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13. For Want of a Nail

Published onApr 08, 2020
13. For Want of a Nail

“The world is so connected that the feedback loops are more intense,” said Ellen Kullman CEO of DuPont.1 She explained, “Our supply chains are global. Our financial markets are global. So uncertainty in one part of the world infiltrates all parts of the world. These days, there are things that just come shooting across the bow—economic volatility and the impact of natural events, like the Japanese earthquake and tsunami—at much greater frequency than we’ve ever seen.”2 A flicker of power can reveal the fragility of a company’s supply chain: a 70-millisecond power dropout at Toshiba’s Yokkaichi memory-chip plant in late 2010 affected the world’s supply of NAND flash.3

Whereas Japan’s 2011 earthquake, tsunami, and nuclear reactor disaster disrupted hundreds of businesses and affected many companies’ supply chains around the world, the March 31, 2012, fire at Evonik’s factory (See chapter 4) was tiny by comparison and strictly localized. One part of one factory in one town had a fire. Less than a day later, the fire was out. Yet the effect of the Evonik fire was significant—at GM, supplies of 2,000 parts were jeopardized, which was one-third as many parts as were disrupted by the far larger Japanese disaster. The impact of Evonik fire was so large because all of those GM parts required nylon-12 plastic, which suddenly became scarce.

Diamonds Are a Supply Chain’s Worst Enemy

When the Allies wanted to stop the German war machine in WWII, they bombed the ball bearing factories around Schweinfurt, because almost all of Germany’s tanks, warships, and airplanes relied on Schweinfurt’s ball bearings. Knocking out a single key supplier to many industries would do the greatest damage to those many downstream industries.4

The archetypal diagram of a supply chain shows a fan of suppliers feeding the company in an inverted “tree structure.” (See figures 13.1 and 13.2.) Each OEM or brand owner has many suppliers, and each supplier has many other suppliers, and so on. The diagram seems to imply robustness, with many alternative suppliers across the tiers. But, unbeknownst to the OEM or brand owner, some supply chains show a different pattern, with a single supplier deep in the chain—such as the Evonik chemical factory or Schweinfurt ball bearing plant—playing a keystone role. Instead of a fan, the shape is more of a diamond, in which the OEMs and many of their suppliers are dependent on that one provider.)

<p>Figure 13.1<br>An industry supply chain schema</p>

Figure 13.1
An industry supply chain schema

<p>Figure 13.2<br>A “Diamond”-shaped supply chain schema</p>

Figure 13.2
A “Diamond”-shaped supply chain schema

Deep-Tier Diamonds

Silicon chips may get all the glory as the premiere technology that powers laptops, tablets, and smartphones, but the unassuming black plastic packaging around the silicon chip is also a work of the highest technologies. Whereas the first integrated circuits (ICs) had perhaps a dozen or so pins connecting them to the circuit board, current-day microchips can have over 500 connections using a tiny grid of solder balls embedded in a thin substrate.5 That inscrutable density of connections requires high-tech materials such as bismaleimide triazine (BT), an epoxy resin that is strong, thermally conductive, and able to hold extremely tight tolerances over time and temperature variances.

Eighty percent of the world’s supply of BT comes from Mitsubishi Gas Chemical’s (MGC) Fukushima facility in Japan.6,7 The 2011 Japan quake changed that. “Our contacts in Asia suggest one of the bigger problems may actually be the growing shortage of BT,” said Craig Berger, an analyst with investment bank FBR.8 A prolonged shutdown of MGC’s factories after the earthquake caused bottlenecks in the worldwide IC assembly industry supply chain.9 Lead-times for IC substrates grew to the 75–125-day range.10 A company such as Apple or Samsung might buy chips from more than a dozen different chip makers, including second sources and second fabs for many components. Yet all of those chip makers and alternative suppliers depend on BT, most of which comes from that one MGC facility.

