How the lock-down is affecting business

An on-the-ground view in Shanghai

An on-the-ground view of what is happening with manufacturing and supply chains in Shanghai during the current lock-down.

Factory Production:

Almost all companies in Shanghai, and now many in the Shanghai region, are having production challenges.

1: Re-opening the facility

-          The business must be on the "White List" of gov. approved industries and facilities to open.

-          A permit is needed, which takes time to procure, and every step and regulation must be followed; otherwise, a local official could close the facility down.

2: Staffing

-          The need to get staff into the facility can be highly challenging.  There is minimal movement in the city or region, subways are closed, many roads are blocked, and each district has regulations on who can and cannot enter the area. 

3: Covid testing and closed-loop requirements

-          To re-open, you must have a robust Covid testing regimen that includes not just daily testing but also being able to house, feed, and take care of workers.

4: Lack of components needed for production

-          There has been almost no delivery or pickup of goods inside Shanghai since March 25th.  Businesses producing products ranging from entirely produced cars to chemicals are running out of components, unable to receive goods or ship out to customers.  For example, thousands of parts go into a car; you cannot complete it if you miss one.  Even if delivery is made, sometimes it cannot be picked up because it is behind a newly imposed fence, or local regulations require it to be "cleaned" with bleach or something close to it and left for days before pickup.

Current Status:

-          Some businesses opened and complied with regulations but have stopped production due to the complexity of requirements, the enactment of personal liability, and Covid outbreaks.

-          Many facilities have had Covid outbreaks inside the closed-loop system, requiring the company to stop production.  All those on-site, infected and non-infected, go into isolation and quarantine for a minimum of 14 days. 

-          Plants currently running, such as Tesla, will run out of parts soon unless replenished (May 1st is a good mark).  If deliveries do not occur quickly, these facilities will have to shut down again.

-          Some plants have kept workers in the closed-loop system since mid-March.  This is not a long-term solution, and worker burnout is increasing.  The inability to go home or have decent personal care (most factories do not have showers, and few have any form of sleeping arrangement) increases dissatisfaction and the health of the businesses.

-          When workers and parts are available, scalability in production is limited.  Currently, it is 15-25% of total capacity on average. 

Logistics:

1: Trucking

-          Mostly unavailable.  Local regulations, such as needing a special "permit" to drive in the city or outside it, are required and must be government-approved.  There are few available, and they are expensive to obtain.  Those that have them are charging high prices to deliver.  In some cases, a truck will bring products from another area outside of Shanghai, stop at the Shanghai border, and offload the cargo.  Another truck from Shanghai will load the cargo and go back into the city to deliver.  All of this adds time, cost, and complexity to the process.

2: Regulations

-          Shipping inter-city inside Shanghai is challenging.  Each district and sub-district has different requirements for what can and cannot be delivered.  Inter-provincial logistics is virtually impossible.  If you can hire a truck and get it into Shanghai, or vice versa, they are not allowed to return to where they came from (see below).

-          Covid testing procedures, requirements, and who can travel are not uniform.  Some require a PCR test within 48 hours, others an antigen test within 24 hours, depending on location, still others a different regulation.  When trucks exit the highway, they are at the mercy of ever-changing local policies and regulations.  Some drivers have been caught by changing rules and forced off roads, sleeping and eating in their truck while not allowed to open the door; others refuse to drive into specific areas.  Another challenge is that the system is overwhelmed; even if you get tested, results will not be available in the required timeframe.  Many refuse to leave their home area due to fears of getting locked down or quarantined. 

-          Permits to get goods out of Shanghai are also needed.  Critical industries, including semiconductors and medicines, have challenges getting into or leaving the city due to a lack of available permits and trucking capacity. 

3: What can be shipped is limited

-          Trucking into Shanghai is focused on food, PPE, medicines, and other critical supplies.  Chemicals, parts, and non-essential items (read for businesses) are not a priority at this time.  What is allowed to ship and move around is also often at the discretion of local officials.  Size restrictions produce another challenge.  Some logistics carriers cannot ship as expected, and there is often a limit, sometimes as little as 30kg, per package.  This requirement makes it challenging for many parts and suppliers to ship as it is too small.

4: Customs

-          Imported products are backed up at major airports and ports.  One example is medicines needed for patients stuck at the airport and waiting for processing.

