This Is What The Coronavirus Means For The Chinese Supply Chain

another episode of the Odd Lots Podcast. I'm Joe Wisenthal. I'm Tray all Away, Tracy. You know, it's really struck me in the markets over the last several weeks. I go on, Well, obviously the crisis over the coronavirus continues to be this massive story for the global economy, for China, Asia, all kinds of different companies, and yet investors, in a weird way, outside of some specific names or specific currencies, still seem surprisingly or maybe not surprisingly, but generally not

that worried. Right now. Yeah, um, I find this pretty amazing. So at the time that we're recording, I think the SMP five is still pretty close to its all time high, and what amazes me about that is we spent two years collectively worrying about how trade tensions between the U S and China we're going to affect global supply chains and economic growth and consumption, and we sort of followed every tiny in and out when it came to the

trade negotiations. And now when you have something the ownavirus and the containment efforts underway in China, you have something that is guaranteed to impact production and consumption in the world's second biggest economy as well as disrupt a bunch of supply chains, and no one seems to care. Yeah, it's it's really odd, it's really surprising, it's counterintuitive. It's

not what I would have guessed. Even this week, the week that we're recording it, we got um a warning from one of the sort of emblems of US China trade globalization, Apple, which is heavily exposed to China on the supply chain front and heavily exposed to China on the revenue front, saying, look, this quarter is going to be worse than we previously expected. Factories aren't opening up for our suppliers as fast as we had anticipated. A couple of weeks ago, we're not totally sure when things

will be back to normal. Uh, not to mention the fact that people are outlets opping and uh, you know, the stock fell about two in the immediate wake of that, maybe because people figured this was the case already, And then the next day the stock immediately basically erased all

of those losses. So even a company coming out and saying, um, no, this is a serious issue for us, even it's not having that much effect on them right now, I guess people are so confident that the effects will just be transitory and everyone will okay, but be back to be

back to work eventually. Yeah, and our colleagues over at Bloomberg Intelligence actually counted up the number of companies that are talking about the coronavirus at the moment, and I think they counted something like nine trillion dollars worth or companies accounting for nine trillion dollars worth of market cap have mentioned the coronavirus. But so far we only really have a handful of them who are issuing, you know,

the kind of warnings that we saw from Apple. Most of them are just talking about how it's too really to say that, you know, they'll get a direct hit but again, frankly, watching all of this uh go down in China and in Asia, I find it really difficult to see how global supply chains would not be impacted at this point. Right. So obviously, look, we don't know what the markets are going to do, and nobody does,

and we'll just see what happens. But I do think, and I did think, in light of that Apple warning, we really need to dive deeper into the question of supply chaine because so much of the world, so much so many companies that manufacture anything are exposed to China or East Asia in some way, and getting some sort of handle on what the risks are is key, and what the risks of course to the China economy are going to be that's also key. Uh So that's what

we're going to discuss today. Great, I think that's a good, good, good idea given the circumstances, let's do it all right. We have a really great guest. We've had him on podcast I think a couple of times before, at least once, but I'm pretty sure twice. He's Dan Wang. He's an analyst at gav coll dragon Omics. He's talking to us

from Beijing. He's a tech analyst really knows a lot about Chinese manufacturing, Chinese supply chains, the interaction with global tech, and uh, he'll walk us through the risks posed by this virus, what we're seeing right now, as well as other risks that maybe people aren't even thinking about right now beyond the virus. So Dan, thank you very much for joining us. Thanks very much for having me on

a gun. We've all seen the images of various cities across China, either quarantined or de facto quarantine, empty streets and so forth. We know that there are numerous factories that have yet to reopen, and the schedule for that is remains unclear. We got the warning this week from Apple that this is going to be a hit to

their performance in the current quarter, So that's known. What to you, based on your work that you're doing looking at the industry, what you've seen, what really jumps out at you in terms of the coronavirus hit to China's industrial economy. So I think you've all lad by saying within a really good way, by saying that basically the