BT wasn’t the only diamond-structure disruption of specialized materials exposed by the Japan quake. Disruptions in the supply of Xirallic, a sparkly pigment made in Japan by Merck, affected manufacturing of certain colors of luxury cars at Toyota Motors, Chrysler LLC, GM, Ford Motor, BMW, VW, Audi, and other car makers.11 Lithium ion batteries require PVDF (polyvinylidene fluoride), and 70 percent of the global supply came from one factory in Fukushima province. Although the plant survived the quake, the tsunami devastated the nearby port that was critical to supplying raw materials to the plant.12 Other supply chain diamond structures revealed by the Japan quake included high-purity hydrogen peroxide used in chip making, and EPDM (ethylene propylene diene monomer) used by car makers in rubber gaskets and seals.13 “What we’ve found is that in Tiers 3 and 4, the convergence of underlying raw material supply starts to become really significant,” said Jackie Sturm, Intel’s vice president and general manager of global sourcing and procurement.14

Diamond structures can also create widespread quality risks. In 2005, contaminated Teflon made by DuPont was coated on sockets supplied by Federal Mogul and assembled into diesel injection pumps produced by automotive Tier 1 supplier Robert Bosch. Automakers including Audi, BMW, and DaimlerChrysler had to stop their assembly lines and recall vehicles when the defect came to light.15 Similarly, when Takata, the world’s third largest automotive airbag manufacturer, had a problem with improperly manufactured airbags in 2013, the result was a recall of more than three million vehicles worldwide by Toyota, Honda, Nissan, and Mazda.16 In 2014, NHTSA forced an expansion of the recall to include 15 automobile manufacturers, and some US lawmakers called for a criminal investigation by the US Department of Justice.17

Few people have heard of Sunland Inc., a $55 million processor of organic peanuts and other nuts. Yet when the company’s only factory in the small town of Portales, New Mexico, became contaminated with salmonella,18 the hidden role of this small food processor was revealed. Sunland wasn’t just the maker of some minor off-brand of peanut butter; they were a supplier to dozens of prominent brands.

The recall began with just two peanut butter products from US retailer Trader Joe’s but then grew to encompass over 300 products from 36 brand-name companies. The recall hit a number of “healthy” manufacturing and retail brands, such as Whole Foods, Earth Balance, Newman’s Own Organics, and Cadia All Natural,19 as well as more mainstream brands such as Harry and David, Target, and Stop & Shop. And it wasn’t just jars of peanut butter but also cookies, snack crackers, brownies, nut mixes, and even ice creams that were recalled. Sunland’s products sickened 42 people in 20 states.20 The direct costs of the recall were $78 million; yet the estimated costs to American peanut-containing product makers was $1 billion, including growers and product makers unaffiliated with Sunland.21 Deep-tier diamond structures reside in many industries, and a small problem with a niche supplier can reverberate far and wide.

From Eruption to Disruption: Europe Gets Grounded

In April of 2010, a modest-sized ice-capped volcano named Eyjafjallajökull in southern Iceland roused from a 187-year slumber. When blazing hot lava hit the volcano’s ice and water-filled caldera, the mixture flashed explosively into ash-laden steam that rose high into the atmosphere. The prevailing winds carried the thick gray-brown ash cloud southeast.

European aviation authorities grew concerned as the ash cloud drifted toward the continent and the UK. If a jet aircraft flew through the ash cloud, the ash could damage the plane’s engines, sand-blast the cockpit windows, and damage aircraft instruments. As a precaution, civil aviation authorities shut down portions of European airspace, starting with Norway. The closures expanded and shifted over a six-day period as the eruption continued and shifting winds pushed the ash in different directions. Major airfreight hubs such as Heathrow, Amsterdam, Paris, and Frankfurt were closed for up to five days.22

The last time a volcano shut down European airspace was … never. Although volcanoes, primarily in the Pacific Rim, had in the past caused trouble for individual aircraft and particular air routes, they had been localized incidents easily handled by detouring around the affected area.23 Companies, however, weren’t prepared for an event that shut down every airport and every carrier over a large region. For example, FedEx’s contingency plan for a closure of Paris was to use Frankfurt, but Frankfurt was closed, too.24

“There’s a major disruption of the supply chain,” said Paul Tsui, vice chairman of the Hong Kong Association of Freight Forwarding and Logistics.”25 In the UK alone, airfreight provides 25 percent of all imports26 and 55 percent of exports to non-EU countries.27 Although some airfreight might not be particularly time-sensitive (e.g., jewelry), many categories of freight are (e.g., perishable foods, vaccines, emergency spare parts, surgical instruments, and components for JIT manufacturing).28