-          Facilities that test and certify products, such as chemicals or medicines, are closed, and workers are stuck at home.  This situation is delaying the release of critical goods.

Current Status:

-          Rules and regulations are evolving almost daily, and their implementation is often at the discretion of the local administration. 

-          Freight costs are sky-rocketing due to the lack of available trucks, increase in fuel prices, drivers' unwillingness to go through these trials, and potential quarantine at any time.

-          Warehouses are closed around the Shanghai region.  If a business could ship, more often than not, it cannot because a warehouse is closed and workers are at home. 

-          Shanghai ports are running close to normal, but containers are backing up at the port, delaying some ships and offloads.    Exports from Asia-EU out of SH have declined 70%, and Asia-US out of SH fell 40%.  YOY through April 21st.  When you start looking at the numbers, it will be an astronomical impact on the global economy.

-          Many customers require urgent delivery, but goods cannot be shipped or produced.  Businesses are not just losing sales, but often customers and market share. 

Management issues:

1: Local regulations

-          Gov. officials fear repeating the "Shanghai Mistake" and do not want to risk anything that might cause a repeat in their location.  Administrations with a Covid outbreak have usually been demoted or relieved of their positions. 

-          In Shanghai, and now in most towns and cities in the region, each district and sub-district has its own rules on whom, what, and when people and goods can cross its borders.  One of the biggest challenges at this time is getting these various groups on the same page.  

-          Policies also diverge based on industry, business size (think tax revenue), and importance to the city.  Small and medium enterprises are primarily left out of the picture, with no idea when the business can re-open. 

-          Local authorities are taking significant initiatives and controlling the opening/closing process.  When pushed to re-open by higher-ups, the local administration goes back and says if there is a local outbreak, will  you (read central authorities) be responsible for it? 

-          One example is a plant outside of Shanghai making products deemed critical to the country.  In the last days of March, the local administration closed it down, not for any Covid cases but because they did not want to take the chance that a Covid outbreak might occur.  It escalated to a central department overseeing the industry.  Said department essentially ordered them to allow the plant to open, regardless of local considerations.  The locals asked for a signed document stating this, but none was issued.  Local administrators said you could not make us do this (because it will be our job on the line and not yours), and we are adhering to the "Dynamic Zero Covid" policy as instructed.  The plant remains closed to this day, with no sign of when it will re-open.   

-          Local administrations run the show as long as they follow "Zero Covid" policies.  This is one of the primary drivers for such extreme positions and contributes to the far-reaching restrictions and lock-downs throughout the country. 

2: The "White List," what that means, and how it works

-          The "White List" is a government list of various businesses deemed critical to opening and are the first ones allowed to open, get workers into the facility, and produce goods.  The first list included 666 companies, with more added each week.  Being on the "White List" allows you to open, but not much else.  It does not help get workers back because each district has its own rules on who can come in and out. 

-          Another issue is to re-open, company management should sign liability consent letters, meaning companies and executives are personally responsible if there is a Covid outbreak.  These letters do not state what would happen if such an outbreak occurred.  Would it be a fine, prison time, or losing a business license?  It's unclear.  This requirement has received strong push back and is deemed unreasonable.  This is another reason why some have chosen not to open even when they could. 

-          There is hope that some policies will relax after the May holiday (1-5).

3: Closed-loop

-          Closed-loop production means you have staff working and living in the factory or office.  Some businesses have had staff on site for over 40 days to ensure business continuity, but this is a temporary solution.  In a previous post, we discussed Tesla offering a 400RMB/day bonus ($63) for workers doing this. 

-          The closed-loop system is meant to be temporary for business continuity.  GM, Tesla, and many others are doing this, but it is limited as most cannot get additional parts into their facilities.  Once parts run out (as they are in the next week or so for many), businesses will stop production.

-          Workers live on-site.  They cannot go home or return to the facility if they leave.  Worker burnout is becoming an issue, as some have been running since mid-March.  This will affect the long-term health of the businesses using this system.

-          Limited production capacity.  Most factories are operating at less than 20% capacity due to staffing, parts, other shortages, and gov. requirements for the business. 

-          Most facilities are not set up for living.  Workers are sleeping on floors or production lines, not showering, and using bathrooms meant for shift work, not permanent residency. 

