Japan Disaster Shakes Up Supply-Chain Strategies

The recent natural disaster in Japan brought to light the fragile nature of the global supply chain. Professor Willy Shih discusses how companies should be thinking about their supply-chain strategy now.
by Dennis Fisher

The full cultural and sociological aftershocks of the earthquake in Japan—the worst disaster to hit the country since World War II—are washing like a tsunami across many industries as manufacturers and their customers scramble to replace suppliers disrupted and even closed down by the events of March 11.

Tokyo, and indeed much of eastern Japan, is an epicenter of high-tech manufacturing. But dozens of suppliers in other industries are located in the region as well, and the loss of their production may have far-reaching effects in many economic sectors for years to come.

The disaster is causing many companies to rethink their supply chain strategies, which suddenly seem extremely fragile.

When a natural disaster hits, relief organizations such as the Red Cross and Doctors Without Borders swing into action with crisis-response plans that have been honed, refined, and improved with experience. Not so manufacturers and their complex webs of suppliers, who in many cases lack that same experience or large-scale backup plans. The result: a chaotic scramble resulting in production delays, product shortages, and higher prices.

“They put all of their eggs with one supplier that had the best product at the lowest price"

About 22 percent of the world's 300 mm silicon wafer supply came from the Shin-Etsu Handotai's Shirakawa plant in Fukushima prefecture, and 60 percent of critical auto parts were in the same area, says professor Willy Shih, who has studied the ways that supply chains work and the performance of the factories that comprise them. The area is also a primary supplier of lithium battery chemicals, flash memory, and anisotropic conductive film used in LCD flat panel displays.

"In the race to provide better quality at lower prices, manufacturers picked very narrow, optimized supply chains," Shih says. "They put all of their eggs with one supplier that had the best product at the lowest price."

Suppliers Squeezed, Too

At the same time the suppliers, also under pressure to continuously cut costs and optimize production and delivery systems, focused on serving niches rather than being generalists. So a company that in the past produced a specific auto part now makse one component of that part, and then pasess it on to another supplier in a different country for additional assembly. One small piece can pass through six or eight or ten suppliers in as many countries before it lands in the hands of the final assembler.

"The sequential, multicountry production model is what dominates now, and it's a model where little bits of value get added here or there and it's hard to see country of origin. It can be a very costly process to figure it out," Shih says. "For example, if you really wanted to trace conflict minerals, you would turn off the valve at the Congo border and see who screams. It's the same structural problem as in Japan. A Wii has a chip designed by IBM, which may have been fabbed in New York, tested in Taiwan, stored in Hong Kong, aggregated in parts, and sent in kits to China for assembly."

All the suppliers in this chain are typically operating on very thin margins and tight schedules—any disruption can have severe consequences for companies several steps down the chain as well as end users. Already, some auto parts plants in the United States have had to suspend production because of shortages, and it's likely many more problems will follow, especially in the high-tech sector. Lithium battery production, for one, is likely to slow, resulting in the delay of lots of consumer electronics.

A consequence of the rise of the modern, highly dispersed supply chain is that many manufacturers—let alone consumers—have little idea where the things they buy come from. Most consumers likely don't care, until they try to buy an iPod and discover that there are none to be had because of a shortage of lithium-ion battery components.

"This kind of disaster cuts a wide swath across the auto industry, but there's probably some similar geographic area that, if hit, would affect a different industry. It only takes a very small piece of the world to influence an industry in a major way."

The open question is how quickly manufacturers can recover from the shortages and delays. It may take several months for all the economic and supply-chain effects of the disaster to be felt fully, and the product shortages could extend well beyond that. Still, Shih says from what he's seen so far, suppliers and manufacturers have done fairly well.

"It's the luck of the draw when it comes to natural disasters. We have very highly concentrated pockets of expertise in small areas around the world. It's how we've designed modern production systems," Shih says. "We've seen moderately good behavior from this quake so far."

Who Pays The Price?

As Japan recovers from this disaster and other countries prepare for future ones, manufacturers and all the various companies that make up their supply chains need to rethink their strategies, Shih says. But the answers, such as using redundant suppliers in various parts of the world, can be expensive. Would customers be willing to absorb some increase in cost if it meant that there would be fewer shortages or production delays?

"Will consumers pay more for a more robust solution to this problem? I don't know. It's an important question, though," Shih says. "Should I distribute my suppliers around the world to avoid things like this? We don't know. But the shortages are starting to emerge, and over the next couple of months we'll see a broader impact from this."