“It’s a terrible nightmare,” said Stephen Mbithi, the chief executive officer of the Fresh Produce Exporters Association of Kenya.29 During the six days of airport closures, thousands of tons of fresh flowers rotted in storage units and warehouses, representing a loss to the Kenyan economy of $3.8 million per day,30 which represents about 3 percent of Kenya’s daily GDP.31 “Cow food, that’s about all we can do with it now,” concluded Kenneth Maundu, general manager for Sunripe, the Kenyan produce exporters.32

Migros, the Swiss supermarket chain, noted disruptions in supplies from the United States (green asparagus), Iceland (cod), and Southeast Asia (tuna). Italian exporters of mozzarella and fresh fruits lost about $14 million each day that flights were grounded.33 The Federation of Hong Kong Industries said hotels and restaurants in Hong Kong had shortages of French cheese, Belgian chocolates, and Dutch fresh-cut flowers.34 UK grocery stores ran out of presliced fruit and tropical fruits like pineapple.35 For many retailers of perishable goods, airfreight to or from Europe was a diamond in their supply chain structure—a chokepoint in transportation that affected all of them.

To meet delivery commitments, air couriers routed some airfreight through Spain and Turkey.36 Similarly, some freight forwarders chartered flights to southern European airports like Barcelona and then transported goods by road to northern Europe.37 “The cost is doubling,” said Tiku Shah, owner of Sunripe in Kenya. “But we don’t have a choice. If we don’t have product on the shelves, our customers will look for alternatives.”38 The bulk of European airfreight was grounded as carriers suspended delivery time guarantees and stopped accepting European airfreight.39

The International Air Transport Association (IATA) estimated that the Icelandic volcano crisis cost airlines more than $1.7 billion in lost revenue in the six days after the initial eruption. At its worst, the ash cloud grounded 29 percent of the world’s scheduled air travel and caused the cancellation of some 107,000 flights over an eight-day period.40 The disruption of passenger air travel would seem to mean little to the airfreight industry, except for the fact that most airfreight actually ships in the bellies of passenger aircraft.41 In total, global cargo flights were down over 15 percent in April, proving that the post-disruption rebound did not make up for the losses.42

In many cases, the declared value of the airfreight belied the importance of the shipments to the recipient—an issue discussed in chapter 7. Nissan’s inability to fly $30 air pressure sensors from Ireland to Japan kept the car maker from producing $30,000 Nissan Murano SUVs.43 Three BMW plants in Germany couldn’t get inbound parts from Asia.44 And an inability to ship transmissions out of Europe disrupted production at BMW’s US factory.45,46

Airfreight isn’t the only vulnerable mode, and volcanoes aren’t the only risk to bottleneck transportation routes. The Rhine River carries 16 percent of Germany’s trade.47 Recurring droughts,48,49 an overturned barge in 2011,50 and finding unexploded bombs from WWII51 have all created constrictions in freight volume on the river. In the United States, a quarter of all rail traffic and half of all intermodal rail traffic passes through Chicago. If the weather misbehaves, such as during the 1999 blizzard, then Chicago chokes. “The traffic just kept coming and coming and coming,” said David Grewe, a supervisor for Union Pacific Railroad. “We basically waited for the spring thaw.”52

Labor, a Striking Chokepoint

When 400 unionized shipping clerks walked off the job at the Port of LA and Port of Long Beach on November 27, 2012, it set off a cascade of effects. Ten thousand dockworkers in a sister union refused to cross the clerks’ picket lines, and 10 of the ports’ 14 terminals shut down.53 “We estimate that the two ports handle about a billion dollars’ worth of cargo a day,” said Art Wong, spokesman for the Port of Long Beach. “Three-quarters of the port complex is shut down, meaning $760 million a day worth of goods are just idled.” Over the eight days of the strike, those 400 disgruntled workers held up an estimated $6 billion in shipments and threatened 20,000 jobs.54

The effects spread beyond the ports. President Matthew Shay of the National Retail Federation called on President Obama to intervene and end this work stoppage. Shay added, “The work stoppage not only impacts retailers but is also affecting their product vendors—many of which are small businesses—and other industries like manufacturers and agricultural exporters that rely on the ports.”55 Jonathan Gold, vice president for supply chain and customs policy of the National Retail Federation, added: “These retailers will also face unanticipated costs. The ocean carriers will charge a $1,000 congestion fee per container for every day they are at sea… The truck drivers … transporting the containers, will not get paid.…”56 After eight days, the two sides reached a tentative agreement and the ports reopened.57 But the effects spread beyond the eight days. “Typically, what we hear from our retailers [is that] for every day of a shutdown, it takes two to three days to clear,” Gold said.58

