Supply Chains and Earthquakes

by: The Operations Room

By Martin Lariviere

Given that the earthquake and tsunami and subsequent nuclear issues disrupting global supply chains happened in Japan, someone would inevitably tie supply difficulties to Japanese management practices like just-in-time production. Now, I would agree with readers who would argue that it is wrong to characterize lean operations etc. as Japanese when such approach have become standard business practices around the world. That said, Reuters stepped into the breach with an article linking the quake to just-in-time production (Special Report: Disasters show flaws in just-in-time production Mar 21).

In a globalized economy where manufacturers have moved ever more toward lean inventories and "just-in-time" production — keeping ultra-low quantities of parts on hand to avoid holding expensive stocks of parts — a speedy response was vital because a disruption to the global supply chain would spread quickly, shuttering plants employing legions of workers around the world.

Arguably, what the above quote fails to recognize is that globalized supply chains would essentially be infeasible if it were always necessary to carry large amounts of inventory. The ability to run complex supply chains in a lean fashion is essential to being able to take advantage of lower labor cost overseas or (in the case of Japan) to work with specialized suppliers with unique skills and capabilities.

Despite its alarmist title, the article is actually very informative about the challenges a variety of firms are facing. It even quotes a few of my Kellogg colleagues. It has two interesting points on where and how the impact of the earthquate and tsunami will show up.

The most immediate threat to manufacturers stems from the fact that the weakest link in the global supply chain is what Japan is best known for: high-end, highly technical parts like semiconductors, which also weigh very little.

"The earliest impact will be felt with high-cost, low-weight products," said John Hoffecker, managing director of restructuring advisory firm AlixPartners LP. "They come out of Japan by plane so manufacturers don’t have much of a buffer for those products." …

Obtaining information is a problem right now because the supply base below the top suppliers is opaque.

"When it comes to the supply base companies tend to focus on the level below them," A.T. Kearney’s Cheng said. "It’s simply time consuming and cost prohibitive to go deeper than that across your supply base."

Barry Tarnef, a senior risk specialist at property insurer Chubb Corp, said the murky nature of the supply base may mask the fact that somewhere down the chain a company may "control the lion’s share of the market."

"If something happens to that one company it could shut down an entire industry," he said.

That gets us to the world auto industry (Japan Parts Shortage Hits Auto Makers, Wall Street Journal, Mar 24).

One part coming under increased scrutiny goes into mass airflow sensors. Made by Hitachi Automotive Systems, a unit of Hitachi Ltd., at a plant north of Tokyo that was damaged by the quake and remains shut down, the electronic part is used by about a dozen auto makers.

Hitachi, which has a 60% share of the world’s market for airflow sensors, said it hopes to resume operations by Saturday, but isn’t sure how much of its capacity will be restored by then. The area is suffering from water and power shortages.

The sensors cost about $90 each in retail stores. While supplies of the chip are still available and Siemens AG (SI) and Robert Bosch GmbH also make airflow sensors, some auto makers are curtailing production out of fear that their supplies could run out. …

In France, Peugeot-Citroën (OTCPK:PEUGY) was scheduled to reduce production at most of its European plants from Wednesday due to shortages of the airflow sensor. The reductions will affect production of the Peugeot 207, Citroën C3 and other models.

The parts are flown in from Japan, and PSA normally only keeps 10 days’ worth of supply, said a company spokeswoman.

This example seems to fit both points raised in the Reuters report. Airflow sensors are small high value part that firms would prefer to airship. Interestingly, I suspect that if you went to a Peugeot factory and asked for what parts they carried tens day of inventory it would be a pretty short list. That is, they are taking a hit on a part for which (relatively speaking) they carry a fair amount of inventory.

The second point here is that Hitachi serves half the market. This one disruption then has very wide impact. While the insurance guy Reuters quotes expected to find this a few tiers down, here it crops up right away.