The True Cost of Consolidation: Why COVID-19 Will (Hopefully) Reshape the Way We Think About Free Markets
Efficiency, at a Price
“To what extent would companies be willing to sacrifice quarter-to-quarter efficiency for resilience over the long term, whether that’s natural disasters, the climate crisis, pandemics or other shocks?”
— Susan Lund as quoted in the New York Times
In an episode during Season 7 of The Office, an obviously disturbed Michael Scott (Steve Carrell), storms into the frame and starts grabbing random objects, turning them over to see where they’re made. A stuffed animal: “China!”; a pen holder: “China!”; and a reception placard: “China!”. His colleague’s (Ed Helms playing Andy Bernard) reaction to Michael’s rant about Chinese manufacturing is tellingly nonchalant, “Yeah, it’s where they make stuff.”
Not much has changed since this episode aired 9 years ago. Everyone knows that China (and a handful of other countries) is where they “make stuff”. As supply chains have become increasingly global, they have reached unprecedented levels of efficiency — reducing prices for consumers, but also concentrating production into limited geographic locations. While these decisions have maximized profits for manufacturers seeking to limit overhead expenses, they have also created supply chains that allow little room for error, making them particularly susceptible to shocks.
The COVID-19 pandemic has exposed the depths of this problem as manufacturing shut down in China and the world was temporarily cut off from essential goods across sectors. To further increase efficiencies, some industries have grouped together in geographic clusters, such as China’s dominant solar cell manufacturers, 60% of which are based in Jiangsu province. The unfolding crisis was even starker in the world of public health, where China represented not only the source of the pandemic, but also many of the drugs manufactured globally.
For those working on access to medicines, the sudden breakdown in manufacturing that occurred in February and March 2020 represented a worst-case scenario. For decades, pharmaceutical manufacturing has become increasingly concentrated in India and China, which together comprise 80% of the drug ingredients used in the United States. This move towards lower cost manufacturing locations represented a collective action problem that few paid any attention, until now.
While global health organizations have concerned themselves with the affordability of medicines, sometimes at the exclusion of other issues, the hidden costs of consolidation have barely registered. The COVID -19 pandemic highlights the nuanced market forces simultaneously impacting access to medicines around the world. An over-concentration of manufacturers jeopardizes the health and well-being of markets, and consequently the consumers who rely on them. The collection of individual supply decisions made by manufacturers in this moment, whether to prioritize efficiency or resiliency, will determine societal well-being in the face of future shocks — literally a matter of life and death in some circumstances.
What Happens When the Country that Makes Your Drugs Gets Sick?
“With the growth of China’s chemical industry and its subsequent dominance in API (Active Pharmaceutical Ingredient) manufacturing, the world is becoming increasingly dependent on China as the single source for life-saving drugs.”
– U.S.-China Economic and Security Review Commission
When the COVID-19 outbreak struck China, where a vast amount of the world’s pharmaceutical material is manufactured, many feared that there would be shortages of life-saving drugs due to supply disruptions.
While this fear was well-founded, there was a deeper concern — that supply disruptions could exacerbate the outbreak itself. Since the shock (in this case to health) and the supply chain (pharmaceuticals) are related, the pandemic could have undermined our collective ability to respond to the outbreak due to concentrated supply chains leading back to China.
I’ve uncovered this dynamic firsthand through work increasing access to essential health products for consumers in low- and middle-income countries. My experience tracing supply chains for drugs, including a drug that was a prime candidate for COVID-19 treatment, has underscored these system-wide vulnerabilities.
As part of these efforts, I’ve worked with companies across Europe and North America who produce finished versions of drugs — the type that you can find in a pharmacy. It’s not uncommon to find that all of the companies who produce a certain drug are sourcing their Active Pharmaceutical Ingredient (API), the building blocks of drugs, from a single supplier in India.
If you continue to trace the supply chain backwards, Indian suppliers often procure the starting chemicals for drugs from another single manufacturer, this time in China. Coincidentally, many of these Chinese companies are based in in the same province as Wuhan, where the COVID-19 pandemic was thought to originate, or neighboring regions.
In effect, the entire market for many critical drugs rest on sole manufacturers at multiple points in the supply chain. If any of those drugs had proved to be successful in treating COVID-19, the world could have been cut off from the only manufacturing source, further exacerbating the pandemic.
If this sounds like a “perfect storm” hypothetical, then consider the following case: In October 2016, there was only one factory in the world producing the API for the antibiotic piperacillin-tazobactam. This factory, located in China, experienced an explosion that shut down production. This single event caused shortages of a critical antibiotic that reverberated around the world.
Such a disruption in the face of a shock like COVID-19, could have contributed to countless unnecessary infections or deaths. Consumers would have paid a far heavier price for consolidation than any manufacturer ever could.
How Civil Society Organizations Can Balance Interests Across Manufacturers and Consumers
“At minimum, we expect they (companies) will be increasingly inclined to spread their risks rather than put all their eggs in the lowest cost basket, as many long did in China.”
–Kearney forecast: COVID-19 reveals that resilience is key
The COVID-19 pandemic has ushered in a wave of predictions about how companies will evaluate supply chains in the future. In addition to traditional metrics, many believe companies will spread their risks by incorporating measures such as resilience in supply chain designs. Such enthusiasm may be premature. Manufacturers could calculate, quite rationally, that the cost of retooling their supply chains is far greater than the losses incurred by occasional shocks.
What will almost certainly not figure into company deliberations are consumers, who tend to be left out of the equation when the future of supply resilience is considered. We focus on companies rather than the larger picture because global markets are not intentionally designed, unlike corporate strategies. These strategies, intended to maximize shareholder value, created markets that are efficient in the short-term, but carry inherent and significant societal risks.
It’s unlikely that private sector manufacturers or national governments are capable of tackling this problem on their own. Manufacturers run the risk of continuing to focus on efficiency at the expense of consumer resilience, and national governments that each push to reshore strategic industries sit at the other end of the spectrum, all resilience and no efficiency. Civil society is best placed to address this issue by aligning incentives and monitoring the health of markets.
Such steps would marry efficiency and resilience, enabling manufacturers and consumers alike to weather the shocks that lie ahead:
1) Increase sourcing transparency: Consumer advocacy groups should push manufacturers to disclose where they source their materials or ingredients to produce final goods. For instance, by including the source of raw materials to produce drugs, pharmaceutical manufacturers would dramatically increase industry awareness of consolidation- showing market weaknesses.
2) Facilitate supply diversification: Often suppliers are not willing to invest in new products or operating models because they lack a solid business rationale. Nonprofit organizations can bridge information gaps by providing clear market research on opportunities to expand manufacturing to non-traditional locations with low production costs.
3) Explore consumer-centric business models: As corporations begin to recognize a responsibility to more than just their shareholders, there’s an opportunity to bridge the disconnect between manufacturers and those who are most impacted by their decisions, consumers. Foundations can and should invest in research to understand successful models that align corporate and consumer interests. An example are Direct Public Offerings (as opposed to IPOs) that offer equity stakes in companies for their customers.