Labor unions covering key infrastructure or industries have the potential to create systemic risks, as was the case during the 2002 West Coast Port Lockout that shut down all the port along the US Pacific Coast. The rapidly growing damage to the US economy caused then-president George W. Bush to intervene, invoking the Taft-Hartley Act of 1947 to force open the ports.59

Collateral Damage

“The disasters in Japan and Thailand this year [2011] were the worst hit that CBI [Contingent Business Interruption] coverage ever took,” said Volker Muench,60 head of corporate underwriting property at Allianz SE’s industrial-insurance unit. CBI covers the collateral damage caused by supply chain disruptions by underwriting some of the business losses incurred by companies indirectly affected by a disaster. “If a factory burns down, that’s only one claim in property insurance, while the same incident could potentially disrupt the supply chains of hundreds of companies if the factory supplies essential goods to other companies,” said Jochen Koerner, a member of the executive board of insurance broker Marsh & McLennan Co.61 Apple alone filed a $500 million interruption claim after the Japan quake because of interruptions in supplies of flash memory, DRAM, and digital compasses three weeks before Apple was to launch its iPad 2.62

Disaster Sprouts for Veggie Growers

When a rare and particularly virulent strain of E. coli bacteria infected some residents in Northern Germany and some European tourists, government investigators rushed to identify the source of the outbreak. The frantic search for the cause depended on very sick people’s fuzzy memories of where they had eaten and what they had eaten. The first cases appeared on May 2, 2011; during a two-month period, some 3,100 individuals suffered from bloody diarrhea, more than 850 got hemolytic uremic syndrome, and 53 people died.63 In addition to a large number of cases in Germany, health officials discovered victims in Britain, Denmark, France, the Netherlands, Sweden, and Switzerland, all involving people who had traveled to Germany. “Our absolute first priority is to clarify the source of the outbreak because, if we can’t do that, we’re not going to win back consumer confidence,” said Roger Waite, a spokesman for Dacian Ciolos, the European agriculture commissioner.64

Based on victims’ reports, salad topped the menu of suspects. The Robert Koch Institute advised consumers to avoid raw vegetables.65 Supermarkets all over the continent drastically cut their orders for tomatoes, lettuce, and cucumbers that people wanted to avoid, causing significant losses for European farmers. On May 26, the Hamburg Institute for Hygiene and the Environment found three cucumbers from Spain that tested positive for E. coli.66 As a result, Germany, Denmark, the Czech Republic, Luxembourg, Hungary, Sweden, Belgium, and Russia banned Spanish cucumbers.67 The effect was swift and devastating. Spanish farmers lost €200 million a week as some 150,000 tons of unwanted Spanish fruit and vegetables (not only cucumbers) piled up each week, according to FEPEX, Spain’s fruit and vegetable export body.68 Asked about the scope of the slump in demand, Jorge Brotons, FEPEX president, said: “Almost all Europe. There is a domino effect on all vegetables and fruits.”69

When further tests showed that the E coli found on Spanish cucumbers did not match the strain behind the outbreak,70 the German agriculture secretary Robert Kloos admitted: “Germany recognizes that the Spanish cucumbers are not the cause.”71 Yet German officials continued to advise consumers to avoid eating raw tomatoes, lettuce, and cucumbers, causing the slump to hit farmers in other countries, too. Victor Miranda, a grocer in Paris, said, “Even if the cucumbers are from France and not from Spain, nobody wants to eat them.”72 Koos De Vries, a Dutch cucumber grower, said, “From a business point of view, it’s a catastrophe for us.”73

When authorities finally found the true cause, they discovered that it had nothing to do with any kind of Spanish produce or any other growers’ tomatoes, lettuce, and cucumbers that so many people were warned to avoid. Instead, the E. coli contamination was finally traced to a small producer of organic sprouts in Germany.74 The warm moist environment of the seed-sprouting trays proved ideal for E. coli growth. Yet the farmer denied that his farm could be the true cause,75 because he didn’t use any manure-based fertilizers that might introduce E. coli to his sprouting houses. And he was right that it was not the fertilizer. Further analysis traced the E. coli to fenugreek seeds imported from Egypt and substandard sprout seed production practices in Egypt.76 Yet vindication was cold comfort for all the cucumber and salad ingredient producers in Spain and across Europe who were brought to the edge of bankruptcy by the scare and erroneous government warnings.

