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Disaster Planning and the Modern Supply Chain

|Includes: Apple Inc. (AAPL), GM

The recent earthquake in Japan has raised concerns about single point and JIT supply chains around the world.  GM shuttered an entire auto assembly facility, and Apple's ability to meet bigger-than-expected demand for Ipad 2s could be in danger due to five chips sourced from Japan according to IHS iSupply.  Supply chain design and management is as complex as ever in this age of technological specialization and globalization- just as it makes no sense for someone to be their own doctor, lawyer, and plumber, it's equally nonsensical for one company to be their own financial, fab, and assembly expert given today's cost of establishing fab and biopharma capabilities.  Yet, the risk of disruption in supply chains is not a new phenomena- a 1993 fire in a Sumitomo plastics facility that supplied 60% of the world's epoxy resin for integrated circuits led to shortages that lasted for months.  These potential disruptions are bound to continue- natural and manmade disasters will continue to occur without warning.

But is the solution to go back to large lot production, safety stock, and captive production?  Given the waste associated with these practices (imagine the losses if the tsunami swept away 6 months of safety stocks in each home and factory) it makes much more sense to assure adequate disaster response plans are in place through the supply chain.  By conducting careful analysis into the specific risks of each point, creating viable backup plans, and constructing contractual obligations to prohibit unacceptable stoppages, risk can be managed if not totally removed.   These plans need to take into account the time sensitivity of the final product and value of lost sales, the fixed costs of operations that may be impacted, and the cost to mitigate various disasters, and many top companies have had them in place for years.

A good disaster plan includes some safety stock (consigned on customer site, or goods shipping by boat that can be used for weeks while the line is moved and air freight then used to re-fill the line later), provisions for offsite information backups, redundant lines by technology if not for each product, standardization of components, and insurance.  In some instances, however, it will be virtually impossible to restart a line within three months, so a second source that could establish a new source of supply should be considered- including financial reward for the original supplier for successfully moving the business to another supplier.  And this should be a topic of discussion all the way down- and up- the supply chain.  Companies with databases that track formal disaster plan submissions- or perhaps a third party registrar as is the practice for quality registrations- will be used to eliminate- or at least identify- gaps.

It's also likely that some companies will look to move operations to lower-risk locations, especially those with sensitive and/or large capital expenditures.  But companies have been considering the risks associated with earthquakes, hurricanes, labor unrest, tax policy, and the like for years.  At this time, a knee-jerk reaction against outsourcing, JIT, and other modern supply-chain practices makes no more sense than it would have the past 30 years as these practices were lowering costs- and raising living standards- for people worldwide. 

Investors should be careful about assuming long-term supply disruptions.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.