Japan One Year Later: The Long View On Tech Supply Chains

Guest post written by Linda Conrad

Linda Conrad is director of strategic business risk management at Zurich Financial Services.

Linda Conrad

One year has passed since the tragic earthquake and subsequent tsunami ravaged north-central Japan causing nearly 20,000 deaths, sparking a nuclear crisis and generating total economic loss of more than $300 billion. The alarming, heartbreaking images coming from the region encapsulated the human loss, but the ripple effect for businesses across the globe wasn’t as easily captured by the camera’s lens.

Between the catastrophe in Japan and the devastating floods in Thailand just eight months later, 2011 proved to be a difficult year for multinational manufacturers and their suppliers.

Damage and workforce displacement left critical suppliers and subcontractors for auto-makers, technology firms and countless other industries short on parts or completely out of supply. In Japan, a factory manufacturing 60 percent of global car engine airflow sensors was shut down during the disaster, pitting competitors against one another in the fight to access scarce materials. Companies with finely tuned inventories saw their cost-cutting efforts and just-in-time strategies eaten up by the financial and reputational cost of supplier disruptions.

Despite the images coming out of north-central Japan last March, a significant portion of the supply chain impact was not caused by physical damage at the epicenter of the catastrophe. Instead, rolling brownouts in southern Japan delayed production at many firms, costing even more in business interruption and recovery expenses. This surprising cause and effect taught multinational organizations some hard lessons about supply chain sensitivity, and caused some to rethink their procurement interdependencies from risk perspective as well as a cost calculation.

In the face of shortages, one company was unable to secure similar inventory and was forced to purchase higher-cost, spare supplies in the open market. They were forced to pull engineers out of research and development to redesign their products and production to accommodate these spare parts, which lead to lost innovation and delayed a new product launch, which only intensified the sales disruption. In another case, a factory that was the sole supplier of brake parts for a major Japanese automobile manufacturer was destroyed. The production disruption immediately shut down the manufacturer’s just-in-time supply chain, forcing 18 plants to close for nearly two weeks resulting in a total loss of sales on the order of $325 million.

Taking the Long Range View

To grapple with this, businesses must start viewing the supply chain outside the silo of procurement to get a better handle of the likelihood of a disruption and real cost of recovery. Steps like sole sourcing, which are taken to drive cost out, can often inadvertently drive risk into the supply chain. When procurement is compensated only for short-term, cost-cutting measures, companies may lose sight of the increased threat posed to their longer term reward of business resiliency.

It is ill-advised to ignore the fact that the frequency and impact of natural and man-made disasters is increasing. According to the 2012 World Economic Forum risk report, of the 25 most costly insured catastrophes in the past 40 years, two-thirds have occurred since 2001. Without the benefit of a thorough supplier risk analysis, companies can simply underestimate their exposure and overall investor impact when supply chain logistics and cost aren’t optimized and counterbalanced with proactive risk management tactics.

While the awareness for this balance is shifting, businesses still have plenty of ground to cover. A Zurich Financial Services-sponsored study conducted by the Business Continuity Institute showed 85 percent of companies reported at least one supply chain disruption in 2011 with about 50 percent facing more than one disruption.  Yet only eight percent of companies said they ask to see their suppliers’ business continuity plans, or investigated who and where their suppliers get their components. This robust risk review could be vital since over 40 percent of disruptions come from sub-tier suppliers with which a company has no contractual connection.  In other words, disasters will strike, but the majority of today’s businesses may not be prepared for the long-range threat they pose without taking additional analysis and contingencies.

Thinking about “just in case” rather than “just in time”

A century ago, relationships across the supply chain were more hands-on and high-touch. Just 20 years ago, the supply chain included third party suppliers playing a key role in stockpiling and storage and offered a broad choice of competing producers and suppliers of goods and products. But in the last 20 years, there are fewer competing producers, and businesses have adopted “just-in-time” manufacturing, component outsourcing has gone offshore and supply standards and third party suppliers have been replaced with direct and single sourcing.

Due to the increased complexity of today’s value chains, they are more frequently disrupted by non-physical events like IT outages, transportation issues, strikes or supplier insolvency. Companies who only insure and protect themselves against physical plant damage can miss the competitive advantage of increasing supply chain resiliency and continuity planning. A greater understanding the various causes, geographic locations, political and industry issues surrounding disruptions can help companies to begin to think beyond “just in time” to planning for “just in case” a disruption occurs.

By taking an enterprise-wide view of the impact the loss of a single supplier could have, companies can gain crucial insight into supplier risk costs. Here are a few suggestions:

• Assess and quantify suppliers’ risk exposures, incorporating factors such as natural catastrophe modeling, political risk, marine/ transportation issues, financial review and historical data from prior disruptions for other companies and industries. Remember to review factors within a company’s sphere of influence, and risk issues that remain outside their control.
• Look at the impact and likely frequency of potential supply chain disruptions. Determine which suppliers or supplies are most critical to the organization’s ongoing success – and which suppliers would cost you the most to recover from should they fail to deliver.
• Map out the value chain, to identify concentrations, bottlenecks and interdependencies, particularly across product lines and business units.  For example, the flooding in Thailand last fall demonstrated the importance of ensuring supplier geographic dispersion, as the long recovery shackled the hard disk drive industry.
• Do business impact and scenario analysis to assist in developing and pricing the increased expense to quickly recover production and reduce potential brand damage.
• Consider todays’ innovative financial solutions such as supply chain insurance which offers an ‘all risk’ coverage to insure against the broad variety of disruption causes and offer financial support for the extra recovery expenses that follow the interruptions at a critical supplier.

A company’s supply chain is its lifeblood, a critical contributor to profitability and shareholder value. What the 2011 disasters showed us is that many companies haven’t kept up with the risk management side of the additional exposures posed by global value chains. So if a silver lining is possible, it’s the realization that modeling disaster preparations and recovery for a business and its suppliers is the key to long-term survival.