Wednesday, March 23, 2011

Evidence of Supply Chain Weakness

Recently, I claimed that increasing risks to our global economy are caused by the increasing interdependence between our economies and global systems of production. I also talked about the need to improve our risk management capabilities in order to solidify our global economic system and to avoid deep crises. A few days later, in a Flock of Black Swans, I posted an article by Doug Kass warning us about the increasing frequency of Black Swan events. The author also identified globalisation and interdependence as the breathing ground for Black Swans.

Both of these blog entries claimed that the channel of risk transmission that contributes the most to increasing both the frequency and magnitude of  Black Swans is an increasingly efficient but fragile global value chain.

Although recent events in Japan and in the Middle East intuitively make us understand and fear that large natural catastrophes and significant social unrest can jeopardise the weak and nascent recovery, it still remains difficult for many of us to imagine how can this concretely happen. Some would identify the rising price of energy as a damper on world growth. It is a significant element in my view but not one that is sufficient, at least by itself, to cause a Black Swan event that could reignite events similar to those that occured in 2008 and 2009.

More important, in my opinion, is the danger of a severe breakdown in the global production process.  However, at that point in my posts, I offered readers no concrete examples to illustrate how this phenomenon would play out. However, in Crisis Tests Supply Chain's Weak Links, published in the Wall Street Journal a couple of days ago, James Hookway and Aries Poon supply such evidence. The article shows that the global supply chain is under some significant strains following the Japanese earthquakes and tsunami and that, as a consequence, the interdependent world we live in is indeed very risky as it rests on a very fragile construct.

Here is the piece:

“Companies around the world are scrambling to retool their supply chains as they cope with the Japan earthquake—and many are finding they might not be as well-prepared as they thought.

“Logistics experts said the quake's aftermath has exposed critical weak points for a slew of global businesses, such as electronics and automobiles.

“General Motors Co. on Thursday became the first U.S. auto maker to close a factory because of the crisis in Japan. GM said it plans next week to idle a Shreveport, La., plant that builds small pickup trucks. The company cited short supplies for a Japan-made part it didn't identify and didn't say when it expected to restart production.

“World-wide, companies slowed production or searched for new suppliers to avoid running out of components for which Japan dominates the market. Japan accounts for roughly one-fifth of the world's supply of silicon wafers used to make semiconductors, according to VLSI Research, and is home to a large number of manufacturers for a key material in liquid-crystal-display panels.

“The country also supplies about 90% of the world's supply of bismaleimide triazine, a chemical used in making circuit boards for telephone handsets.

“Meanwhile, Boeing Co. officials said Thursday that they are determining how to deal with possible airplane-parts shortages from suppliers in Japan.

“Nearly one-third of the company's coming 787 Dreamliner, and parts for all of Boeing's other in-production commercial airplanes, come from dozens of Japanese suppliers.

“A Boeing spokesman said the company had "identified points of risk within the supply chain and [is] developing mitigation plans." He said the company will be able to largely manage those risks with "minimal" supply-chain disruption as long as the power supply and transportation infrastructure doesn't worsen in the coming days or weeks.

“"What good companies do is look at a supply chain as a movie, rather than as a photo," said Yogesh Malik, a partner at consulting firm McKinsey & Co. Instead of judging a supply chain by what suppliers can deliver at one moment, a well-prepared company accounts for rising oil prices, environmental activism and regulatory risks to determine whether the chain will hold for the next five years. "It's not a matter of if, but when, something goes wrong," Mr. Malik said.

“An added wrinkle is that companies often buy parts from a producer that relies on raw materials or smaller components that come from yet another location, like Japan. Many companies were scrambling to figure out how much exposure they have to such hidden bottlenecks.

“Honda Motor Co.'s Thailand operation said it was seeking information about the availability of Japanese-made electronics systems. The company's top executive in Bangkok, Atsushi Fujimoto, said the auto maker has enough parts to keep production going in Thailand until mid-April and is considering using alternative suppliers if its Japan-based plants remain closed.

“Also in Thailand, Mazda Motor Corp. Managing Executive Officer Yuji Nakamine said the auto maker is waiting for information from Japan about component supplies and is slowing production near Bangkok. "All Japanese manufacturers are affected but we need more time to get clearer details from our suppliers," he said.

