In today’s global business environment, almost every company is at risk of supply-chain disruption from a man-made or natural disaster, though most won’t be as severe as last year’s earthquake-tsunami in Japan. While companies can’t control events, they can minimize the fallout their brands suffer with proper contingency planning.
Renesas Electronics Corporation, the world’s largest manufacturer of microcontrollers and one of the world’s largest manufacturers of semiconductor systems, was hit hard by last year’s earthquake in Japan. A number of the Renesas factories were badly damaged, including the company’s leading-edge factory in Naka, Japan. The company was able to have the factory back up and running in a few months, but Renesas is taking supply-chain and business-continuity lessons learned during the earthquake to heart.
Renesas is one of hundreds, if not thousands, of companies that have been affected by recent natural disasters. According to an international survey on supply-chain resilience by the Business Continuity Institute (BCI), 85 percent of respondent companies were affected by at least one supply-chain disruption last year, with 20 percent of companies affected by the earthquakes and tsunami in Japan and New Zealand. Denise Harrison, executive vice president and COO at Center for Simplified Planning, Inc., says that the recent flooding in Thailand may have affected even more types of companies than Japan’s disaster.
The price of a supply-chain disruption can be far more than just the actual cost of replacement of the lost inventory or capacity or loss of current sales. “Everything is about brand management in the modern world, and if you’re not managing your brand image, then you’re going to start losing not only short-term sales, which most large organizations can live with, but actually losing market position,” says Lyndon Bird, BCI’s technical development director. That’s much harder to recover from, he notes.
An oft-pointed-to case study that illustrates this point occurred in 2000 when lightning struck a Philips microchip plant in New Mexico. Mobile phone manufacturers Nokia and Ericsson were among the major customers for the chips. Nokia quickly switched to another supplier but Ericsson did not, leading to a major loss in market share from which the company never quite recovered before merging with Sony a year later.
Companies that want to avoid that fate must plan ahead. Among the issues they need to address are: which of their suppliers are critical, what risks are likely to affect those suppliers, and what countermeasures can mitigate the risks.
While any or all suppliers can be affected by a disaster, not all are critical to a company’s supply chain. Thus, the first step in business continuity with regard to supply-chain security is to assess which suppliers really matter. “Then work with those to understand their vulnerability,” says Bird. “And if they are too vulnerable, look at having more than one supplier and making sure they’re in different geographic locations,” he says. (More on supplier countermeasures ahead.)
After identifying critical suppliers, the next step is assessing their exposure to risk. Harrison advises companies to conduct risk assessments of their critical suppliers that look at everything from financial risk to disaster risk. Companies also need to consider risks to themselves and their suppliers related to globalization and just-in-time inventory practices.
The global nature of today’s business environment increases the overall supply-chain risk exposure. Carlo Altomonte, associate professor at the Universita Bocconi in Italy, describes the path that an electric toothbrush takes to get to market as an example. He explains that “this electric toothbrush would be produced in 11 different plants in nine different countries in three different continents.” And that’s the case for many products.
In the past, local disasters would only have affected local supply chains, but now, as a result of that type of global production and supply-chain process, the consequences of a local event can be felt the world over.
Probably all executives would say they are fully aware of the global nature of business, but when they assess risks, they still don’t necessarily think about the risks facing their suppliers around the world. They don’t really think about the threats where those local plants are, says Bird.
Adding to the risk of fallout from any disruption in the supply chain is that most companies today operate using the “just-in-time” model for inventory. Based on an approach developed by Toyota, it essentially means that companies do not maintain much inventory; they order parts and equipment as they need them, which cuts costs. But that lack of inventory can make a company vulnerable. The risk is that when a disaster like an earthquake strikes and destroys existing inventory or existing production capacity, there is no backup inventory to make up for the loss.
Renesas, as noted, is one example of a company that is aggressively working to reduce its exposure to supply-chain risk. It already had arrangements to ensure that 80 percent of its microcontrollers could be produced at an alternative supplier if need be. Now, it is working to up that to 90 percent. “We are now establishing a system to enable a multi-[factory] approach so that, in case another disaster strikes, we can quickly shift to those [other factories],” says Ali Sebt, CEO at Renesas Electronics America.
