Spotlight on Supply Chain Risks and Resiliency

It's possible that "supply chain disruption" is not quite the right way to describe the impact on logistics providers of the triple blows of the March 11 earthquake, tsunami, and nuclear catastrophe in Japan. Disruption implies a temporary or even minor condition. But in the weeks following the disaster, it is becoming clear that the disruption to supply chains - especially in the auto, auto parts, and electronics industries - is anything but minor or brief.

This has vast implications not only for dealing with the immediate situation, but also for how logistics professionals assign risk and plan for random events and worst-case scenarios. Indeed "worst case" seems to be getting more frequent and, well, worse.

This is becoming increasingly important as our global supply chains become longer and more complex, while the potential for severe events and natural disasters (earthquakes, tornados, floods), terrorist activity (9/11, Somali pirates), political activity (the Middle East), and military actions (Libya, etc.) multiply. Given that these events are more probable and occurring more frequently than in the past, today's managers have to develop flexible supply chains. This includes multi-sourcing raw materials, reviewing inventory strategies/JIT/lean programs that minimize inventory, developing contingency plans and testing them, and providing technology to connect the dots - if the dots (for instance, real estate) - move or suddenly disappear.

Risk of Single Sourcing
As you stretch the length and complexity of the supply chain, it becomes subject to a wider array of possible interruptions. Many of them are unpredictable, but pattern recognition and contingency planning can help mitigate the impact when the unpredictable strikes.

For example, the situation in Japan calls into question the concept of using single vendors and single sourcing. Let's take a look at what supply-chain managers are facing as problems have spread rapidly to other Asian countries, as well as to Europe and the Americas.

By late April, reports indicated that Japan's exports had declined nearly 20 percent since the disaster struck. The maritime law firm Ince & Co. advised ship owners and charterers to "consider carefully" what risks they are prepared to undertake with potential radiation contamination affecting vessels calling on Japanese ports. Meanwhile, shipping rates for cargo to Japan have risen 55 percent since the earthquake and tsunami occurred.

As a result of supply-chain problems, Toyota will limit production at its plants around the world. The plan was to suspend production at North American plants on Mondays and Fridays between April 26 and June 3. Production on Tuesdays through Thursdays was set at approximately 50 percent of the normal rate. In Canada, production was to be suspended for the week starting May 23, and in the United States, for the week starting May 30. Plants in the UK closed over Easter, and production was also slated to be reduced in May. Production in China was to be reduced 30-50 percent of norm from April 21 through to June 3. Parts plants were directed to alter their operations accordingly, and a decision on production after June 3 would depend on the parts-supply situation. Toyota has estimated that output would begin to recover at mid-year, but levels would not return to normal until the end of 2011.

Nissan and Honda have also reduced production schedules. All three of Japan's auto giants received negative ratings this month from Standard & Poor's following steep declines in their March output. S&P said supply-chain disruptions are posing a greater challenge for Japanese automakers than it had initially anticipated and had forced virtually all Japanese automakers to significantly cut output in Japan. The agency expected that parts shortages would be largely resolved by July, but cautioned that "full production is unlikely to recover in the summer" due to power shortages and a time lag for parts to arrive at overseas plants. "We currently expect automakers to eventually return to full or near full production by around October," S&P said in an April 25 report.

And it's not just Japanese automakers that are feeling the effects of the supply-chain disruptions. Japanese companies account for about 40 percent of the world's technology components. The country makes 30 percent of the world's flash memory, used in smart phones and digital cameras, and 10-15 percent of D-Ram memory, a key component in every personal computer. Among the core parts made in Japan that are impacting supply chains are capacitors and transistors - components contained in virtually every electronic product.

Assessing Risk Early On
According to Robert Bach, chief economist at Grubb & Ellis, "The Federal Reserve and many private economists have lowered their 2011 U.S. GDP growth forecasts by up to a full percentage point due to turmoil in the Middle East, rising oil prices, growing angst in the Eurozone, and the disaster in Japan." Negative forecasts like this - and there are plenty more coming in each day - add up to severe headaches for supply-chain managers for the rest of the year.

According to Kiyohiko G. Nishimura, deputy governor of the Bank of Japan, it will take a considerable amount of time to reconstruct supply chains interrupted by the Japan disasters. Repairing supply chains is just one of three inter-related issues facing the country; restoring production capacity and constraints on electricity supplies must be addressed as well.

"At present, firms are working to repair or rebuild supply chains by, for example, seeking to secure alternative suppliers, including from overseas, and reviewing product specifications. However, as supply chains are complex and interconnected, if a bottleneck occurs in any one part of the chain, accurately gauging its impact and addressing the problem present various difficulties," Nishimura says. "Therefore, a considerable amount of time is considered necessary to reconstruct supply chains."

Those words put the spotlight firmly on the need for a firmer understanding of supply chain risks, risk assessment, and risk management. Japan's events underscore the importance of assessing the risk that manufacturing and distribution companies are taking within their supply chains early on, understanding the tools that can help cope, and implementing those assessments. Obviously, in a complex and long supply chain, risk can be difficult to see; even if one small link is broken, the damage will spread quickly throughout the chain without proper planning and foresight.

Many Japanese auto parts and electronics components are from single-source vendors and are not available elsewhere. In other words, even the smallest single-source widget can cause huge reverberations and delays along the supply chain. If this comes as a surprise after a disaster or interruption occurs, it's too late. Companies are then in scramble mode - and it is hoped that communications and "war room" protocols are in place.

Importance of Resiliency and Backup Sourcing
A major lesson for managers now is to build in resiliency and backup sourcing as part of the contingency planning process. This should include dual and long- or near-shore sources for manufacturing and distribution throughout the chain.

For single-source suppliers, reliance on just-in-time and lean approaches is potentially dangerous and shortsighted. Keeping a week's or even a few months' inventory of vital parts and components from single sources will keep the chain intact during a crisis while production ramps up.

Up to 90 percent of supply chain-contingency planning should comprise dual sourcing. In cases where the chain must rely on a single-source supplier, a different inventory strategy is needed. In an extreme case, such as presented by the disasters in Japan, this could mean an additional six months of storage.

Paying attention to the total landed costs along the entire chain will also help in sourcing, inventory, and contingency planning. Obviously, longer supply chains carry significantly greater risk than short supply chains. Modeling the total landed costs associated with procurement reveals a comprehensive picture of the financial value of various sourcing strategies. This calculation includes not only labor and manufacturing costs, but also transportation, distribution, handling, real estate, duties and taxes, and damage costs. The total landed cost analysis gives managers a clearer picture of the global supply chain, its inherent risks and rewards, and whether to opt for a dual-source and/or near-source strategy.

This analysis can also play a major role in decisions on back-up production and distribution plans (flexible real estate options), substitute parts suppliers, and alternate transportation and inventory strategies. I am aware of one company that has a full real estate and technology "backup" plan in place to get a 400,000-square-foot facility up and running in a matter of weeks if one of their major distribution centers goes down due to a natural disaster. The "site" moves around the country as the landlord rents the space, but a T1 connection also moves to the new building location to ensure instant connectivity to the facility if execution of the plan is initiated.

With the Japan disasters, for the first time, many logistics managers have had to face this type of situation lasting a prolonged period of months rather than days. Disruption, interruption, or whatever you call it, is one of the most significant supply-chain events in modern logistics and outsourcing times.

In that respect, it can - and should - also be a learning experience, by providing the impetus for implementing comprehensive and resilient contingency and backup planning strategies along the supply chain.