“In Taiwan, Nan Ya Printed Circuit Board Corp. was looking for new suppliers of bismaleimide triazine. Its main supplier, Mitsubishi Gas Chemical Co., suspended production in Japan on Wednesday. Nan Ya "is speeding up the testing of the substitute," a person familiar with the situation said. "Normally it would take three to four months, but this time it should probably take one month."

“Advanced Semiconductor Engineering Inc., a major Taiwan chip-packaging company, said it was attempting to get new supplies of the plastic molding compounds, which are used to house semiconductors, from China and South Korea.

“Even companies that said they were unaffected by Japan's crisis qualified their statements with "so far" and "yet." South Korean memory-chip maker Hynix Semiconductor Inc. said it has enough inventory of silicon wafers to continue operating normally in the short term. "But if the situation lasts longer, it may impact not only Hynix but the whole chip-making industry," a spokeswoman said.

“By building inventories and diversifying their range of suppliers, companies can spare themselves much of the anxiety rippling across Asia and beyond, analysts said, even if it might cost more to store contingency supplies.

“Some logistics specialists have warned that just-in-time delivery systems—pioneered in Japan and often used in the technology and car industries to deliver components and raw materials only when they are needed—are vulnerable to supply shocks.

“Many global producers also have moved in recent years to pare their roster of suppliers to get reduced rates from the suppliers they do use. That creates risks if that smaller base is unable to deliver goods.

“The political turmoil in the Mideast and North Africa, Iceland's volcanic eruption last year and China's move in September to restrict exports of rare-earth materials should have put companies on notice. "Heightened risks and outright disruptions are coming at us at a furious pace and it is absolutely critical that firms be prepared with detailed contingency plans," Jeff Karrenbauer, president of Insight Inc., a Virginia-based consulting firm specializing in supply chains, wrote recently.

“To some degree, the disaster in Japan is unusual. The country has carved out a niche as a high-end producer of many advanced components and materials, and Japanese companies often dominate their sectors. Japan supplies 78% of the global supply for the electrode materials in lithium-ion batteries, nearly all of the protective polarized film for liquid crystal displays and large quantities of other high-tech materials, according to Credit Suisse AG.

“Nonetheless, the deepening worries over supplies of such goods is underscoring how disasters can trigger global supply shocks.

“Sweden's Volvo Cars, a unit of China's Zhejiang Geely Holding Group Co., said that it has only about a week's supply of Japanese components and that unless the company can acquire more parts soon, production will be hit significantly.

“Volvo Chief Executive Stefan Jacoby and the rest of the executive board are meeting every morning to monitor supplies and assess contingency plans. One possibility is to partially manufacture some models and fit them later with the missing components, though that could work for only a short time. Another possibility is to shuffle some production to focus on models that aren't as affected by the supply shortage.”

1 comment:

  1. The critical concept presented here is: "...increasingly efficient but fragile..."

    Everything else is “details” - important details maybe, but still subject to this increasingly evident truth: Efficiency and brittleness/fragility are codependent factors in the cutting-edge systems we are creating. Slack removal has become the modus operandi of our hyper integrated and efficient systems/economy. Digitization has provided a renaissance in efficiency-mongering with no 'sea-anchor' to slow down or temper the speed of change. I first wrote about this four years ago, just before the global financial meltdown, and called it "obscure dependencies": systems that contain critical but largely opaque interdependencies. Opacity is always relative, but refers specifically to systems users and decision-makers, particularly leadership (as opposed to narrowly-focused technicians experts e.g. “quants”).

    There is a profound lack of “systems thinking” in the business world today, which is still based primarily on rewards for extracting value, as opposed to long-term value creation. This leads to increasingly sophisticated systems for extraction, but ignores the importance of slack and redundancies in systems - the very things that allow for resiliency, adaptation and sustainability.

    The possibility for fundamental change to this thinking and these systems is daunting. There are a few business leaders who are advocating a more holistic view. (Roger Martin at Rotman in Toronto for example) It remains to be seen if people are willing to put everything on the line to slow the momentum towards total systems collapse. Just imagine something similar to the financial meltdown happening in our fragile the agricultural, educational, energy and telecommunications systems (to name a few) simultaneously. A few years ago most business leaders couldn’t imagine what is now a reality. It’s time we get more imaginative.

    -scott francisco