everybody else in trying to secure their holiday seasons in 2021. They did better. It’s because they majored in it as opposed to letting somebody else do it.

So how do boards, CEOs, ask better questions to make sure that their organizations are doing the kinds of things that you’re talking about? Strategically, how do they step back and really say, “We need to get good at this, how do we get good at this?”

The key is asking the right questions, obviously, at the board level—asking a lot of questions about ensuring that your management team understands their vulnerabilities, that they pay attention to the structure of the supply chains, that they’re making very deliberate choices about supplier location, supplier diversity. “Do I have multiple sources for parts that have a high revenue impact on me?”

You won’t always be able to have multiple sources on proprietary parts or things that have unique suppliers. Well, then the question is: “Well, what is our contingency plan there? What is our contingency either for rapid design around, or do I want to maintain inventory of parts?”

I was talking to a reporter yesterday about the infant formula shortage. And, you know, I said I don’t know anything about infant formula, but the same type of first principles analysis applies, which is: How much slack capacity is there? Abbott Nutrition, when you have a plant that gets taken out, that’s always a huge problem because it removes a lot of capacity from the system. There’s a lot of concern about those unique formulas for, you know, infants who need particular special nutritional needs.

I said some number of years ago, I visited the Novo Nordisk factory in Kalundborg, Denmark. They make half the world’s supply of insulin. Since they make half the world’s supply of insulin and they realize that they cannot leave the world short because that’s a huge responsibility, they had a five-year-stockpile in the deep freeze of insulin in case anything went wrong.

I gave them high marks for that because they said, “This is my responsibility. This is the lives and well-being of lots of people are depending on us. Therefore, we are gonna plan accordingly,” right?

So I think a lot of it is like: “How do you think about this problem?” Some of these problems, there don’t appear to be simple solutions, but you have to have those types of contingency plans.

You did a book years ago about the need for an American manufacturing renaissance. We’ve seen a lot of companies at least talk a great deal about re-shoring to the United States, shortening supply chains, getting closer to customers. What do you make of that? We also hear a lot of conversation about de-globalization. Where do you think companies need to be going on this for the decade ahead?

Everybody wants resilience, and, well, not enough people are talking about how do you pay for that. So all these things, if you’re going to maintain multiple sources, or you’re going to maintain sources that are more regional, that are closer to the market, that means your products are going to cost more. Having multiple sources or having other sources in higher-cost locations means your products are going to cost more.

Everybody’s complaining about inflation right now, but I would argue one of the reasons we’ve had relatively low inflation for the last two decades is because we’ve benefited from offshoring to inexpensive manufacturing locations like China.

If you offshore manufacturing from a high-cost region to a low-cost region, that’s pretty easy. That’s easy because the cost savings will pay for that.

But if you want to bring manufacturing back to the U.S., which is all the rage—everybody’s talking about political and technological sovereignty, not only in the U.S. but in Europe as well—that’s different.

When you go from a low-cost country to high-cost country, there’s nothing that’s going to pay for that. It’s obvious—that’s also first principles. It’s obvious, but people haven’t thought about that.

So, if you’re going to do that, then high cost is competing with low cost. You either have to have better productivity‚ that can be through automation, it can other things, or you have to have process innovation that says, “I’m going to have a lower-cost way of doing this compared to others,” or you have to be R&D and innovation-led, where the cost of labor doesn’t matter.

I’ve been in factories in the United States where the fully-burdened cost was $130 an hour, and it didn’t matter because the product had so much value-add. Labor cost, while it was a significant component, it was not that big a part of the overall cost. So you can do it, but, again, based on first principles, you have to think about how are you gonna do this in a sensible way?

From a first-principles standpoint, what are the world’s supply chains telling you about where we’re going in the 2023-2024 time range? What are you seeing?

First of all, input costs are going to be higher. We are going to go to more regional manufacturing. We are going to more regional manufacturing because, frankly, China is making it very hard. With Zero Covid, a lot of people are saying, “I can’t deal with this anymore.” A lot of people moved to Vietnam, Southeast Asia, and so on, but those places are filling up. They don’t have the raw capacity that somebody like China does. I’m very high on Mexico because Mexico has a good labor environment. They have political issues, but all in, I think it’s still an attractive location.

The other thing, and this kind of goes to the ESG discussion, there are big changes coming in terms of decarbonization of shipping with IMO 2023 regulations coming. That’s not on people’s radar yet. It should be because it’s going to mean higher costs. Between the politics and a lot of the economic forces, it argues for a shrinking of the tradeable sector, which is something that we haven’t seen in this generation.

If there’s one thought you would leave directors and management teams with about thinking about the supply chain next year, what would it be?

Really try to learn more at every opportunity because you need to build this mental model of your company’s supply chains and understand your vulnerabilities. With that, comes a mindset of, “I know change is going to be a constant, it is going become a much more a dynamic game where I’m constantly trying to adjust to whatever new shocks come.”

We keep having these new shocks. Resilience, as much as anything, is the ability to respond to these new things. That’s the new reality.