market seems to be parting all of this off. I think there could be an economics way of thinking about that in just uh, you know, if you assume that the virus is going to be mostly contained in this current quarter, and there's some evidence that that could be the case, um, and that's the Chinese economy while basically bounced back into the normal previous trend growth, that will be all expecting there will be some pent up demands that would be released later on, and you know that

it will be a quite that quarter, but everything gets back to trend. I think that case could be made for the general macro economy, and that's why most people are not reacting very much. But in terms of electronics, I think that story would not be so simple, and that's because electronics manufacturing is uh some involves most some of the most complex supply chain ever. Um. You need basically a lot of different components in place in order

to begin production. You need a thousand and one or movie even a dollient and one components all at the right place and all at the right time. And so if you have this delay, which hasn't really resolved itself yet, I think that can ripple on and cascade on throughout the supply chain all the way throughout the rest of the year. When it comes to basically the peak selling season, which is the Christmas season in the US. I think that will ripple on throughout the rest of the year.

How much flexibility is there when it comes to altering global supply chains for electronics companies, because you know, during the trade tensions, we saw a lot of people talking about, well, they'll just move production from China to Vietnam or to

wherever there was that option. But in the current situation, it seems like, first of all, you have to do it much much more quickly um And secondly, no one's really sure how the virus is going to play out, so you don't necessarily have the motivation to move production if you're thinking that it's going to end very very quickly. So how easy is it to to shift supply chains

for electronics companies? It is all pretty difficult. And we have not seen a great deal of production move overseas um as a result of the US terristan Chinese production.

We have that certainly seen. Some have seen a few marginal products something like servers and something like wearables move overseas, especially to Vietnam that's the most cited place, But in general, it hasn't been a wholesale movement of supply chains, and I think, um, you know, that's a pretty difficult thing for our companies to deal with on a short term. A manufacturer made a statement a while ago to say that, you know, the terrorists are something that we can deal with.

That's a cost increase, and that's something you have to we're into, but that is a predictable and something that we are able to resolve. Where he as Um, if we do not have a lot of parts, as that coronavirus has threatened. Um, if we do not have workers in our factories because they just are not coming back, or we cannot pass these sanetary checks or quarantine checks uh imposed by the local government, then we don't even have the parts in place to engage in production. So

this is like a much bigger deal. Talk to us a little bit more about modern electronics supply chains, and in a sense, uh, there are an absolute marvel because all these different companies come together and the logistics are such that companies can hold very little inventory, and and the key part arrives just in time for the other company or the other manufacturer to assemble it into something and then that goes into something else. And it's this

sort of beautiful orchestra. Maybe when it's working, uh, when it's working, ideally, talk to us about what you said when you pointed out, look, it's not as simple as just restarting this because it's so complex. It's not just a matter of Okay, the switch goes off for a few weeks and then maybe you just turn it back on. What is that cast scading effect you're talking about? And why is it not so simple to get it going again once? Once? Uh, the you're ready to restart, Yeah,

that's exactly right. So basically, to really get production going at the major manufacturer like fox Con, you need a lot of different components in place. So you need to have let's play something like the house and components in place. You need all of the labor in place. Also, to begin stacking, you need to make sure that all of the components are um aliving on a daily basis that um,

there is a lot of flow. You need to make sure that the components are of pretty good quality and used to make sure that the labor is of good quality. And right now, basically none of those conditions are holding. So fox Con, it's not said, uh, very publicly very much about how many workers have been able to return UM. Our estimate is that something like half of China's UH migrant labor force has UH allied back into other factories.

It's going to take up quite a while, probably in March or early April, for everyone to get back into their place. And so you know, I think that the larger manufacturers are probably able to deal with a lot of these problems. So fox Con, in spite of a lot of bad press that has received over the last decade, is still the best pain of the large manufacturers that has the best working conditions. UM it is just really large.

It employees about a million people in China every year, and then the five other big contract manufacturers in Taiwan UM employee about collectively UH five thousand, so about one point five million people total working on UM, which is just directly on all types of electronics, but especially the smartphone. And so basically Apple needs a lot of people in place UM and it should be able to hire all

of the people that it needs. But if fox Con is able to hire for everyone, because it is working for its largest customer, Apple, which has a lot of cash to throw at these problems, UM, it might suck away the labor from a lot of the sub assemblers, so the component makers that are supplying goods for Fox con to put onto lines of people to actually produce.

