Global Supply Chain Under COVID-19: An Explanation with Network Structures and Game Theory
The fast-developing globalization in the past decades has increased the inter-connectedness of global businesses, especially in terms of their supply chains. Businesses seek to outsource their production to countries with cheaper costs of the factor of production to earn more profits. Meanwhile, each of the producers is more specialized, forming regional or industrial clusters of firms, forming a network of processes of production.
If we look into the global supply chain, each firm, country, or industrial sector can be represented as a node, and the edges represent their connections. As a network, the global supply chain is highly interconnected, so there are many possible routes from one node to another. In other words, there are many different intermediate supply-chain compositions to produce the final product. This way, each firm can have multiple choices in building up its supply chain.
However, the unexpected breakout of COVID-19 caused a sequence of lockdown and suspended production, and therefore created a shortage of supply for many businesses. This was followed by fluctuations in prices (and therefore production costs), unstable output, and inefficiencies. Companies start to reevaluate their supply-chain management.
If we consider this supply shock from the perspective of networks, we can see that producer underestimated the risk caused by the structural holes: that they may disappear and break the inter-cluster connections. A structural hole is defined as a node at the end of multiple local bridges. That is to say, it connects up to several components of nodes so that there will be no close connection between each of the clusters if the “structural hole” is deleted. A real-world example of a structural hole would be China, a major manufacturer which accounts for 28.7 percent of global manufacturing output in 2019. It has taken advantage of being the global manufacture “structural hole,” which has both information benefits and control benefits and has achieved exponential economic growth. However, as the place where the COVID-19 outbreak starts, the productivity of its manufacturing industry, as well as the international logistics, were heavily impacted. As one of the central parts of the global manufacture supply network, China’s disconnection to its trade network resulted in the disconnection of many clusters and the network as a whole. Another example of a structural hole is the semiconductor industry. As electronics technology develops and is widely applied, the semiconductor industry connects both to traditional manufacturing and high-end, cutting-edge technology. The impact of dropping production of semiconductors reached a range of products —from smartphones and auto-vehicles to LED lighting.
The pandemic warns firms of the vulnerability of their supply chain. Businesses worldwide are seeking supply chain diversification, in order to alleviate the sudden disconnection of the local bridges. The change in firms’ strategy can also be explained by game theory. A simplified version is a decision between low risk and low cost. Before the pandemic, players tend to choose a low-cost strategy to gain higher payoff and outcompete their rivals. However, after the pandemic, the cost of choosing low cost dropped dramatically, so low risk is preferred to the low cost. Therefore, because the cost of defection increases, the decision of rivalry firms also changes (for example, from a prisoner’s dilemma to the one with mutual best response). This market trend of supply chain diversification and a reduction of opportunistic behaviors are also results of changing strategies of interconnected firms as the payoff matrix changes.
The disruption of global supply chains by COVID-19:
“Global Supply Chains in a Post-Pandemic World” https://hbr.org/2020/09/global-supply-chains-in-a-post-pandemic-world
“Supply Chain Lessons Learned From The Covid-19 Pandemic” https://www.forbes.com/sites/forbestechcouncil/2021/09/09/supply-chain-lessons-learned-from-the-covid-19-pandemic/?sh=7feb424724ca
More information about the structural hole:
https://link.springer.com/referenceworkentry/10.1007%2F978-1-4614-6170-8_263)
Global supply chain and game theory:
“Pandemics and Supply Chain Management Research: Toward a Theoretical Toolbox” https://onlinelibrary.wiley.com/doi/10.1111/deci.12468