Billions in profits evaporate due to supply chain disruptions

20 August 2020

As political, climate, and pandemic risks increase, companies could lose an average of 45% of annual profit once per decade due to supply chain disruption, according to a recent McKinsey report. The consulting firm’s study, which polled 325 companies in 13 industries, projects that the massive supply chain shock of the Covid-19 pandemic could lead to more than $5 trillion in economic losses.

In recent decades, value chains grew in length and complexity as firms chased efficiency and low costs. However, the pandemic has put an elevated emphasis on rebalancing overextended supply chains – which are also being increasingly tested by natural disasters and political instability (including trade wars, civil strife, and terrorism).

McKinsey’s report notes that changes in the environment and the global economy are increasing the frequency and magnitude of shocks. There were forty weather disasters in 2019 that caused more than $1 billion in damages each, while a new multipolar world of broader geopolitical uncertainty and tension means that 80% of trade now involves countries with declining political stability scores.

The research projects that, on average across industries, companies can expect supply chain disruptions lasting a month or longer every 3.7 years.

Supply chain disruption losses equal 42% of one year’s earnings

Different industry value chains have varying exposure to risks from factors like extreme weather, pandemics, terrorism, and military conflict. Generally, value chains that are heavily traded relative to their output are more exposed than those with lower trade intensity. This means that value chains using electronics and semiconductors, which are high-value, concentrated, and heavily traded are more exposed than those centered on food and beverage or fabricated metals, for example.

The five sectors most exposed to shocks are communications equipment, apparel, petroleum products, transportation equipment, and mining – accounting for $4.4 trillion in annual exports. The least exposed sectors are food and beverage, pharmaceuticals, fabricated metal, wood products, and medical devices – accounting for $2.4 trillion in exports. 

The report also estimated the bottom line impact that companies could expect to experience over the course of a decade, based on an estimated probability of a severe disruption twice per decade. McKinsey then combined the expected frequency of disruptions with the varying financial impact experienced by companies in different industries. The firm says that companies can expect losses equal to 42% of one years’ profit over the course of a decade, on average.

Business leaders cite multiple sources of supply chain vulnerability

Industries where companies hold larger inventories and lower fixed costs will tend to experience smaller financial losses from shocks, according to the report.

McKinsey also surveyed company leaders on where they see the greatest vulnerabilities in their supply chains. Respondents highlighted demand variability and the difficulty of accurate forecasting as the top concern (32%). Covid-19 has made forecasting more difficult, with varying impacts on consumer behavior and preferences, global economies, and uncertainty about the length and severity of pandemic-fueled changes. Automotive and chemicals firms were especially concerned about demand variability.

Sole sourcing and non-substitutable inputs was the second choice (28%), with half of pharmaceutical firms selecting the issue as the top vulnerability for value chain disruptions.