So how should firms adapt their supply chains to maximise returns, minimise risk and improve resilience in the face of sudden or long-term interruptions? What trends do they need to be aware of as they build their networks in the new global economic order that is emerging? Moreover, what will the supply chains of the future look like? In this CUHK Business School Research Whitepaper, we review a raft of studies that provide some early answers to these questions and may help to guide businesses through the turmoil and unpredictability that have characterised global markets following the pandemic.

An initial hint is provided by our recent study, The Bullwhip Effect in Supply Networks, which challenges the traditional wisdom that supply chains are linear in nature and demand shocks are amplified upstream along the chain. Our study demonstrated that today’s companies operate as part of a complex supply network, with each player having multiple customers and suppliers. Firms at the higher levels of the supply chain network (where raw materials are typically procured) do not tend to feel the “bullwhip”, or an amplification of the fluctuation in demand, from their individual downstream customers as they essentially serve a portfolio of networked firms. We also found that suppliers who actively manage their customer base go on to enjoy a notable reduction in demand variability, suggesting that firms could mitigate the bullwhip effect through their choice of customers. Global supply networks involve complex webs of links between different sectors, industries, and countries, in which a company may have multiple supply relationships and simultaneously operate at higher and lower levels of the network.

Focusing on the Chinese Real Estate Sector

To do this, the researchers looked specifically at the stock market performance of real estate firms in China from the beginning of February 2020 to the end of March that same year, a period which coincided with the implementation and subsequent lifting of a lockdown in the Chinese city of Wuhan in Hubei province, where initial reports of virus transmission appeared.

“Corporate diversification could be especially useful in mitigating negative stock market reactions that firms experience during times of crises, such as during the pandemic.”
Prof. Desmond Tsang

They chose China to study the impact of diversification on stock market returns because the country provided a “clean” timeline for study. As a result of the stringent measures that the government undertook to control the spread of COVID-19, including lockdowns not only in Wuhan but also in other cities throughout the country, China largely succeeded in suppressing the spread of the virus and avoiding a more widespread outbreak. Unlike other jurisdictions, the policies implemented there also largely prevented any large-scale flare-ups from further taking place.

Moreover, by focusing on the real estate sector – where firms tend to invest in property assets in specific locations – the researchers were able to cleanly identify a company’s geographical scope. Chinese real estate firms were also easier to compare, since most firms tend to dabble in developing residential and commercial projects, unlike in some markets such as the U.S., where real estate firms focus on various forms of property operations. Finally, real estate developers had a shorter investment horizon than passive investment vehicles such as REIT, or Real Estate Investment Trusts, and thus they might be more likely to be affected by the short-term volatility brought about by the pandemic.

To go about their study, Prof. Tsang and his co-authors first examined the returns of A-share companies listed on the Shanghai and Shenzhen stock exchanges with the growth rate of the number of confirmed COVID-19 cases as a measure of exposure to the pandemic. This confirmed the onset of the COVID-19 pandemic caused equity prices for real estate firms in China to fall significantly. As expected, it found that firms that were bigger in size, which employed lower leverage and which had higher cash holdings were affected less.

Next, the researchers looked into their main research question at whether firms’ geographic scope affected their stock prices during the period. They found that those with broader geographic scope and more geographically diversified property allocations were better able to endure the crisis. “In other words, the results indicate that investors seemed to perceive that firms with a more geographically diversified portfolio as being better able to weather the COVID-19 pandemic,” says Prof. Tsang.

The Effects of Leverage and Firm Size

Pressing on, the researchers then turned their attention to whether this ability of geographical diversification to shield companies from negative stock market consequences of the pandemic was able to help firms with weak fundamentals. It found that firms with higher leverage reported lower returns during the pandemic no matter their levels of diversification, indicating that geographical diversification did little to soften the valuations hit that real estate companies took during the pandemic if they had high leverage, which in turn signalled a higher risk of bankruptcy especially at times of crises.