So you know, again, I want to emphasize that it only takes a few missing parts for an entire supply chain not to be functional, and so there will be a lot of these gaps out there, even for Apple. Apple every year launches a new iPhone by Q four that is highly predictable. But even for Apple it is a pretty hot affair. The supply chains are pretty tight and every week counts towards Q four, and not very many firms have a few weeks of production to lose.

So my thought here is that even though large manufacturers working for large consumer electronics companies like Apple are able to get through this, many smaller companies are going to

have a lot more problems. Q one is typically the time of the year where many consumer electronics companies um engage in prototyping and developments with the UH with the manufacturers, and if the manufacturers just are have persistent labor shortages and supply shortages, are going to be dedicating all of their people to their large customers like Apple, and I think the the the case would be here that this year that consumer electronics will be pretty that a lot

of smaller companies won't even be able to launch the products they had hope to launch by the Christmas season. It's if that's already probably the case, and it's going to be a stretch even for Apple. Could you talk to us a little bit more about the labor shortage idea and how the containment efforts that we've seen rolled out across China at this point, how those actually impact the way the labor market functions. So China today has a lot of restrictions in place in who can go where.

When I leave my apartment in Beijing, I have to have flash this little card at these doormen who have are newly set up to exit and enter the building. Um. Every uh three blocks I go, there is someone um taking my temperature to make sure that I'm all right. One thing that I'm struck by now is that the amount of state capacity that China has brought to bear

on this problem is impressive and also frightening. That China has been able to quarantine about sixteen million people around the population of Italy and the span of around twelve hours. My thought here is that China can mobilize it, that isn't more quickly than many countries can mobilize their armies, and so it is imposing many sorts of restrictions on labor. Even today, many UH migrants are not able to enter

the large cities to actually begin a production. So a lot of the public transportation in terms of trains are shut, a lot of roads are a lot of cars are not able to go on the road, and this is creating a lot of problems for factories that really needed labor. And I think the biggest issue here is that there's considerable and certainty about when this virus could be declared eradicated and for everybody to feel faced to go back to other jobs. So these travel restrictions could evaporate, um

let's say next week. Um there are tap could take something longer, um let's say a month, But it will take probably even longer for all of the flights to resume and for all of the people to feel that they can safely travel about in China, and that will create a lot of uncertainties. There is just a lot of human contacts feel required for to engage in production. Yeah. And one of the things that we've seen anecdotally as well is this notion of a sort of patchwork of

local and national rules. So, for instance, in order to open up a factory, you know, local officials will require the factory owner to give face masks to all of its workers. But of course there's a giant face masks shortage, and so there are an able to do that. And we've seen a lot of chaos, let's say, in confusion when it comes to what the rules are and what they are not when it comes to work environments, right can trying to deal with that right around the holiday

and uh, you know, the huge moves extraordinary, Dan. Is there a compounding effect of the delays such that okay, uh you know, I know that at one point the goal was okay, reopened by February tenth. That didn't happen in many cases. But is there a sort of nonlinearity where a week of delays does not just mean a week of problems and each week the situation uh sort of snowballs and grows, uh you know, compounds or grows exponentially. Yes, there is that risk that there is a lot nonlinear

aspect of this. UM. If you were expecting basically a lot of components to rise and a few don't, then UM, a lot of manufacturers could be quite stuck. And for the manufacturer like Fox cons who are at the end of a supply chain basically waiting for everybody to send everything through, UM, they don't necessarily have great visibility into which little part they require. That just doesn't necessarily make it so UM. Every time there's an earthquake in Japan,

UM reminds us. The reminds the world about how dependent the entire world is on perhaps a particular factory making a particular widget, and so UM, these things can be a little bit unpredictable. But I think the the I think the large companies like Apple realize that at this point, and I think everybody is going to be in a scramble in the coming weeks to really understand how deep

the supply chains are. Another issue for Apple right now is that Apple sends a lot of engineers from its headquarters in Cupertino to come over to China and then actually monitor a station. These engineers and monitor the progress of these component makers. Have quality assurance and product development purposes. A lot of those flights are canceled, and I expect that Apple is only able to send a trickle of staff over to China to actually monitor all of that production.