A number of companies are already making investments in redundancy. Canon is considering a move to diversify its production base by expanding its under-construction Hita factory in Kyushu in southern Japan, and increasing production lines at its two factories in China's Guangdong province. Manufacturers in mainland China, Taiwan, South Korea, and Thailand are reporting increases in orders as companies look for alternate sources, according to analysts.

"There are a lot of moving parts in this, and it will be interesting to see how it works out," says Shih. "Companies need to understand the depth of their supply chains and critical dependencies. Then they can think through how 'narrow' is the optimum solution, and the cost/benefit tradeoffs of steps like incorporating more supplier or geographic diversity."

About the Author

Dennis Fisher is a writer based in Plymouth, Massachusetts.
    • Bonnie
    • Manager, DB Schenker
    The SCM strategies for OEMs are always very different than IT. Whilst it is imperative for organisations to have a BCP in place, like most of the IT ITeS organisations have; this was an are of absolute neglect not only in Japan, but also many other countries and manufacturing inustries. It is not a very cost effective way to look at setting up 3-4 different factories in diferent countries or cities. What may change the face of japanese ways of looking at this is, to see if or not they can outsource some of their manufacturings to other small scale units within or outside Japan. The March 11 tsunami has indeed been a global disaster, throwing off many questions on the table.
    • Frank Riganelli
    • Author
    Japan Disaster Shakes Up Supply-Chain Strategies
    If often takes a crisis like this to get an organization to look at the way their strategies. As unforeseen as the coming of an earthquake is, we know they do happen which presents a choice to companies in their supply-chain strategies.

    As Willy Shih explains, ""In the race to provide better quality at lower prices, manufacturers picked very narrow, optimized supply chains.""They put all of their eggs with one supplier that had the best product at the lowest price."

    Organizations can opt to consider the tortoise and the hare fable where priority is given to approaches that value the longer-term, as opposed to the short-term. Not only does this protect against unexpected crisis which damage supply-chains, keeping the wheels of the business productively turning, but it also adds in a way to the company's strategy toward sustainability. Is there a cost to this? Of course, and it is recovered over time in ways that are often not measured although the benefit is there.

    Crisis are a peculiar thing in how groups prepare for them. The article says, "When a natural disaster hits, relief organizations such as the Red Cross and Doctors Without Borders swing into action with crisis-response plans that have been honed, refined, and improved with experience. Not so manufacturers and their complex webs of suppliers, who in many cases lack that same experience or large-scale backup plans. The result: a chaotic scramble resulting in production delays, product shortages, and higher prices."

    I had worked for a multi-national company in the past and we had gone through the steps in developing a crisis response plan for the chance that a nearby facility might release harmful emissions. The crisis never took place for my time with the organization, but the plan was put in place and people felt secure knowing that should it happen, they would be safe. For all the effort, resources, and consideration put into designing the most efficient manufacturing facilities and systems we can, it should be a natural next step to protect them by developing crisis response plans. In terms of ROI for the initiative and the associated cost, if it is looked at as being amortized over a long period of time, which is consistent with the likelihood of an earthquake happening, for most geographic regions, the cost to the business is minimal. It's a matter of risk management and taking steps to prevent the chance of unexpected losses. If people need help in selling this idea to their organ
    izations, they can present the case as a matter of cost avoidance or loss (risk) management. Benchmarking to other organizations is always helpful, where you will find some companies have an entire department dedicated to loss control.

    Frank Riganelli, Author
    Former Fortune management, consultant, and trainer.

    P.S. -- People have questioned my posting at this group for the fact that I write mainly fiction novels. I explain to them that the hypothetical thriller novel which has a character scramble for their life when a disaster hits their workplace is that much more realistic when the group's actions and responses are true to life. And then I tell them that I also write books on the topic of business.
    • Smriti Khanna
    • Professor, MITCON
    As organizations in the behest of differention, competitive advantage, and efficiency have resoted to globalized supply chain, I am not to sure about the efficiency of such unbound inclusion in business whereas why not give a look to the localization of supply chain.
    • Narendar Singh
    • Professor, Free Lancer
    Japan built its economy on one concept viz. quality and no stock holding to lower costs (Just in time processes). However, the total economy has to be built on redundancy. There has to be an inbuilt redundancy in each aspects, of process of supply chain managemnt. Credibity is the basic essential in all commercial deals, and if credibility and relaibility is lost there is no place in the market for the firm. Hence redundancy is essential for industry. japanese model had no inbuilt redundancy and hence the upsetting of supply chain.
    • William P. Hall
    • Hon Fellow, Engineering Learning Unit, Melbourne University
    The Japanese tsunami highlights the vulnerability of many of our supply chains and other distributed and complex systems supporting our populations.