Interestingly, when examining firms with strong fundamentals, they found that larger firms were only able to lessen the adverse impact of the pandemic if they adopted a geographically diversified strategy. Conversely, larger firms may be actually be more seriously exposed to the pandemic if they were geographically focused. Prof. Tsang added that while smaller firms, by definition, may find it difficult to expand their portfolio geographically, investors only viewed larger firms in a favourable light if these companies recognised the importance of geographical diversification.

To conclude, Prof. Tsang says with the pandemic creating an unprecedented crisis for the world and for global stock markets, it has become increasingly important that firms and policymakers better understand the factors that can allow markets and individual businesses alike to become more resilient to such shocks. “Overall, our results do much to validate what many would consider common sense but not all firms have actually been doing. Corporate diversification, in this case geographical diversification, could be especially useful in mitigating negative stock market reactions that firms experience during times of crises, such as during the pandemic, though its effect is not almighty when it comes to firms with weak fundamentals,” he says.

“However, for larger organisations, which typically have access to better resources and are considered to be usually better at absorbing losses when the going gets tough, we show that diversification could actually become more essential, as these firms are expected by the market to be more diversified and to have put fewer eggs in one basket.”

To combat the spread of COVID-19, the Chinese government imposed an unprecedented and controversial lockdown on Wuhan, a city of 11 million people, starting on the morning of January 23, and then in other Hubei cities several days later. Under the order issued by the government, all public transport, including buses, trains, flights and ferry services, were suspended. Residents of Wuhan were also not allowed to leave the city without permission.

This lockdown, which is only being relaxed two months on as the number of new infections in China has tailed off, is being emulated by a growing number of governments from the U.K, Italy and Spain to the Philippines as infections have spread across the globe, with over 360,000 people infected and over 16,000 dead.

A new study has further strengthened the case that COVID-19 cases in China would have been significantly higher had the government not enacted the historic lockdown on the city of Wuhan in the early days of the outbreak.

Conducted by Yang Yang, Assistant Professor at the School of Hotel and Tourism Management at The Chinese University of Hong Kong Business School in collaboration with Prof. Hanming Fang at the University of Pennsylvania and Prof. Long Wang of ShanghaiTech University, the study sought to quantify and isolate the effect of restricting travel on the spread of the virus.

It estimated COVID-19 infections would have been 64.8 percent higher in Chinese cities outside Hubei province, and 52.6 percent higher in the other cities within Hubei but outside the provincial capital and outbreak epicentre of Wuhan, if the government had not acted to shut the city.

The results of the latest study has lent further weight to previous findings that the lockdown significantly delayed the spread of the virus across China.

“We find that the lockdown of the city of Wuhan contributed significantly to reducing the total infection cases outside of Wuhan, even with the social distancing measures later imposed by other cities.”

Prof. Yang Yang

Entitled Human Mobility Restrictions and the Spread of the Novel Coronavirus (2019-nCov) in China, it examined data from Baidu Migration, a travel map offered by the Chinese search engine of the same name, which tracks the real-time location of every smart phone using the company’s mapping app.

Controlling for the fact that the virus itself would have reduced travel on its own, and the panic would have increased travel, it found that the lockdown on Wuhan itself cut the outflow of people from the city by 56.4 percent compared to if a quarantine had not been in place. The lockdown also reduced the inflow of people into the city by 76.6 percent and movement within the city by 54.2 percent.

These results were then correlated with COVID-19 infections figures released by the Chinese Center for Disease Control and Prevention, also known as China CDC.

“We find, using simulations with these estimates, that the lockdown of the city of Wuhan contributed significantly to reducing the total infection cases outside of Wuhan, even with the social distancing measures later imposed by other cities,” says Prof. Yang.

A World Without a Wuhan Quarantine

This model was also extrapolated to estimate the actual number of infection cases in Wuhan and elsewhere in Hubei.

