6. Case Examples
Rubber Products from South-East Asia: Trade Frictions Arising from Government Monopolies Disrupt Markets
South-East Asia dominates global rubber production, but substandard infrastructure, poor quality control and long lead times make the supply chain for finished goods unreliable. Suppliers of medical disposables and devices have little room to bargain when negotiating prices and are forced to endure supply chain bottlenecks that result in high inventory costs and tie up capital. Eliminating supply chain barriers could reduce inventory lead times by as much as 90 days and lower supply chain costs by some 60%.
South-East Asia accounts for 70% of the world’s production of rubber,50 the indispensable raw material used in countless final products, including surgical gloves and many other healthcare applications. Their monopoly position gives producers in the region the power to impose high prices that squeeze distributors’ margins. Because they tend to set prices at the point of delivery rather than where and when customers place orders, price levels are volatile and unpredictable.
Market factors strongly influence the price of rubber. Production is seasonal, with yields falling during winter months; demand fluctuations, investor speculation and adverse weather conditions combine to make raw material prices volatile. Speculation led to a rubber price spike in 2011 and prices have declined sharply since then. But governments of some of the top rubber-producing countries across the region distort prices by attempting to control supply.
Top exporting countries have tried to influence prices with a variety of policies. These included measures by the Thai government in 2012 to purchase product directly when prices fell below 120 baht per kilo and a zero-interest 15-billion-baht loan programme to assist struggling rubber farmers.51 Last August, the governments of Thailand, Malaysia and Indonesia agreed to trim exports by 3%, or 300,000 tonnes, for six months to shore up prices. When those measures proved ineffective, the three top rubber producers set a price floor, agreeing to intervene in the rubber market when prices fall below US$ 2.70 per kilogram.52 The coordinated action did manage to lift the global rubber price, imposing higher costs on producers, distributors and end users.
Another reason why these markets hold more power is that Indonesia never developed a strong rubber products industry,53 limiting the supply. As the largest rubber producer, it was well positioned to develop this market when AIDS became more prevalent. A certain European-based distribution company hardly ever sources from Indonesia, as it perceives it as corrupt54 and generally finds it difficult to operate in the country. It believes these business environment factors prohibited the development of strong infrastructure and technological capabilities. One of its business development managers mentioned a Malaysian manufacturer who moved to Indonesia, but that he was “forced to pay bribes just to keep the electricity on. Many producers encountered similar challenges. Most ended up closing up shop within 3 to 5 years or so.”
In South-East Asia, the rubber market is also beset with supply chains made unreliable by labour unrest, substandard infrastructure, natural disasters and widespread official corruption. Quality levels are inconsistent, requiring buyers to maintain costly quality control teams on staff to certify quality before the product is brought to port. Order processing also creates bottlenecks because the manual procedures used in local plants cannot accommodate electronic orders placed by European distributors. Facing long lead times of up to five months, suppliers risk delivery delays requiring them to accumulate large inventories sufficient to cover orders for 120 days, raising financing costs and cutting profit margins. A large US supplier that depends on rubber sourced from South-East Asia estimates that if supply chains were reliable, it would be able to reduce its inventories to just a 30-day supply. Together with reduced quality controls this could lower supply chain costs by some 60% (see figure).
Beyond having to contend with unreliable supply chains in producing countries, distributors’ sales are affected by unfair competition resulting from the different controls they face in end markets. In particular, technical and quality standards in the European Union (EU) differ from those in the US, with adverse effects on the production process. Manufacturers adapt by trying to manufacture all of their products to satisfy the higher EU quality standard, but inspections are infrequent at European borders and very common for goods coming into US ports. Shipments that do not meet US Food and Drug Administration (FDA) standards are refused entry and their distributors are put on alert status, requiring them to ensure that their next five consecutive shipments are clean to have the alert lifted. Repeat violations ratchet up the penalties and potential fines the FDA will assess. The discrepancy between the levels of enforcement of quality standards ends up hurting EU customers and benefiting those in the US. Shipments of substandard products that are refused entry to the US are most probably dumped at below-market prices in the EU, where hospitals and other buyers sensitive to product quality are using them.
Note: Reducing barriers assumes 75% reduction in safety stock costs based on decline in inventory lead from 120 days to 30 days, 90% reduction in quality management + inspection fees.
Source: Company data; landed cost per container ex. Asia.