    Many other rare events (i.e., less frequent than once every 50 years) besides tsunamis will inevitably happen that are potentially even more disruptive to our support systems. Well known possibilities include major volcanic events near critical industrial areas (Japan, Indonesia, Mexico City and Seattle are areas facing obvious risks), massive solar storms (able to destroy significant fractions of our electrical transmission capabilities), major earthquakes (Japan copes comparatively well with these, but the same cannot be said for California or the Mississippi Valley) and even meteorite strikes (consider the damage a Tsunguska size strike would cause if it hit an industrial region or the ocean). Some scenarios could lead to massive famines and population 'die-offs" if we lack the capacity to mitigate them.

    It is time for government and large industries to take these risks seriously (we know they will happen, what we cannot answer in advance is when and where). We need to rethink the values of a lot of our "efficiencies" and see what we can do to make our critical infrastructure and supply systems more resilient.

    Such mitigation activities will undoubtedly be expensive, but they will also offer a lot of new business and employment opportunities in a world where very few countries suffer from labor shortages.
    • priyanka
    • student
    Well, this is true. Japan is seriously under massive pressure. This is going to effect japan' s economy surely.
    but rebuliding the same position again is what phoenix is and Japan knows how to do it. We have many examples from the history of Japan- whether it was second world war or Hiroshima Nagasaki bomb blast. Undoubtedly, japan is going to prove that inspite of crisis or casualty like tsunami, Japan will rebuild itself.
    • Arminder Singh
    • Regional Support Manager
    An interesting article. We are already seeing the impact of the short supply of auto parts in the US where the Japanese car makers in the US are struggling to keep up with supply. My wife and I have already received atleast 3 offers on our Honda (2008 model) and Toyota (2007 model) cars from the local dealers in the last 1 month with very aggressive pricing.

    As far as the thought goes whether the consumer is willing to shell out more for the same product or not is something which needs to be analyzed based on the data collected in the last few months. The way I see it (without this data in hand) is that consumers will probably wait for the prices of the non-essential items to come down before they buy them.

    A situation similar to this scenario is the oil prices and how they are impacted when there is unrest in the middle east. However, since gas is more of an essential item, so even if the prices go up, the consumers are willing (or rather I say forced) to pay more for it...
    • WA Osterman
    • Consultant
    White Paper:
    Second Supply Chain Tsunami--The Impact of the Japan Disaster on Defense Procurement

    Commercial Impact: The commercial impact of the Japanese tsunami and nuclear power disaster is now being felt at Japanese firms and their family of sub-contractors. Damaged plants and infrastructure, power shortages and rolling blackouts, and supply chain disruptions have stopped or reduced production in Japan and around the world. Output is forecast to drop this year; with the greatest impact in the power intensive electronics, electro-optics, and highly automated manufacturing plants.

    Commercial Response: US and European commercial electronic firms have already reacted to the Japan disaster - canceled their Japan vendors and orders in panic, created misleading multiple backup orders, disrupted fragile global supply chains, in weak global markets, at a time of peak Yen-Dollar exchange rate fluctuation. The impact will be seen in higher US Dollar procurement costs, consumer product price increases, delayed and reduce production, and a production shift to Chinese and other Asian sources.

    Defense Supply Chain Impact: Defense Department and defense contractors are reacting more slowly; and will not see the impact coming - as vendor inventories slowly draw down, Japan's engineering and production shifts to recovery priorities, and marginal product lines and production are canceled or shifted to China and Asia. These changes will ripple through the defense supply chain; first in defense sub-contractors, then in DoD procurement, and then in foreign military sales of systems and spare parts. The by the time these shortages are visible in DoD; the recovery plan will take years - to change designs, specify new components, upgrade manufacturing process, and develop and qualify new vendors.

    Supply Chain and Export Control: DoD faces an additional problem - in balancing the conflicting policies of supply chain security and export control. As Japanese and Koran engineering and Chinese sub-contract manufacturing increasing dominate global markets, DoD and defense contractor are more dependent on Chinese materials, components and sub-assemblies. It is increasingly difficult to identify and enforce export control restrictions on US and European firm shipments to Chinese firms - particularly those owned or controlled by the Chinese military - as it scales up while the US scales down.

    Supply Chains and Watch Lists: DoD and defense contractors do not now have a legal obligation or an operations capability to check their import supply chain data domains with the State Department Export Control/ITAR approved vendor lists, or the DoD, State, Commerce and Treasury Disapproved Lists and the ODNI/IC Watch Lists. Most important, all of these USG Watch Lists are still in English/Latin text; and are ineffective in managing Chinese, Japanese Korean - and Middle Eastern language data.