If a lockdown had not been put in place, the 347 cities in China outside Hubei would have recorded a total of 20,810 cases as of the end of February, compared to the actual number of 12,626. Similarly, for 16 cities within Hubei but outside of Wuhan, cases would have reached 23,400 without the mandatory quarantine, instead of the actual 15,330.

It also found a persistent gap between the estimated number of infection cases with the actual numbers in Wuhan from the start of the outbreak. This gap widened over time, possibly as a result of the overwhelmed health care system and peaked on January 26, with the number of official cases constituting 80.03 percent of the estimated total, before tailing off to settle at around 11.3 percent.

“We are thus able to conclude that almost all infection cases in Wuhan were able to be treated over time as the stress on the health system was relieved,” says Prof. Yang, adding that the discrepancy may be explained because some of the infected may have recovered on their own or died without reporting their situation during the early stages.

If the mandatory quarantine had not been put in place, the simulation also predicted that new infections would still have peaked on their own – on February 2 in Hubei excluding Wuhan, 9 days after the real-world lock down took place, and on February 3 elsewhere in China. It also predicted that estimated new cases would gradually converge to the real-world reported daily cases by February 22.

“This suggests that the social distancing measures implemented elsewhere in China would have worked eventually to contain the spread of the virus, even if the city of Wuhan was not locked down,” Prof Yang says. “However, the initial onslaught on the medical system in all cities in China would have been much more severe, and the total number of infection cases elsewhere would have been significantly higher.”

Do Less Stringent Lockdowns Work?

Elsewhere in China, the study also looked at the effectiveness of less severe lockdowns implemented to different degrees in other cities, from establishing checkpoints in building entrances and quarantine zones, shutdowns on public transport as well as limits on the movement of people in and out as well as within cities.

“The results suggest that these enhanced social distancing policies in destination cities were effective in reducing the impact of population inflows from Wuhan and other source cities in Hubei. This in turn implies that population inflows from the epicentre contribute to the spread of infection only before the social distancing measures were applied.

“It appears that after implementing various control measures, cities adopting an extended lockdown can flatten the upward trajectory of the virus,” Prof. Yang adds, noting that the results of the study will have strong implications on other countries in their fight against COVID-19.

China is expected to maintain a prominent role in global supply chains despite the COVID-19 pandemic, which has renewed discussions about whether countries around the world have become too reliant on Chinese manufacturing, according to one of The Chinese University of Hong Kong’s (CUHK) leading researchers on global economic networks.

Jing Wu, Assistant Professor at CUHK Business School’s Department of Decision Sciences and Managerial Economics, acknowledges that the pandemic, which resulted in an extended shutdown of factories across China following Chinese New Year, may lead firms which operate global supply chains to diversify their manufacturing base in addition to China as part of a stronger focus on risk management.

For decades, China has provided the bulk of components to manufacturers around the world. But even after new infections tapered off within its borders, factories have been slow to resume their normal production capacity. This has been blamed on a number of challenges including a shortage of labour due to the slow recovery of transportation links post lockdown, as companies scramble to ensure adequate protection for the workers against infection, and a shortage of parts from upstream suppliers.

A recent survey of companies in the U.S. by the non-profit Institute for Supply Management reported 75 percent of respondents said their supply chain had been disrupted due to the coronavirus, with one in six, or 16 percent, having already revised their revenue guidance down by an average of 5.6 percent. There has also been media reports the the U.S. administration is accelerating an initiative to pull global supply chains out of China as it considers new tariffs in reaction to the Asian country’s handling of the coronavirus outbreak.

It also comes amid reports that Japan, one of China’s biggest trade partners, has earmarked US$2.2 billion of its record US$1 trillion stimulus package to help its manufacturers shift production out of the world’s second-largest economy.

Prof. Wu says it is not unexpected that, as a result of the pandemic, national governments may become more aware of the importance of supply chain security in national security concerns and strengthen themselves against their exposure to foreign manufacturing risks.

