Supply Chain In Crisis: One Disaster Can Have It All Come Tumbling Down

IT industry, beware: The next obstacle to being able to feed customers' insatiable demands for business and consumer electronics is just an earthquake, or maybe a cough, away.

Just-in-time manufacturing, developed in Japan in the 1970s, has over the decades helped control manufacturing costs by delivering components when and where they are needed rather than depending on keeping huge inventories. When properly executed, just-in-time manufacturing is a major boon to the IT industry.

But when something goes wrong, it can easily turn into a nightmare for manufacturers and customers alike.

With just-in-time manufacturing, a small kink in the supply chain can disrupt both production lines and entire businesses.

Those kinks could be something as massive as the 2011 flood in Thailand that wiped out about 25 percent of the world's hard-drive manufacturing capacity, or huge earthquakes in Japan or Taiwan that in the past couple of years have disrupted supplies of key IT components.

Or they could be as small as the September fire in a South Korea DRAM factory that caused a massive spike in DRAM prices, or an earthquake in the Philippines that temporarily closed more than 100 call centers in an area housing the world's eighth-largest concentration of call centers.

They also could some day include a massive pandemic such as Severe Acute Respiratory Syndrome (SARS) or the bird flu, or a new Korean War, or even something out of science fiction such as a zombie apocalypse.

A zombie apocalypse?

"At some point, I would love to see our business continuity plan around zombies," joked Scott Zahl, vice president and general manager of the Advanced Computing Division of Ingram Micro, the Santa Ana, Calif.-based distributor.

All kidding aside, few people in the IT industry will see such a plan. Unfortunately, getting concrete information about IT industry preparations for man-made or natural disaster is almost as hard as understanding how manufacturers are planning for the walking dead.

PLANS FOR MITIGATING DISASTERS?

Distributors and system builders typically pass when asked about their plans to mitigate supply chain concerns or, when they do respond, are less than forthcoming about such plans.

No one can control tsunamis or earthquakes, said Joe Quaglia, senior vice president of U.S. marketing at Tech Data, a Clearwater, Fla.-based distributor.

Instead, Quaglia said, the main emphasis for mitigating the impact of disasters is on improving supply chains using such methods as spreading manufacturing and inventories around multiple countries.

"We're not a heavy components distributor, so we are not as directly susceptible to disasters on the components side," he said. "Our concern is when the supply of servers, notebooks and tablets, once plentiful, suddenly becomes constrained."

Dan Schwab, co-president of Harrisburg, Pa.-based distributor D&H Distributing, wrote in an email to CRN that the IT industry's advanced supply chain means future disasters, both natural and otherwise, likely will have a significant impact.

"There is no way to eliminate this risk, but D&H proactively works to have multiple sources for all categories, plus carries a 45-day of supply versus most distributors at 25 days, which helps to mitigate supply chain challenges. For our own business and customer security, we have advanced disaster recovery systems and protocols to help mitigate or avoid potential impact to our business that could affect our valued customers," Schwab wrote.

Ingram Micro's Zahl said that short of taking much larger inventories of components and housing them in the supply chain, there's not much that suppliers can do to mitigate disasters.

"Keeping a large inventory of something is not a big part of anyone's business model now," he said.

An unforeseen disaster that takes components out of production becomes a shared experience across the IT industry, Zahl said.

"We have relationships with vendors who can help offset problems with supply, but they can't insulate us from that kind of event," he said.

Todd Swank, senior director of product marketing at Equus Computer Systems, a Minneapolis-based custom system builder that depends on a steady supply of components, said he has seen the impacts of those kinds of disasters, and they are not pretty.

For instance, he said the fire at the Hynix DRAM factory might have been overblown. "But vendors take advantage of any chance to increase prices," he said. We're seeing memory prices shoot up. It was the same with the Thailand flood. Component prices can double in a couple of weeks."

In such a situation, system builders can be in a precarious position, Swank said. For instance, while a shortage of a components can significantly increase costs or decrease supplies, system builders cannot renegotiate existing purchase orders placed by customers.

"You're damned if you do, damned if you don't," he said. "You have to roll the dice. You can't stock up heavy. Remember, prices are more likely to fall than go up. Stock up in a big way based on the wrong information, and you're stuck with high-priced components."

Larger suppliers such as Intel can factor in potential disasters such as a new SARS pandemic, Swank said. "You need savvy management groups who can manage inventory," he said.

THERE'S NO AVOIDING FUTURE DISASTERS

Dr. Erwann Michel-Kerjan, adjunct associate professor for the Wharton School and managing director of the Wharton Risk Management and Decision Processes Center, called the Thailand floods a big eye-opener for many in the IT industry.

The floods realigned not only the suppliers, but the suppliers' suppliers, Michel-Kerjan said. "They saw that even for smaller products, the supply chain is not easy to change," he said.

The past 20 to 30 years has seen a big push to adopt just-in-time manufacturing for the global supply chain as a way to help reduce costs, a push that provided big economic incentives to develop global supply chains, Michel-Kerjan said.