Two elements were responsible for the collateral damage in this case. First, public fear led to overreaction fueled by unsubstantiated media reports, because fear “sells.” The second element was hasty government actions, under pressure to quell these fears. But the German Government and the EU are not the only governments to over-react in haste. A substantial portion of the economic damage following the 9/11 terrorist attack was caused by the United States government closing the borders, stopping the flow of parts and products to and from Canada and Mexico. Similarly, most of the economic damage caused by the 2001 UK foot and mouth disease outbreak, was caused by the UK government closing the countryside, bringing the travel and tourism industry to a halt and causing losses that were higher than the damage to the agricultural industry.

No Disk Supply = No Chip Demand

When floods inundated hard-disk makers in Thailand in 2011, neither Intel nor its suppliers were flooded. In fact, Intel stood to gain because the company sold SSDs (solid state disks), which compete with hard disks for mass storage solutions in PCs, laptops, and servers. “We’ll be using this as an opportunity” to increase sales of solid-state drives, Intel’s chief financial officer Stacy Smith told analysts.77

But the shortages of disk drives hit PC production. In the fourth quarter of 2011, the PC industry faced a 35 percent shortfall in disk supplies.78 “The floods in Thailand have had an impact on the supply of hard disk drives and as a result [on] the PC supply chain,” Smith said in a conference call with analysts. “We’ve seen a drop in orders for microprocessors in the fourth quarter.”79 Intel lost about $800 million in revenue for the fourth quarter 2011 relative to expectations.80,81 “We found with Thailand that for want of a nail a kingdom can be lost. So for us, even though our production might continue, if other critical components to our customers can’t ship, like a hard drive, then everybody stops,” said Intel’s Jackie Sturm.82

What a Pain in the Acetonitrile

Collateral damage can spread across industries. Acrylic and ABS (acrylonitrile-butadiene-styrene) are very popular plastics used in carpet, cars, electronic housings, and small appliances. When the financial crisis struck in 2008, demand for acrylic and ABS plummeted. Both plastics are made from acrylonitrile, a colorless liquid with a garlic-like odor made by reacting ammonia with propylene gas. As demand for these plastics dropped, global production at acrylonitrile plants dropped by 40 percent.

Acrylonitrile synthesis also creates a sister chemical, acetonitrile, as a byproduct. For every 100 liters of acrylonitrile, the chemical maker also gets about two to four liters of acetonitrile. Some chemical plants simply burn the byproduct as fuel for the factory. But a few companies extract the acetonitrile, purify it, and sell it for a host of minor applications, including as a solvent used in research labs and in quality assurance testing in the pharmaceutical industry.

When acrylonitrile production plummeted, the acetonitrile supply went with it. Moreover, the Chinese restricted production during that same time in order to reduce air pollution for the Beijing Olympic Games, and Hurricane Ike knocked out a Texas supplier.83 “The market is beyond short,” said Jerry Richard of Purification Technologies, a Chester, Connecticut-based firm that buys acetonitrile in bulk, purifies it, and sells it to laboratory chemical suppliers. “You have people scrambling around trying to get material. My phone is ringing off the hook,” Richard added.84 Many industries are cross-coupled by deep tier suppliers in ways they don’t understand, increasing the chance of collateral damage from remote events.

No Systemic Supply Chain Risks

In addition to its horrendous human toll, Hurricane Katrina also knocked out 20 percent of the US supply of coffee just as demand was ramping up for the holiday season. Hurricane damage closed P&G’s Folgers plant in New Orleans for more than three weeks as the company worked to restore the factory and its supporting infrastructure (see chapter 6). Yet, US coffee drinkers never saw a shortage—other manufacturers were able to fill the gap. In fact, the Herculean efforts of Procter & Gamble to restart the plant were motivated by the reality that competitors were there to take up the slack.

A true systemic risk is the risk of a collapse of an entire industry or an industrial system. The term is typically used in finance to indicate a global financial system collapse, such as almost occurred during the 2008 financial crisis when credit dried up worldwide. It is also, however, used in reference to a regional event such as the 1997 Asian financial crisis. A systemic risk in supply chains can be defined as a disruption that brings an entire industry to a halt, resulting in consumers not being able to buy an entire category of products.

