Understanding Global Distribution Networks in The Hour of Chaos

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April 3, 2020 1:13 p.m.

Let me share with you three notes from TPM Reader SK. The exchange starts in response to TPM Reader BW and my post from last night. Some of the points SK makes about BW I don’t necessarily agree with, or at least points of emphasis. But I’m sharing these emails because SK is in the distributor business (though not for medical supplies) and has a wealth of knowledge about the nitty gritty of how these distribution channels work. That’s critical background to understanding any of this.

One point that is incredibly important to understand is the distinction between two very different kinds of players involved in these transactions.

There are a handful of big national distributors who service the health care sector. It seemed to be those that Adm. Polowczyk described working with at yesterday’s press conference. Those players have longstanding relationships with their customers and ones they’ll need to be there once this crisis is over. They have significant incentives not to brutalize their customers during the crisis or over-press their advantage.

But there are also a mix of middlemen and interlopers who are jumping into the market, often with little history or future in the medical supply world. Those folks have every incentive to wrest every last dollar out of each transaction. I talked to one source in a midwestern state who described just this sort of thing happening. States dealing with middlemen holding critical supplies in cases where it’s clear the broker doesn’t care. Even a kind of gleeful indifference to the buyer’s desperation. That person is never going to deal with the hospital system or that state again. So any hard feelings don’t matter.

But the distinction can get blurry because these are not separate channels. It’s not like there’s legit supplier stream to hospitals and shady shark broker stream. As desperation escalates the latter group is clearly dipping into the former.

With that, let’s hear from SK. This is three successive emails. So it may be a bit choppy but the perspective and knowledge is important to absorb …

Email #1

Reader BW is a little out of his depth on how goods make it from China to the US in terms of air freight and one has to be very careful reading too deeply into logistical statements without a deep baseline in international logistics.

It doesn’t surprise me the military has arranged international flights for freight for the single reason that a large portion of air freight was/is piggybacked in the belly of commercial passenger airlines. Most people will never realize it, but international air freight uses excess commercial airline traffic plane storage capacity to make it cost effective to move something overseas quickly. Compare this to ~21 days travel via ocean freight, not counting port delays and line for unloading vessels which can push sea freight to a 4-6 weeks delivery window just to a Los Angeles warehouse (NYC from China is about ~24-27 days on the water plus port time). Don’t assume carriers like DHL/Fedex will just run more planes (if they even have more planes that could make international trips), as they have always relied on commercial jets, not their own flight capacity, to move substantial international freight by the air.

Commercial air freight costs have risen substantially (we quote these to commercial clients weekly and they started rising as soon as commercial flights started cancelling) because there simply aren’t enough, or really any, commercial air freight flights making inter-country travel in the quantities that have enough capacity to meet demand. It’s not surprising the military might be arranging flights just to increase capacity to move goods. Now, is the military being re-imbursed, and by whom, who knows? Is the government simply offering a free service to carriers to book shipments (a deal with carriers is maybe more likely than it is distributors themselves depending on whose doing the loading/unloading of the planes and where is that happening, commercial or military airport) or are carriers paying for the service somehow. My guess is there was likely identified an immediate shortage of capacity to move freight via air and the quickest way to solve that problem would be to have the military arrange flights (this would be opposed to maybe using the DPA to seize control of commercial airlines that have international capable planes to do similar since it’s unlikely carriers have a surfeit of international planes they weren’t already using), but in a definitely less efficient manner than using something like a C-17 (sic) which is built to hold cargo in large volume.

You do make a slight error in mentioning distros might control delivery from airports to their warehousing. That’s not likely to ever be true, namely because normally you’d have a carrier company working that link in the chain. Just like it would be extremely unusual for a distro to have their own plane with which to carry freight.

So, on the surface, there’s nothing inherently corrupt about an airbridge and there are some logical reasons this would be an optimal solution in the short run. That said, illuminating the actual details would be effective for helping readers understand how things like masks from China get to their doors and the risks that go along with that when an interwoven economy is crashing at the same time.