    This is a rare opportunity to bring DoD senior management and Congressional oversight into the quiet but growing crisis in balancing defense supply chain management with export control and arms control policy - with the growing dominance of Japanese, Korean and Chinese engineering and manufacturing.

    DISCLAIMER - This White Paper is an UNCLASSIFIED review of Japan Disaster and Supply Chain Issues.

    It does not represent the views or polices of the US Government.

    Author: Wm. Andrew Osterman - HBS/83e

    Consultant to State and Defense Departments. Former manager of electronic and display engineering and manufacturing supply chains for US and Japanese firms in Asia. Former Foreign Service Officer at White House Staff, State/EAP and Embassy Tokyo. Japanese and Chinese Language Officer.
    • Charles Putz
    • CSN
    We learn in statistical process control aplied to supply logistics that it's better to have less suppliers, which will result in less volatility and better quality. In economics we learn that less suppliers means higher economies of scale and lower costs. But a disaster of this magnitude brings "the black swan" to mind, and perhaps teaches us that there is no single best way of doing things, and what seems the best way under given conditions, may prove wrong when conditions change.
    • Yadeed Lobo
    Surprisingly no one has mentioned small business enterprises who are the actual suppliers?

    What about small firms(the actual suppliers) say in the middle of Christchurch CBD in New Zealand who cannot access their businesses after the earthquake?

    Software as a Service (say for accounting) could potentially provide some respite against future calamities. But not being able to actually get to your goods is something which cannot be easily captured inside a framework.
    • Kapil Kumar Sopory
    • Company Secretary, SMEC(India) Private Limited
    It is not a situation where any company can strategise in isolation of the environmental damages caused by the catastrophy of such a volume. Japanese are a hardy lot and their resilience is well known. They have encountered havocs many times but worked tirelessly and won the lost ground.
    Yes, long-term strategies to face such situations have to be devised. A common blueprint for rendering help has also to be developed for the external helping organisations - red cross, etc. This is important to avoid overlaps which do not lead to optimum results.
    Japan is known for quality and this should not be lost sight of during the recovery phase.
    • Abdul Awal
    • Demand Manager, South East Asia & Oceania, Ericsson
    The Japanese tsunami has severe impacts on the supply chain of hi-tech industries. After the volcanic events, it reminds once again the need for strategic thinking in the supply chain network design and to build flexible supply chain. But it's a trade-off between cost and flexibility. A supply chain network distributed in different continents might reduce the impact but would that be competitive in a normal situation with the extra costs? Especially, this sort of natural calamities does not happen so frequently, and you seldom can predict that. But obviously, these things have to be more and more taken into consideration in supply chain design and if there can be any BCP or a Plan B taken up with maintaining the competitiveness - we must do that.
    • Anonymous
    I am a graduate student in Iran cultural management. My thesis is associated with the trauma of cultural behavior from the perspective of management and sociology. I'm asking you for your cooperation and help topics in the event of earthquake victims in Japan in 2011. Can you help me? Thanks
    Undo edits
    • Elizabeth Farquhar
    • Managing Editor, Knowledge@W. P. Carey
    As companies work through the challenges posed by the supply interruptions in Japan,they are also thinking about how to be ready to respond better in future crises situations. ASU W. P. Carey School of Business Professor Thomas Choi comes to the situation with research on whether good systems are enough, or whether leadership is the deciding factor. We posted a report about that research today: "Most Valuable Asset During Supply Chain Disruptions: Strong leader or Great System?" http://knowledge.wpcarey.asu.edu/article.cfm?articleid=2005
    • Kenneth Mitchell
    • Project Manager, Kendew Promotions
    I'm not sure that the disaster is causing many companies to rethink their supply chain strategies. If everyone is using the same strategies, then the end result is that everyone is working through the same system fog and there is no clear winner or competitive advantage. This is unlike Southwest Airline's decision to buy a large amount of gas futures whereby the other airlines did not thereby giving Southwest Airline a competitive advantage in their pricing structure.
    • Victor Cortez
    • Engineer, Baker Hughes
    Other areas that are being affected by the disaster in Japan include those that utilize AFLAS, which is made from a special polymer only made in Japan. This will force many to start looking at other alternatives that may be more expensive. Shortages are already being reported by rubber manufactures that make orings and other rubber products from this compound. Companies that provide components that utilize this material will likely pass the cost on to the customer or be forced to bear the cost or may increase the cost of their products. In some cases there may be a need to sacrifice some performance if customers can make due without risking safety or suffering operational impacts.