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The Danger Of Twin Supply Chains

The ongoing trade war will have lasting repercussions, and that’s not good news for the chip industry.

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No matter how the ongoing dispute between the United States and China turns out, damage already has been done. It’s not the kind of damage that is immediately visible to the outside world. It’s more of the long-term, policy-shift kind of problem, which over time will likely prove much worse.

Many executives have termed recent sanctions on Huawei and other Chinese companies “China’s Sputnik moment,” because Chinese officials recognize they need to develop their own technology rather than relying on non-Chinese companies. From a high-level perspective that’s a problem, although one that is potentially reversible. But drop it down 30,000 feet, and the view is that Chinese manufacturers don’t want to be dependent upon any single country, because they’ve had a first-hand view that supplies of key parts can evaporate overnight. So they will either support local suppliers, or they will look for suppliers in multiple countries. That’s a much bigger problem, and one that is not likely to be shaken away anytime soon.

Having a reliable supply chain is essential for any business. And if Chinese companies want to compete on a global stage, or even internally, they need all of the necessary parts, equipment and raw materials to make their products. That’s basic business. You can’t make processors without memory, even if you have the best engineers on the planet.

But this also erases some much-needed improvements in supply chain management that were added after the 2001 crash. The big problem in the years leading up to the crash was that demand for parts far exceeded the supply, particularly for communications servers to fuel the dot-com revolution. As a result, manufacturers began double and triple ordering components and tools. When the dot-com market dropped into a free-fall, they were stuck with months of inventory that eventually was dispersed on the gray market.

It took years for the industry to recover from that disaster, and the move to just-in-time manufacturing and better supply chain monitoring had a significant impact on inventory in the 2008 recession. While the 2008 crash turned out to be a deep and lasting economic downturn, semiconductor inventory was not a major issue. As a result, the market recovered much more rapidly than what would have been possible without those changes.

The introduction of a parallel supply chain reverses years of improvements. It’s true that a single source makes it difficult to ensure competitive pricing, some regions have more expertise than others in certain areas. This is why second sources of some products are often located in the same region.

China’s supply chain is relatively opaque, however, and increasingly it will be disconnected from the rest of the global supply chain. So as China begins ramping up inventory, that won’t be obvious to other suppliers. And when there is a glut of inventory, it will likely be dumped into the gray market without warning.

For the past decade, the supply chain has been a finely tuned instrument that is the model for any industry. Over the next decade, that may not be the case. Damage already has been done, and that will become obvious in the years to come.

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