However, he said, the increased interdependences that built between component suppliers and manufacturers, combined with the fact that the system does not create a buffer inventory of components that could be called upon in a disaster, created new risks for global companies.

As a result, he said, businesses increasingly are looking at their map of suppliers to determine which are the most critical.

For example, he said a company might have 100 suppliers, of which maybe three are critical. "They then start working with those three key suppliers, and ask them, 'How resilient are you?' " he said. "There are many more key suppliers out there today compared to three to five years ago. This is true of IT and of other industries."

To survive a disaster in such an environment, a company has to understand its "risk appetite" and what it would take to make its supply chain resilient, which requires serious investment, Michel-Kerjan said.

There is a behavioral aspect to supply chain disaster planning, he said. "Ideally, with large-scale investments, the decision goes up in a company to the board of directors," he said. "But those decisions are competing with 25 other investment ideas. One way to make that pitch is to not bring in a lot of numbers, but instead bring in a plausible scenario for that company. That has a better chance of changing the board's mind."

Michel-Kerjan said he sometimes briefs companies on their supply chain disaster planning, and asks what they are doing about it. "Sometimes they say they're waiting, that it's too big an issue for them," he said. "I suggest they work together with competitors through trade associations. We see this in the insurance industry, which helped insurance companies cover their losses in the Thailand flood."

Equus' Swank said the biggest issue in a disaster, at least initially, is whether suppliers are providing enough information.

"Those that can tell you what's happened and what the current situation is are important," Swank said.

That includes knowing the status of the lowest-value-add components of a solution, Swank said. "If only one part is missing, even a hard-drive rail or adapter plug, you can't ship a server," he said. "A guy who handles Intel motherboards told me there may be a component, such as a resistor or transistor, which if it were in short supply would mean Intel couldn't build a PCIe connector, which means it couldn't build a motherboard. The impacts are up and down the supply chain."

Even so, no amount of planning can ensure even partial success in the event of a disaster, Michel-Kerjan said.

"We tend to fight the last war," he said. "People are good at handling floods because of what happened in Thailand. But what about other risks? A war in Korea could happen. It might not happen. A company may spend $10 million to be prepared for a disaster, but may never have a problem. That's where many companies are today."

THE WEAK LINKS?

When it comes to natural disasters and the IT supply chain, Asia is the big bottleneck, said Dale Ford, vice president of the Electronics and Media group at IHS, an El Segundo, Calif.-based research firm.

"Where there is concentration, there's vulnerability," Ford said.

Ford said that South Korea has a concentration of DRAM, flash memory and display manufacturing, while Japan is critical for supplies of microcontrollers and wafers, and Taiwan is a center for fabless semiconductors.

For system builder CTL, about 60 percent of the components are directly imported by the company from China, and 30 percent come from China via distributors, said Erik Stromquist, COO of CTL, Portland, Ore.

"Nearly all our IT components are foreign-sourced," Stromquist said. "But our suppliers are mostly Taiwan-based companies, where they have earthquakes all the time."

However, a disruption in component supplies is only one kind of supply-chain-threatening disaster.

Ford noted that China has become the dominant source of rare earth materials and in the past has used threats to cut supplies to gain concessions in other areas. He also cited the potential supply chain problems from other raw materials such as so-called conflict minerals, which are heavily sourced in countries beset by active civil wars and human rights violations and may be subject to import regulations.

Pandemics are high on Michel-Kerjan's list of the most likely causes of critical disruptions in the supply chain going forward.

He said to consider the disruption to the travel industry and to retail businesses that resulted from the 2003 SARS outbreak, a tragic event in which hundreds of people died.

"But what would happen if millions of people grew sick or died, and the ports of Rotterdam, Shanghai and Long Beach were shut?" he said. "If the world's top 10 ports were shut down, that would cut 95 percent of worldwide trade. It may start with a few hundred people, then a few thousand, then more. People will stay home, and will not work with other people."

The fact is, Michel-Kerjan said, nobody wants to think of that scenario. "With past pandemics, there was no big impact."

The U.S. Department of the Treasury, working with multiple financial organizations, in 2007 studied the ability of 2,700 financial companies that volunteered to take part in a three-week exercise of their ability to survive a pandemic flu. It found that a pandemic would cause significant impacts on the financial services sector, but the sector would still continue to operate.

A declassified 2009 planning document from the U.S. Department of Defense Northern Command titled "Concept Plan to Synchronize DOD Pandemic Influenza Planning" assumed that a pandemic influenza in the U.S. eventually would sicken 30 percent of the population and eventually kill about 2 million people, overwhelm government services, and severely restrict international and interstate transportation.

CTL's Stromquist said he hopes companies in the global supply chain have learned lessons from the past.

For instance, he said, buyers did everything wrong in the wake of the Thailand floods and the Japan earthquake.

"They didn't react quickly enough and then bought too much supply afterward," he said. "On the hard-drive side, we were late to find out about the floods, late to react, and then late to correct. If you are a buyer with a tier-one company, you are more aware of what's happening."

PUBLISHED OCT. 28, 2013