Seeking Alpha
Profile| Send Message|
( followers)  

By Gad Allon

Businessweek had an interesting article on the consequences of the flooding in Thailand for the hard drive industry. What I found most interesting is how it highlights different aspects of risk mitigation, both strategic and tactical ones.

The article describes the situation at Seagate (NASDAQ:STX). Even though floodwaters that have affected much of the industrial heartland north of Bangkok for the past six weeks have spared both of Seagate’s Thai factories, Seagate’s network of supplier is affected:

Seagate Chief Executive Officer Stephen J. Luczo is forecasting difficult times for the drive industry. Each of the hundreds of thousands of drives Seagate’s Thai factories ship every day contain parts from 130 or so suppliers, many still under three feet of water. The projections by some Wall Street analysts that production will be back to pre-flood levels by summer is nonsense, Luczo believes. “This is going to take a lot longer than people are assuming, until the end of 2012 at least,” he says. “And by then, demand will have gone up.”

When thinking about risk, one usually separates between likelihoods and consequences. The first question here is were the risk of floods appropriately evaluated and managed:

Few of the companies in this finely tuned supply chain, lured to Thailand by low wages and government incentives, ever thought they would need to worry about massive floods. When suspension arm maker Hutchinson Technology (NASDAQ:HTCH) opened a plant in the Rajana Industrial Park seven miles from the Chao Phraya River a year ago, it had no problem getting flood insurance, says CEO Wayne Fortun. Hours after the levee broke on Oct. 10, his plant was filled with six feet of water. Employees moved some inventory and equipment to the second floor, but some $50 million worth of highly specialized gear remains bolted to the ground.

The article points to the fact that the risks were known and that flood insurance was purchased. The article mentions loses of the order of $50 million for one firm, but it is difficult to know whether the insurance was adequate. Yet, the idea of buying insurance to hedge against risk is one of several risk mitigation activities a firm can engage in. In this case, the insurance does not reduce the likelihood of flood, yet it reduces the consequences once an event occurs.

Clearly choosing to locate your plant close to the river increases the likelihood of the flood affecting your plant. I will put that under (lack) of operational risk mitigation. As Seagate learned, it is not enough that your factory operates if your suppliers are under water. Their CEO mentions that he is thinking about requiring Seagate’s suppliers to be outside the flood plain, which is again another type of strategic risk mitigation.

Of course, even a firm reduces the impact of risk by reducing the likelihood of an even, one has to be prepared to its occurrence, and prepare tactical risk mitigation activities.

According to company spokesman Masashiro Nagayasu, they cut a hole in the roof of the Rajana factory, sent divers into the toxin-laden waters to unbolt some heavy equipment, and lifted it onto waiting boats. Some of the equipment is now being used in Nidec factories in China and the Philippines. “This supply chain has been calloused and toughened by years of competition,” says John Rydning, an analyst with market research firm IDC, who said on Nov. 10 that he believes drive shortages may ease by mid-2012.

The ability to take quick actions and recover can make a huge difference. Sending divers to help in pulling important equipment is a very good example of such risk recovery. Several years ago, Procter & Gamble's Pringles plant in Jackson, Tenn., was hit by a tornado. Even though it was estimated to be back in production within a month, P&G managed through a quick response to bring it back to speed within a week. These tactical actions are usually part of a larger, broader strategic plan. As the article suggests, years of tough competition have prepared the hard drive firms to be agile and respond quickly.

Source: Seagate Avoids Thai Flooding, But Suppliers Are In Trouble