“It is no surprise that Japan, the U.S. and other countries would want to reconsider which products can be purchased from abroad and which products should be encouraged by policies to build local production capacity,” he says. “From a risk management perspective, it makes sense to produce essentials such as medical supplies close to the market, just-in-time when demand surges.”

He notes that Japanese culture in particular has traditionally focused on risk management. He expects some essential parts produced for the Japanese market to be brought home or to coastal areas in China which are closer to Japan. For the products that are sold to the overseas market, especially in China, their production is expected to remain in China.

Commercial Decisions

Noting the increasingly political nature of the discussion on China’s role in global manufacturing, which in recent years gained steam with the election of U.S. President Donald Trump who has pledged to return manufacturing to the North American country and heightened by the pandemic, Prof. Wu notes that at the end of the day it is the firm which makes the supply chain decisions, rather than a government or a nation.

“Capital will always chase opportunities and avoid risks. Whether it is a man-made trade war or a natural pandemic, to a certain extent, international capital has seen the need to diversify China’s manufacturing risks,” he says, citing the results of a research paper he co-authored, entitled Not Coming Home: Trade and Economic Policy Uncertainty in American Supply Chain Networks.

“Companies may seek to diversify their manufacturing options while maintaining their main sourcing base in China,” Prof. Wu says, despite the fact that the country has been able to wrestle control of new coronavirus infections. “It cannot be ruled out that some companies will shy away from ‘putting all its eggs the same basket’ when evaluating the future configuration of their supply chains.”

“Companies may seek to diversify their manufacturing options while maintaining their main sourcing base in China.”

Prof. Jing Wu

“China’s advantage in manufacturing cannot be replaced in the short-term. At the same time, it is inevitable for China to upgrade its economy from polluting, export-led manufacturing economy towards a high-tech and service-driven one,” he says, adding that the share of low to mid-tier manufacturing would likely decrease slowly as a result of the further economic development and industry upgrades. That process may be expedited by the pandemic due to weaker foreign demand.

The effects of this would be offset by China’s ongoing industrial migration towards high-tech manufacturing, which is high-margin and tends to be less sensitive to labour costs and more likely to stay within the country once the industry is developed, he says.

To help it adapt to changing attitudes in global sourcing, China needs to change its strategic thinking on price advantage to continue its move up the value chain away from low-cost manufacturing reliant on cheap labour, understand the strategic considerations of foreign customers on supply chain resiliency and security under trade barriers, and strive to establish strong international brands.

At the same time, China should keep reforming-and-opening-up, including opening and entering potential new markets, he adds.

Globalisation 2.0

Given that the global supply chain shock has since spread around the world, a crucial question is whether the pandemic spells the beginning of the end for the current age of globalisation?

Prof. Wu notes that COVID-19 has disclosed disadvantages related to relying too much on sourcing, or off-shoring. It makes sense that more companies may try to produce their products locally, or closer to consumers.

“Globalization also takes many forms besides in the physical product market or in the form of manufacturing supply chains. It also includes financial globalization, knowledge, and technology globalization,” he says, citing another study he co-authored entitled Global Supply Chains and Cross-Border Financing. “While supply chain globalization has matured, financial and technology globalization is quite incomplete and accelerating.” He refers to this extended definition of globalisation as “Globalisation 2.0”.

On the other hand, while China continues to face the threat of tariffs and taxes in its as-yet concluded trade war with the U.S., he notes that the companies in the Asian economic behemoth may seek to accelerate the reconstruction of their global supply chain structure to effectively avoid trade barriers. In recent years, a growing number of Chinese companies have sought to widen its global manufacturing footprint, such as by directly building factories in destination markets such as the U.S., or ship components and assemble the final products in other countries. “A more global layout can enhance the flexibility of the supply chain, thereby reducing the negative effects of sudden risks,” he says.

In the new era of Globalisation 2.0, China should keep transforming from export trade to overseas investment, encouraging its firms to acquire or open foreign subsidiaries, produce local and participate in overseas market competition, he adds.