Bidding by the state’s is a problem, as you say, but there are a couple facets to this problem. Namely, what is the viable legal alternative? Even in a situation where the distributor tries to please all of their normal clients, because these client are still going to be around after COVID passes, you’ve got a crush or new buyers and existing buyers who simply are demanding more product than is available, and are just waving higher and higher prices in the distribtuor’s face in order to grab more of a limited supply. Now, it’s possible the government could step in as a buyer of last resort, but it’s not clear what legal authority they would use to do this (not sure if the DPA covers distribution versus production). There’s also the risk that what happens if we muck around with the healthcare supply chain and suddenly that rest of the supply chain stops functioning, not necessarily for masks, but for other medical goods. Distro business on a good day usually has thin margins, so it’s not going to take much of a downturn before they start laying off workers and then that chain is compromised (and they’re likely already seeing some downturn with outpatient surgery centers and elective medical procedures shuttered).

That said, you still do have plenty of scumbags getting into the distro business where they have no interest being other than to make a quick buck. I get WhatsApp messages from Chinese business people about every 2-3 days, most of whom have shady reputations in an unrelated plastics industry, about how they now can offer me 500,000 surgical masks for something around a 400-500% markup over pre-COVID production costs. Maybe one could establish a some sort of temporary import license restriction on certain medical supplies (since anything coming from overseas goes through the import clearance process), but I’m not experienced in import laws enough to know how that would work legally. I think outside of that, a name and shame policy works best on these people simply because most of them won’t remotely add any value and can’t possibly be more effective than established players at meeting the real needs of the healthcare community. In fact, they’re even more dangerous to the established players because they are going to bid up Chinese supplies overall. The optimal governmental path here, if one doesn’t want a total takeover, is probably to ring-fence existing distribution networks and try to smooth out their problems as best one can (also accept that some increased gross profits are simply going to have to happen if one wants a previously calibrated 8-5 supply chain to now be 24/7 because costs are going to go up). Pass a bill to tax excess net profits if necessary, but let’s not forget the government has been subsidizing fat medical profits for years going back to Bush/Obama and Meaningful Use legislation so it’s not like this is out of the ordinary under the current legal regime.

It helps to remember greed and avarice really don’t have borders, and it’s going to be somewhat clearer when we have a full picture where we need to shore up the legal weak points to constrain bad behavior in a crisis. I’d love to see you all report on it, mostly cause I enjoy understanding and working with supply chains, but it’s going to be some tall weeds to sort through to present a truly full picture of the failures and what should be done about them to limit bad acting.

Email #2

I definitely agree bad actors are a serious problem here, but I want to dig into who has the most incentive to be bad actors. The established players, and by that I mean your major medical distros, have the least incentive to act poorly, because COVID-19 will too pass, and if they still want to be in the distro business, they need to preserve relationships. What I own is in the distro business, and believe me, we do care about relationships because they last longer than any season’s profits. If they burn a hospital system today, that system is going to remember that tomorrow, and believe me, they will make them pay for that long term (these non-profits systems going on hundred years in some cases have long memories). Now, I might be totally naive in that, but this provides some definite gates on truly egregious bad behavior on the distro side for long term players who plan on staying in the business. Not that we shouldn’t augment those natural gates, that’s not what I’m saying at all.

Also, I think we both agree those gates absolutely do not exist on fly by night buck hunters. Those types have zero investment in what they’re doing other than to maximize situational arbitrage. These people create way more problems than they offer to solve, for everyone involved. Whatever we do should be first focused on eliminating those types ability/incentive to create an even bigger problem than we’re already trying to solve. Coincidentally, things that hurt the speculators often conversely help the long time players do a better job. To the extent we’ve locked those people out, then we can deal with the different challenges of helping existing players play the role we need them to in this crisis without punishing them, but also gating their ability to truly go off the rails.

I do think (processing this in real time) there can and probably should be some temporary legal strictures, maybe import/export license restrictions, which is where goods run into natural governmental choke points (this gets into HTS code declarations) and combined with threats to carriers who break these restrictions (who do not want to lose their ability to move goods in/out) we can limit the ability to move specific products in/out of country to approved channels. These things already exist in various areas of commerce, think defense, and so a legal argument on those grounds (since pandemic response is a national defense oriented response) could be made here to basically build a pretty fast and durable first wall between profiteers and people who have established medical distros already in place. Subsequent to that, perhaps layering in some national emergency audit capabilities in place would provide a way for distros to validate they weren’t selling out their backdoors to speculators during a crisis. A little bit of required federal paperwork could go a long ways towards tampering down any desire to behave poorly. If I was trying to solve this problem in a Congressional office, these are where I’d be looking to apply new legal requirements on the import/export/selling side (because they already have workable models in other areas of commerce).

