Over the course of decades, the world has been committed to achieving rapid and comprehensive economic integration: global value chains have enabled greater specialization and economies of scale, leading to increased efficiency, lower prices, and a wider range and higher quality of goods and services becoming available. Research conducted by the McKinsey Global Institute on global trade flows illustrates the extent of global economic integration—all regions are mutually interdependent, relying on trade with others for more than 25 percent of at least one important product., McKinsey Global Institute, November 2022.
Moreover, in coming decades, vulnerabilities in connected supply chains could be aggravated due to intensified rivalry between regions to achieve global influence and could result in more significant challenges to every country’s economic and national security. Countries now may need to find a balance between meeting these challenges and becoming more resilient, while not, however, jeopardizing economic development.
Against this backdrop, EU heads of state and governments convened in 2022 to focus on the strategic autonomy of the European Union, where they agreed to take more responsibility for EU security and reduce dependencies, while preserving an open economy. EU member states are striving to reinforce the integrity of the single market through regulatory initiatives, such as the Critical Raw Materials Act and the Chips Act, and to strengthen the resilience of critical supply chains beyond the pandemic response.
As an illustration, the European Union initially established the Health Emergency Preparedness and Response Authority (HERA) in response to the pandemic. Now, in alignment with its efforts to enhance its resilience and strategic autonomy in light of geopolitical and unexpected challenges, the European Union is undertaking measures such as the development of a critical medicines list to proactively mitigate further disruptions.
Nevertheless, there is not yet an EU-wide, overarching mechanism with an end-to-end approach and a single governance specifically designed to address the risk of disruptions in international supply chains across strategic industrial sectors. Such a mechanism, if implemented at a European scale (in coordination with national bodies), could effectively contribute to national and regional security and economic sovereignty through an improved European industrial capacity in critical sectors such as health, defense, technology, and agriculture. The responsible organization will not face an easy task, however, as it will need to demonstrate an ability to remain relevant and targeted enough to manage the high complexity of the supply chains in the sectors addressed.
A resilience mechanism for uncertain times
A national, integrated approach developed in one country to address critical supply chain disruptions could be replicated in other countries or become an overarching approach to ensure supply chain resilience at regional scale. The overall goal would be to reinforce resilience to supply chain crises, especially in those sectors that are critical for national security—defense, for example. A true end-to-end integrated approach would need to include four key elements (Exhibit 1).
Institutional body: An overarching institutional body responsible for managing the strategic reserve and coordinating efforts across ministries and directorates through a single governance structure.
Critical supply chain at risk mapping: A tech-enabled methodology to understand national industrial supply chain vulnerabilities by identifying critical products—necessary for individual and national survival—and assessing the associated supply risk to estimate the minimum industrial capacities required for effective risk mitigation.
Supply chain resilience framework: A ranked list of mechanisms that could be used to mitigate the risk to critical products with an associated high risk of supply (Exhibit 2).
Contingency planning: Levers to be implemented before a crisis occurs to increase critical supply chain resilience. An example of a contingency lever could be an early warning system to monitor key indicators of the supply chain to anticipate disruption. It could also include smart strategies like ensuring a multiskilled workforce, approaches to recalling retirees, or even putting out a credible, holistic demand signal for relevant sectors (for example, by showing anticipated demand across certain technologies or highlighting investable bottlenecks).
Diversification: Before implementing more complex (or costly) mechanisms, diversification—where possible—could reduce the national risk associated with critical products by already starting to import, or promoting further imports, from lower-risk sources.
Minimum capacities mechanisms: To be put in place for those products where diversification is not enough or feasible to reduce high or medium risk. This includes three options (from the least to the most difficult to implement):
- cost-effective and efficient storage of products
- capacities that allow a rapid increase of production in times of possible crisis situation—that is, ever-warm production lines
- last-resource actions to build national capacities, such as developing new domestic production of critical products of high or medium risk
In-depth assessment of these mechanisms for each sector considered is essential, including careful prioritization and recurring reexamination, given the potentially high costs involved.
Operational enablers: A set of elements that could facilitate the functioning of the strategic reserve and its future operations. This could include public-private sector levers (leveraging tax policies, public procurement, or public subsidies); the necessary legal and regulatory basis; a technology platform and tools (dedicated to analyzing vast volumes of trade flow data); and an outreach program (defining the relationships with other entities such as industry, academia, and other public institutions).
