China’s zero-Covid policy poses a challenge for manufacturers and supply chains

China’s fight to limit the Omicron coronavirus variant risks suffocating already stretched global supply chains, production managers and analysts have warned, and threaten the production of goods ranging from smartphones to furniture.

Beijing is determined to prevent any large-scale transfer of Covid-19, especially as it prepares to host next month’s Winter Olympics, and has rushed to impose restrictions on maintaining its zero-Covid target.

A lockdown in the central city of Xi’an is set to enter its third week, forcing around 13 million people to remain in their homes. Mandatory testing measures are required in Tianjin, a 1[ads1]4-meter port city about 100 kilometers from Beijing, several cities in Henan Province, home to the world’s largest iPhone facility operated by Taiwan’s Foxconn, and parts of Zhongshan and Zhuhai, production hubs near Hong Kong Kong.

The curbs are a test for multinational companies and whether they have been better equipped to deal with disruptions in production capacity than during the previous waves of the pandemic.

“When Covid, Moon, New Year’s holidays and the Olympics come together, we can look at a perfect storm,” said Ambrose Conroy, CEO of Seraph, a US-based supply chain consulting firm. “Businesses are a little better prepared for short-term closures now, but a broader closure over a few weeks will create chaos.”

A leader of a Taiwanese producer in Shenzhen said a shutdown in the southern Chinese production hub would be “worse than 2020”.

After the virus spread from Wuhan across China during the lunar New Year holiday two years ago, the government blocked transport across parts of the country. The restrictions prevented hundreds of millions of migrant workers who had traveled during the holiday period from returning to their jobs. The factories were ordered to close for several weeks.

“This time, I’m more concerned because supply chains around the world are already very tense: there are already long delays in transportation and the component shortage problem is still there,” said Didier Chenneveau, an expert partner at McKinsey, the consulting firm.

The latest restrictions have already given multinational companies a taste of what is at stake. Automakers Volkswagen and Toyota both closed their factories in Tianjin last week. In Xi’an, the chip manufacturer Samsung has had problems getting employees to work due to the blockade.

Toyota, which suffered a huge supply chain outage in Southeast Asia last year, said the closure of the Tianjin joint venture was “unlikely to have a global impact on our supply as its location has developed significantly”.

But infections can spread further. Beijing reported its first locally transmitted case of Omicron on Saturday, just weeks before the opening of the Winter Olympics in the capital.

Authorities said the infected person had not been outside Beijing for two weeks and had not been in contact with other confirmed cases. The person’s residential complex was locked down and 2,430 people have been tested in connection with the case, according to Chinese state media.

A case in Shanghai that was reported on Thursday was also confirmed to have been Omicron, an official from the National Health Commission said at a press conference on Saturday.

Some business executives felt that Beijing’s focus on preventing any risk to the Winter Games would protect locations near the capital from a complete Omicron crisis.

“Of course you are unlucky if you are hit by a lockdown,” the Taiwanese leader said. “But the authorities’ attention to places like Tianjin also means that they will do everything to help you manage.”

Ningbo, home to the world’s third largest container port, has reported infections and banned trucks from entering, exacerbating ship congestion.

At Samsung Electro-Mechanics, a component manufacturer that has a factory in Tianjin, local authorities have asked workers not to leave the city during the New Year holidays to avoid the risk of infection.

– These are preventive measures that make sense. Down here, we are less prepared, said the Taiwanese leader, whose company is under pressure to let workers go home for the holidays because they have had to miss the annual trip twice already.

Analysts said that if infections spread, manufacturers would be hit as hard as they were two years ago, with few companies relocating large parts of their supply chains outside China.

“Has anyone really reduced the risk in the supply chain? Have they moved their Asia-based production back on land or near land on a large scale? The answer is no, because these things take a lot of time, Chenneveau said.

A McKinsey study found that only 60 percent of respondents had increased critical inventory and only half have increased dual sources.

Mitsubishi Electric is building a platform to share database information with suppliers on parts that are in short supply, but it will not be completed until 2025.

The virus-induced shutdowns in economies elsewhere actually increased many industries’ dependence on China, at least in the short term.

A typical example is the production of multilayer ceramic capacitors, energy storage components used in any product that has electrical circuits. Nearly half of the world’s MLCC capacity is in China, according to Trendforce, the research company.

“MLCC has been in short supply anyway, and often each plant specializes in making a unique product, so when a factory is down, no one else can go in as a backup,” said Forrest Chen, an MLCC analyst at Trendforce.

The Japanese MLCC manufacturer Murata is building a factory in Thailand to reduce overconcentration in China. But the company has also started producing some products at the factory in the eastern Chinese city of Wuxi after the pandemic forced the closure of a Japanese factory that used to make them exclusively.

“Everyone is trying to build other suppliers in China. This includes finding alternative sources to buy components, as well as identifying locations among your own factories that can serve as backups,” said a consultant working with electronics companies.

But none of these schemes have come far enough. “It takes three to five years to get the geographical diversification in place,” Chen said.

Additional reporting by Xueqiao Wang in Shanghai