So there are a lot of these worsts out there. Dan talk to us a little bit about I guess the big picture, long term impact when it comes to China's technology ambition. So I think the first time we had you on this podcast was to talk about the MAIDE in China initiative, where China is really trying to bulk up its own technology expertise. Would you expect something like the coronavirus outbreak to have a long term impact on those efforts? Certainly, I think it will push greater

geographic diversity. I think that um, the the the events of the last two years have shown that companies are highly dependent on China for our produc ships. I think many companies are thinking more deeply about what geographic diversity

actually means. So previously we we thought that geographic diversity, um you know, it's important in case there's a flood or an earthquake, which are fairly localized events, and so if you want to basically have a more robust supply chain, you should locate a lot of your factories just geographically

quite far away from each other. And I think the events at least of the last year have shown that when President Trump has imposed tariffs on Chinese goods, but there is a political element, So even if you produced in northern China and then southeastern China, you may necessarily you might still be hit by a lot of these name risks. Now whether and how it impacts China's technology development, I think it is going to make it a little bit more difficult for China to do everything that I

would like. Um, at the very least, it is turning on some foreigners and ex pats out off the idea of living for most of the time in places like Baching, China Hi, and I think that will be at least a loss of potential talents that Chinese firms are able to hire. Dan I think, uh, that's a great opportunity to sort of segue into another another risk factor facing Chinese manufacturing, Chinese supply chain, because it was just a few months ago that there was this thought that Okay,

the big risk was just on the trade front. That seems to have cleared up. They got the Phase one deal. Now suddenly there's this which is uh, you know, as your point, could potentially change everything, or at least change really changed the way companies around the world think about

their exposure to China. But as you point out, and as you've been writing, the coronavirus is really not the only major threat to UH Chinese supply, Chaine Chinese manufacturing, and that there's an another thing lurking out there that people need to pay attention to. So what is that? So that is the um the current US policy on how to restrict technology flows to China, and so they're as part of the trade war. There has also been a bit of a tech war hovering in the background

in terms of US policy action. I think the first major shot of that was last year or or or almost a year and a half ago now when President Trump administration designated ETE to something called the Denied Person's List, which more or less cut off vts entire ability to procure from American technology, especially semiconductors, And so that has brought the firm to its kneed, almost the virtual bankruptcy until Presidency and Trump reached a political solution to save

the company. There has been this element covering the background of the US exercising investment restriction on the ability of

foreigners to invest in US firms, especially technology firms. There has been a process initiated by the Department of Justice to scrutinize Chinese actions much more closely in terms of treats ecretments, appropriation, but also Chinese activities, and say university is working with certain professors, and then it US also manifested in specifically this issue of AWE becoming a large

player in the tech world. And then the administration is thinking much more carefully now about how to deny products American products to a firm that it considers a national security threat. What would be the impact on China's tech industry if the US does actually go through UM with a lot of the things that it's threatening, and what options does China have to offset the impact of those curves. I think the issue right now for China is to

figure out how to be Americanized supply chain. So UM again, this is sort of a supply chain story in which the lack of a few components can really defeat system. So if you take a look at your smartphone and has something like fifteen hundred different components in it, and if you lack even through your four different components, the whole system might be defeated. So your phone needs, for example, a battery, it needs a process or needs memory chips,

and it needs a screen. And if you don't have these, then you don't really have a phone. And given that the US has figured out that it is almost a monopolis on very important technologies, especially the semiconductor and by denying U S semiconductors to particular firms of previously EPs

figured out, it can really cripple China technology advancement. Now I take the view that over the long term, China, now that has realized it is very dependent on US technologies, it should be able to figure out a lot of long technologies. UM. In turn, so UM, it's difficult to name in history a country that has monopolized the key

