Does risk diversification work?
A case study of supply disruptions during the pandemic and measures taken by the Swedish industry to improve resilience
The coronavirus pandemic caused major disruptions in the global supply chains of the Swedish manufacturing industry, forcing many companies to scale back or stop production for a period due to a lack of parts and components. Did companies with greater risk diversification in their supply chains fare better than others? And what measures have been taken since the pandemic to improve resilience?
The pandemic caused major disruptions to industrial production in Sweden, especially in the early stages when supply and logistics chains were disrupted as first China and then other countries shut down society to prevent the spread of the virus. Despite the global nature of the pandemic, not all industries were affected to the same extent, nor were all companies within each industry. In this report, we have analysed supply disruptions in the manufacturing sector during the pandemic and the relationship between disruptions and risk diversification. Did companies with diversified supply chains fare better than others? Based on a survey supplemented by data analysis, the report also documents what the industry is doing to improve resilience in the future.
The study is based on monthly microdata for 2570 industrial companies in Sweden for the period from January 2019 to December 2021. The study shows that the risk of supply disruption is lower when inputs are sourced from suppliers in different countries, referred to as geographical risk diversification, but that the return at the margin is diminishing. Excessive risk diversification can even be counterproductive, probably because splitting purchases makes the company a less important customer of each supplier, with the risk of being deprioritised in a shortage situation.
In practice, risk diversification varies considerably according to the size of the enterprise and, to some extent, according to the industry. Large enterprises diversify risks more than small enterprises in the same industry, suggesting that costs are a limiting factor for smaller enterprises. Risk diversification also varies to some extent across industries, probably because they use different inputs. Where supply is concentrated on the world market, the scope for risk diversification is reduced, as in the case of microchips and certain metals and minerals, where supply is dominated by a few countries. The scope for risk diversification therefore depends on the opportunities, costs and benefits, which vary between companies according to size and industry.
The survey, conducted in collaboration with the Confederation of Swedish Enterprises, shows that six out of ten industrial companies have taken or planned measures to reduce their vulnerability to future crises. The most active companies are those that experienced problems during the pandemic, where 67 percent say they have taken or planned a measure, compared with 37 percent of other companies. The most common measure is increased stockpiling (37 percent), followed by increased risk diversification (33 percent) and increased sourcing in Sweden and EU/EFTA (22 percent). Only 3 percent are considering bringing production back to Sweden.
Due to a lack of data, we are unable to verify the extent to which industry actually increased input stocks after the pandemic to bridge temporary supply disruptions. In terms of increased risk diversification and sourcing closer to home, the data do not provide clear evidence, possibly because supply chain reorganisation takes longer than we have been able to track in our databases. The jury is still out.
In summary, risk diversification works to some extent, but with diminishing returns. In practice, risk diversification varies by sector and company size. 60 percent of industrial companies in Sweden are planning measures to improve resilience, but the data show little evidence of action so far, with the possible exception of increased stockpiling.
Does risk diversification work? A case study of supply disruptions during the pandemic and measures taken by the Swedish industry to improve resilience
Serial number: Rapport 2023:15
Reference number: 2023/34