An ever-warm production capacity: A potential approach to mitigate critical supply chain risk
A potential resilience mechanism to consider is the development of ever-warm industrial capacity in critical sectors, due to its innovative nature, potentially lower complexity, and flexibility in its implementation. Ever-warm capacity could be a suitable mechanism for urgently needed products and temporary crises such as supply shortages (for up to 12 months).
Developing ever-warm capacity involves partnering with industrial organizations to ensure access to the production capacity of strategic products in a crisis. An ever-warm industrial partner commits to deliver a certain quantity of a product in a specific timeframe and is compensated for the costs and loss of profits associated with the capacity reserved. This compensation is reflected in a “reservation fee,” which considers precrisis costs such as inventory holding and equipment maintenance, and postcrisis costs—for example, switching costs and possible penalties for breaching other client contracts.
From a technical feasibility point of view, developing ever-warm capacity depends on the ability to meet at least one of the following criteria: that enough companies are already manufacturing the strategic product; existing companies are capable of adapting their manufacturing lines to produce the strategic products; or there are companies that can expand their manufacturing capacities. Moreover, developing ever-warm production capacity needs to be assessed against the expected cost, which could be high and requires a clear commitment to be sustained during noncrisis times.
We have identified three main operating models for ever-warm production capacity; their suitability depends on how urgently the critical product is needed (Exhibit 3).
Latent production capacity is a model in which the industrial partner guarantees access to additional capacity to be used only during crisis events. This is appropriate for the immediate delivery of additional capacity within less than three months.
Reconversion of production lines is a model in which the industrial partner commits to repurpose production for alternative uses. This is suitable for the short- to medium-term delivery of additional capacity—around three to 12 months.
Priority access to production is a model in which the industrial partner commits to redirect existing capacity if need be. This is the most flexible operating model as it enables access to additional capacity at any delivery speed.
Regardless of the ever-warm operating model used, building ever-warm production capacity requires maintaining a continual partnership approach between the institutional body and the industrial organizations. The process of selecting the most suitable partners can be crucial as well as continually monitoring their preparedness to react against a potential crisis event—for example, ensuring that the industrial organization has sufficient stock or access to critical inputs to ramp up capacity.
Ever-warm learnings
There are relatively few instances of ever-warm production capacity arrangements used to improve resilience in national or regional critical industrial supply chains. Yet, there are various notable examples, which include the EU FAB network in Europe and the Biomedical Advanced Research and Development Authority in the United States, both of which offer insights to apply in subsequent endeavors.
In particular, the EU FAB was developed by HERA to create reserve manufacturing capacities and to obtain a priority right for vaccine manufacturing in case of a future public health emergency. This reserve—which amounts to 700 million doses annually—is built through partnerships with pharmaceutical companies and contract manufacturing organizations (CMOs) in the pharmaceutical industry that have committed capacity and stocks of raw materials to produce the committed doses if a public health emergency were to occur.
The study of ongoing ever-warm examples can offer lessons for effectively implementing robust ever-warm industrial production in the future. Considerations include:
Be clear from the start: Be exhaustive and clear when developing the contracts in relation to the crisis declaration process, commitments of quantities and timeframes, specific price structure pre- and postcrisis, and protection against international takeovers or similar geopolitical scenarios.
Keep communication lines open: Traditional contracting approaches may not work. Use instead an open dialogue to engage with the industrial companies involved, both before and during the contractual relationship. Include risk-sharing provisions in the contract to define responsibilities during crises and develop an effective conditions package.
Embrace diversification: Diversify among participating companies and explore potential candidates with vertical integration or consortium structures. Assess diversification not solely based on the number of companies but also considering their footprint and geographical presence.
A more resilient supply chain to strengthen national security
A truly integrated approach toward more resilient critical industrial supply chains could help the European Union better manage the risks and downsides of trade dependencies, improve the entire industrial supply chain, and further develop its industrial capacity in critical sectors. The approach could also harness the benefits of interconnection, thereby leveraging collective strengths and creating a coordinated approach to future disruptions.
The use of smart resilience approaches—for example, developing well-designed, ever-warm industrial capacity—could be helpful in sectors critical for national security, such as defense, as well as for critical products related to basic needs such as antibiotics or fertilizers. Seamless collaboration between industrial and public entities, a partnership approach for enduring and mutually beneficial relationships, and the meticulous design of the key contractual arrangements could be crucial for the successful implementation of mechanisms to enhance national security.