I wholly agree, consolidated purchasing makes sense, the problem is I don’t think anyone has a great model for how to consolidate purchasing on the fly in real time (again showing how little real planning went into the mechanics of fighting a pandemic) across tons of players. If there was a consolidated purchasing regime/plan that we could flip on like a light switch, I’d say absolutely do that. The problem is we don’t and that’s more something that buyers have to agree in advance to do, rather than the distros because working out payment/delivery mechanics are the dirty details here. If someone has a plan for the government can quickly consolidate purchasing across public/private entities and then let the distros do the last mile work of getting the products in place, I think it is something we need to explore fully and frankly bake in pandemic preparedness. All real distros are equipped to deal with consolidated buying offices because we do it today, the problem is it’s the buying office that really needs to get its act together before we lay the problem at the feet of the non-fly by night distro offering the goods. Here’s where we really need a national or regional plan for consolidated buying ahead of an event and then prior emergency service agreements in place with distributors so they can have some confidence they’re not going to get hung out to dry (their money is at stake after all) because suddenly Fauci says masks are useless, and edge case, but it’s a risk that has to be quantified. Again, who gets their purchasing consolidated? Do they need to be tiered by risk factors, etc. These questions can and should be answerable, arguably it’s just hard to do it in the midst of a crisis caused by not doing exactly that before the crisis started.

It’s also insane to me that there are healthcare buyers are paying for goods that aren’t even getting delivered, or aren’t even tested beforehand. There are testing companies like Bureau Veritas for example that should, with planning, be able to randomly assess and validate every lot of supplies coming inbound. Again, a total lack of planning for supply chain management creates an even bigger pull for bad actors due to less risk of getting caught once they abscond.

I’m less concerned about export restrictions than maybe you are. China clearly has to export just to revive their economy (also some of the Chinese prices increases, and they are across the board in other manufacturing sectors, is to me an attempt to recove their losses from the shutdown on their side), although it doesn’t need to go to us. But, we’re the largest single market in the world next to China, and there are a lot of policy levers/carrots/sticks to use there.

I think where it pays to be careful is that we not paint every distro with a brush of greed and avarice without proof (we need to heap scorn and shame on bad actors, but also be willing to look to see if some are doing their best jobs in this crisis and let them share insight into what could be done better). Also we cannot neglect the role of both government, but also major healthcare organizations and groups down the line, as to their abject failures to plan strategically for what is going to look, at the end of the day, like a series of obvious problems that could have been avoided with some forethought and national/regional planning documents/agreements (a friend of mine has done disaster recovery planning for major healthcare firms for years and it’s always a fight to get organizations to pay attention to their risk profiles).

That’s my and others pure frustration with everyone in real power during this crisis. It’s like a comedy of errors that increasingly threatens a lot of good people around my family, yours, and everyone’s, all because we couldn’t, through our leaders, collectively stop and take a moment to game out the full spectrum of risks involved in a real way, how we’d get through something like this.

Email #3

One other small item, but important to consider when we talk about supply chains is indemnification/liability. Existing distros are required by any major business customer, to carry indemnification policies (basically agreeing to be legally held liable if someone sues your customer for products you provided). If I sell a consumer product to Urban Outfitters, for example, they require as a corporate policy, that I test the products, and that I list them on my insurance policy in case of a lawsuit. This creates of course incentives for me to a) validate the products I sell them are of appropriate quality b) make sure manufacturers behave and create products according to specifications. At the end of the day, I’ve put myself on the legal hook even though I’m in the middle of the chain.

This is why it’s so tragic and unbelievably stupid to see anyone going outside existing, normally approved, supply chain channels to purchase products for critical industries like healthcare. I would be exceptionally leery of anyone who did that simply because without those testing and liability regimes in place, we’re all in a caveat emptor place. It’s the worst kind of gambling even if the mistakes being made are in the best interests of everyone involved. We should have from the start looked at how to scale the existing approved channels rather than go out of band here.

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