technology over the long term. So in the eighteenth century, when the UK was the leading industrial power at the time, and when they tried to export control certain textile mills and enginery to the US rising power, certain people just memorize a bunch of mill design gone into a ship and then went to the US. So one of these people is Samuel Slater, who's known in the UK as later the Treator and states side as the father of the US Industrial Revolution. A lot of knowledge just consists

in people's heads, uh, and transfers. I used to working Silicon Valley. The same that we had there was that knowledge travels that has bit of beer beer copy bit for poison. And so long as you can just talk through these sort of ing um and a lot of technology is able to travel. The Chinese don't have to invent anything to novo um. They only have to replicate existing processes. But that is still a pretty big chal um.

The US is basically a monopolist and very many key semic cocceptor of technologies, including the capital equipment to actually advocate the sety conductors and also in things like aviation engines in which China is also kind of catch up.

And so this is why there has been a pretty active debate in the White House on how to actually restrict a lot more technologies to China while also being able to protect the ability of US firms to sell goods to their largest markets and then also generate the revenue for greater R and D. It's so interesting, uh, just sort of thinking about the symmetry or the asymmetry or I guess it's the symmetry of the needs and priorities of China when it comes to trade, and the

needs and priorities of the U S when it comes to trade. Obviously, we know President Trump feels that they he would like to bring back jobs from China, and though maybe you know, it's debatable whether anything that's been done so far I would really accomplish that. Obviously that was a key driving aspect of his campaign and his message and so forth. And then you have the Chinese economy and the Chinese priorities that you've talked to us on the podcast before, and it's not about jobs per se.

It's about the over alliance and uh, you know, winning back the tech tech war against uh, the US. So it's really sort of the same thing in a sense of both just wanting to not need the other. Yeah, that's right. So both countries are clients to reach the purpose serves the technology, which is right now mostly an American affair, and the Chinese also wanting many of the

same things. So I guess then the question is, you know, I've see on the first half of the conversation you were talking about Okay, US companies are going to think about geographic diversity for manufacturing. And of course during the trade war, we heard a lot about Vietnam. But there's really no country immediately that can just suddenly absorb a huge influx of new demand for manufacturing. I mean, there's just all kinds of things that need to go into that.

It's not like you just build a fox Con in Vietnam overnight, or a fox Con in Brazil overnight or anything like that. Who into the race, Like, how long, UH say, will it take for China to accomplish what it needs on sort of, you know, being able to design some of its own semiconductors so that it can wean itself off of US tech. That's a great question thinking about it in terms of a race, and I tend to think that the US has the advantage here.

It is a lot more straightforward for uh Apple to move most of its supply chain out of China uh and into let's say, a mix of places that include India, Brazil, in Vietnam. Then it is for China to figure out semiconductors, which are the most complex technologies in the world. When I think of something like a semi conductor manufacturing equipment from a firm like an smel. Basically, these pieces of

machinery are about as large as buses. Each machine costs about two hundred million US dollars UM and you're really playing with light and physics and math at that point. It's almost like a pure science affair, and the Chinese just have not had enough experience really doing a lot of these things. Now they're the The question that becomes when the US exercises these ex core control actions on China, does it accelerate Chinese technology development or does it are

really crippled? Right? I think odd all over the long term it should still the accelerating China technology development. So UM right now, the you know, the Chinese have always had a program to replace its own internal uh, the

technologies that it uses with Chinese made equipment. Part of that has that has always been a program and has somewhat accelerated UM in after the sting revelations of UM different spying, and I think the Chinese now are m This is the difference in the last two years is that this is no longer a whimsical government effort which

has never really been terribly successful in the past. Now this has led much more by private companies, by firms like um Ali Baba or ten Signs or High Division or sell Me that are asking themselves, can I depend on American supply such that I'm willing to build off my build my technology off in American stack for the next ten years and UM, they are becoming a little bit more hesitant to do something like that. UM, and so they are taking the lead and trying to develop