In addition, the company is working to establish contractual arrangements with more suppliers of raw materials to reduce the chance of a supply disruption if one of its primary suppliers is affected by a natural or man-made event. “We’re going to have more alternate suppliers of those raw materials, but also understand who is supplying to our suppliers [and] have better visibility into their health and their well-being,” Sebt says. The company will do that, in part, by making sure that its suppliers are not single-source suppliers (more on that concept ahead).
Additionally, Renesas is raising the standard that factories in Japan have to be built to. Renesas had secured its Naka factory as was mandated in Japan to survive an 8.0 magnitude earthquake, according to Japanese Meteorological Agency (JMA) standards. But the March 2011 quake was a 9.0. The company is now going to meet the upper edge of the JMA standards instead. (Of course, there was also a tsunami and nuclear disaster afterwards. The solution for that level of disaster is likely to entail going to an alternative location.)
Sebt says that Renesas is also now being sensitive to its responsibility as a supplier itself in someone else’s supply chain. “We’re now going to our customers and saying, ‘Look, these products that you’re buying, in case of a disaster, this is our risk mitigation plan,’” says Sebt.
Renesas exemplifies many good practices, such as in its attention to securing alternative sources for raw materials and component parts. But sometimes a company has only one option—a sole-source supplier. A sole-source supplier is defined as one that is truly the only company that can provide a certain product.
Many companies have a two-supplier requirement for most parts but that rule is sometimes not adhered to because only one company can do the job. In that case, what matters is that the sole-source supplier itself has two separate locations where it can make the parts, Harrison says. That way, if there is a natural or man-made disaster that halts production at one facility, there is a backup.
By contrast, a single-source supplier is when a company is using one source for a product but there are other sources available for that product. In those cases, Harrison recommends qualifying an alternative source well in advance of something happening. “And you need to have a plan for switching,” she notes.
In addition to understanding which suppliers are critical and planning for alternatives, businesses need to consider likely scenarios and timetables. For example, if a tsunami hit a supplier, would the impact be immediate or does the supplier or the company have a month’s inventory? “You need to pay attention to ones where you have immediate problems, and look at what your risk plan is,” explains Harrison.
That gets back to the issue of just-in-time inventory. The alternative is to revert to older models of maintaining more inventory as a just-in-case approach. But it’s a catch-22, because that won’t be as cost-effective day-to-day, says Johann Selle, director of business resilience services at iJet, a risk management provider.
Despite the cost, Harrison says she is seeing companies slowly edge away from a blanket use of the just-in-time strategy, including the originator of the concept, Toyota. She says Toyota saw that Nissan was less hurt by last year’s Thailand floods because “Nissan had looked beyond just taking cost out.”
Companies will never completely abandon the cost-efficient just-in-time model. But they are more strategically assessing whether it might be wise to stockpile some components. For example, there was one commodity that a company Harrison worked with would have real trouble sourcing if a certain event recurred. “So we decided to stockpile that one commodity. And when the next event hit, the company was able to take market share from its competition,” Harrison says.
While the focus tends to be on facilities and supplies, companies must remember that crises also affect the workers who are needed for manufacturing and other aspects of the supply-chain process. Selle says that companies often don’t include locals in their plans because the thought is that they can fend for themselves. But in Japan, with the nuclear fallout and destruction, there was a need to provide ways for the workers to get out of the situation.
Companies should talk with their suppliers about personnel contingency issues, including what can be done to get workers to alternative locations when applicable. They should also discuss other relevant issues, including payment and cash flow, housing arrangements, and family considerations.
Of course, all of this risk management and business continuity planning requires a good working relationship with suppliers. “A company must make sure that its suppliers understand that these precautions enhance the long-term business relationship,” says Selle.
Perhaps most important of all, companies must avoid being in a reactive mode, where they respond to each crisis in an ad hoc manner without a comprehensive plan. For example, if after the earthquake and tsunami in Japan, a company with a single supplier in that location did nothing but find another supplier outside of Japan, then it would not have addressed the issue of supply-chain resilience. The company remains vulnerable to any troubles in the new spot, and it will not have solved the problem of having only a single supplier.
Globalization is here to stay, so when there is a disaster anywhere in the world, it will likely have a butterfly effect. But proper supply-chain risk management can help minimize the impact of any one disruption.