-          Getting enough food delivered and then prepared to feed staff is highly challenging, with one factory paying almost as much for food in a day as they do for one shift of production. 

-          Example: A government inspection team arrived to examine the closed-loop system.  Upon seeing how employees lived, they demanded they be placed only 4 to a room and have other adjustments to the current situation.  The management said, "We are a factory, not a hotel." This factory ended up shutting down due to worker burnout, a lack of parts, and new requirements for the closed-loop system.

-          On-site Covid testing is required for all businesses, regardless of who or where they are located.  You need to hire a 3rd party testing service to do this (the gov. won't do it).  A PCR on-site testing capability is additional and necessary for working at the factory and shows local officials you do not have Covid in the facility.  Companies are being proactive due to the severe consequences faced if an outbreak occurs.  In one area, several factories worked together and hired a 3rd party tester to coordinate daily testing and help save costs.  You need large numbers of people to test, usually above five thousand; otherwise, it is considered too small to be done.

Current Status:

-          Management challenges of operating in this environment are not only trying but also something we have not seen before.

-          With personal liability now put on Executives, some are fore-going opening the business until that requirement is removed.  It remains to be seen how this develops.

-          Regulations are evolving, and the upcoming testing regimen for the city looks to follow the Shenzhen model.  There will be a "Covid testing booth" at various locations around the city, where you can take a test, and the results will be uploaded into the system.  Anytime you get on the subway, enter a coffee shop, etc., you will need to show this code and that you are "Covid free." Shenzhen has been doing this for the last two months.  This is expected to be a new normal for Shanghai through the summer and potentially the rest of 2022.

-          Businesses cannot deploy services and engineers to assist customers because no one can travel outside Shanghai.  Some are trying to use a form of digital support, but this has limited effect.

Overall Impact:

-          The Shanghai lock-down impacts whole industries, the entire country's supply chains, and beyond.  Because products are not getting in or out of Shanghai, producers around the country are being affected.  Some are stopping production as raw materials, staff, or parts are unavailable.  Logistics is in disarray all over the country.  Local administrations set new travel restrictions for truck drivers and workers even in areas with little to no risk.  With Beijing and Hangzhou heading for lock-down, this will only complicate the situation further.  Expect these issues to affect the rest of 2022.   

-          Businesses outside of China that rely on parts, revenue, or other critical areas are also affected, such as Airbus, Apple, and Tesla.  Expect a significant hit on revenue (Tesla about $5B, Apple about $8-10B at current estimates) in 2022 for businesses that touch China.  This will impact stock markets, company balance sheets, and the GDP of many countries.

-          For businesses not under lock-down, this has allowed gaining new customers and taking market share from those who cannot produce or ship goods.  In one case, an auto supplier with international customers lost its entire overseas market to competitors.  They cannot send goods out and have no timeline when they can do so, so existing customers had to turn to alternatives to keep their business going.

-          Reliability of policy, a production ecosystem, raw material supply, logistics capability, infrastructure, and a good workforce has been the hallmark of business in China.  Some view this situation as a bell-weather and changing of the guard.  It will take years to understand the actual ramifications of the lock-downs. 

Suggestions if you have a business in China:

-          How do to open a factory or business?  The "White List" covers critical industries, and you should apply to it whenever possible.  

-          There is some discretion for local authorities on the list.  There is often a quota per industry, location, and need.  Whoever gets on the list first is the first to open.  Engage the government, ask about their progress, and get on their radar.  Get them early in the process so they can think of you as they start planning.   Being proactive as a company is the best way to go and will serve you better than waiting.

-          How do you get workers out of compounds and to the facility?  It is very challenging.  Try to get them from the same district or one close to the business to limit the number of processes and permissions needed.   Remember, once staff is on-site, no one can go home. 

-          To the letter, follow the local requirements for opening and operating a facility, such as disinfection and PCR testing.  Any deviation, however innocent, can be met with severe consequences. 

-          As you ramp up, be careful, and ensure excellent communication and relationships with local officials.  Have a robust strategy & closed-loop plan.  Don't cut corners or ramp up too fast, as repercussions can be severe.  Even with this, there are still risks that can cause punishment at the leadership level. 

-          Expect there won't be clear guidelines on work resumption procedures soon.  For some, permissions will be granted on an individual basis after negotiations between the company and local departments.