it's there more homeground, more politically dependable components. Uh. So, Dan, just to sum it all up, I'm kind of curious to get some of your personal observations about the situation at the moment. What has surprised you about how the coronavirus or the containment efforts around the coronavirus have impacted either the tech industry or the electronics industry. What was most surprising. I think the speed and scale of the

payment effort. I think after Woohim was quarantined, um first of all, they quarantined Wolhi really quickly, and basically there has been a really enormous demonstration of state uh power here and state compa sit here, and I think are now trying to figure out given that there are some

encouraging signs that the virus is abating. Um. The number of infections x Hube has been in the double digits I think for the last three days, meaning that the epidemic seems to be mostly contained in in Hube and Wolheim. And as a question now is really how to restart the economy. So they have been really good at making sure that people are in their place and that these

states has the ability to quarantine very many people. UM. Now I think the interesting a lot points to watch is how quickly they can reverse a lot of these restrictions to uh, well everyone's fears and then really restart the economy because a lot of things are just halted. Now. Well, Dan,

really appreciate you joining us. Always love chatting with you, and we should probably you know, do one again, maybe in three months or six month and just sort of reassess where things are on the supply chain and the degree to which the industrial economy has been able to come back. But Dan, thank you, and hope everything returns to some semblance of normalcy fairly soon. Thanks very much, Thanks so much. Dan, that's really good. So Joe, I

found that conversation really really interesting. It's nice to dig deep into the supply chain issue. And I do think there seems to be a sense out there that they can be very flexible and they can be reoriented as needed. But as Dan pointed out, they they're actually quite complex and it takes time to move these things. Now. There are so many things that he pointed out that I

hadn't seen anyone discuss before thinking about. So, for example, okay, Christmas shopping or holiday electronics sales, that seems like a

long time from now. But if the basic prototyping of the next generation of any products is Q one and QN is looking like for sure a total disaster, then okay, even if there is a big economic rebound in Q two, which we don't know for sure yet, but even if there is, there will be inevitably this cascading effect that last at least through the year, and that to some

extent there's no getting back this lost time. Yeah, And the other thing I've been thinking about is we you know, we were just speaking about the production side of things, but you would think that the coronavirus outbreak is going to end up having a very very large impact on

consumption as well. So China is basically in for both a supply and demand shock to its economy, And I also wonder when it comes to the consumption decline, how long is that going to last and is it going to be similar like supply chains and that it takes a while to get back to normal. You know, the Chinese government has spent so long, uh telling people that they really need to make efforts to contain the virus,

they have to stay at home. Is it going to be easy for them to lift those and suddenly tell everyone, Oh, everything is back to normal, you don't need to worry anymore. To Dan's point in the last question, yeah, totally. Because you know, there's obviously there's no cure. There's no vaccine that we have or anything like that yet. So to declare victory over the virus or to declare that it's

been eradicated seems like an extremely difficult thing. And even after you know, people start coming back to work, it seems plausible that fear of a new outbreak, or fear just one person having it and spreading into a new super spreader situation could really change how people behave at least for quite some time after, you know, after whatever that the idea of any sort of imminent resume, resumption of normal life, it kind of seems implausible. There's so

much going on. It's such an interesting story and really sort of unprecedented in many ways. So what a fascinating topic to talk about. Hearing Dan talk about how there's someone who checks um checks his temperature literally every three blocks and as he pointed out, the state capacity required simply to set that up. I mean, it's just extraordinary

to think about what they what has been done already. Yeah, they're doing it in Hong Kong as well, though not quite on that scale, but certainly to get into the major office buildings at the moment, you have to get your temperature taken, so it's a big change. This has been another episode of the All Thoughts podcast. I'm Tracey Alloway. You can follow me on Twitter at Chase the Alloway, and I'm Joe Wisenthal. You can follow me on Twitter

at the Stalwart. And you should follow our producer on Twitter, Laura Carlson. She's at Laura M. Carlson, as well as the Bloomberg head of podcast, Francesca Levie at Francesca Today and check out all of the Bloomberg Podcasts, under the handle at podcast, Thanks for listening.