Throughout the many disruptions described in this book, end consumers remained largely insulated even as supply chain professionals agonized over how to recover from earthquakes, floods, hurricanes, and all the natural and man-made insults that supply chains endure. Even the largest disruptions—such as the March 2011 Japanese tsunami, the 2011 Thailand floods, or the 2008 financial crisis—had well-contained impacts. Some colors of cars might be delayed, prices for hard-disks might increase, or some companies might disappear. Yet, by and large, retailers’ shelves and dealers’ showrooms remained well stocked with all the goods that consumers have come to expect.

Thus, it’s hard to conclude that modern global supply chains show evidence of true systemic risks. Companies have developed efficient response mechanisms, and the same globalization trends that could create disruption risks for specific companies that use suppliers from faraway lands may also contribute to the prevention of systemic risk by spreading manufacturing capacity around the globe. Most important, global capacity for manufacturing and distribution is large, and while it is crucial for any company to prepare and respond effectively to disasters, there are always others ready to take its place if it fumbles.

Globalization’s Hidden Inventory

Verifone’s point-of-sale credit card readers use many of the same kinds of electronic components found in laptops and cell phones. That includes the intricately designed board-to-board connectors that route delicate digital signals to and fro inside the devices. After the 2011 Japan earthquake, Verifone faced shortages of these connectors because the big PC and smartphone makers had more clout to commandeer supply. But Verifone wasn’t disrupted because it found inventories in the gray market, at distributors, and on the spot market.

The same global coupling that makes many players sensitive to a disruption also means that many players around the globe might have hidden inventories. Competition causes suppliers and distributors to be responsive to customer demand. Given the volatility ofboth supply and demand, companies are motivated to hold safety stock. Long supply chains also imply days or weeks of inventory in the form of goods in transit. And the same IT and telecommunications infrastructure that supports global supply chains helps companies scour the globe for these hidden pockets of supply.

GM’s handling of the catalytic convertor production problems (see chapter 6) illustrates another hidden type of inventory in global supply chains. GM used the inventory latent in three tiers of intermediate suppliers and interconnecting transportation links to buffer a disruption at the deep-tier supplier. Each company in a deeply tiered supply chain might be quite lean, yet the sheer number of companies along the chain holding inventory in low-value form, awaiting value-added steps—plus the large amounts of product flowing through long global supply lanes—lead to a high aggregate level of inventory in the system. This inventory may be hidden, but it’s there in an emergency.

Innovation under Stress

When the Evonik fire created a shortage of the precursors to PA-12 plastic (see chapter 4), many competitors of Evonik and of the PA-12 plastic derived from Evonik’s chemicals rushed to the foreground. Makers of other polyamides (PA) or nylons touted their products. DuPont offered its Zytel and Hytrel brands of nylon.85 Arkema, Rhodia, BASF, Netherlands-based DSM, and DuPont offered PA-12 derived from castor bean oil as a green alternative to Evonik’s petroleum-derived PA-12. Evonik itself offered nylon 6/10, nylon 6/12, nylon 10/10, nylon 10/12, and biobased Vestamid Terra as alternatives.86

The acetonitrile shortage, discussed earlier, spurred innovation among both customers and producers of the chemical. Some acetonitrile users found workarounds, such as alternative solvents,87 and others changed their testing processes to reduce acetonitrile consumption per test.88 Through multifaceted modifications of the process, one supplier helped customers reduce run time by over 50 percent and reduce acetonitrile consumption by over 75 percent.89 Ineos Nitriles, producer of acrylonitrile and acetonitrile, found a way to adjust the reaction conditions during the production of acrylonitrile and increase its acetonitrile coproduct yields by 50 percent.90 If necessity is the mother of invention, then disruptions create a lot of inventive new parents.

So Many Modes, So Many Lanes

Vistakon, a Johnson & Johnson subsidiary that makes contact lens products, has factories in Jacksonville, Florida, and Limerick, Ireland. The 2010 Iceland volcano severed Vistakon’s usual airfreight distribution flows from Ireland to Asia. But the company found many ways around most of the disruption. It used multiple tactics, such as expediting orders from Jacksonville to Tokyo, trucking 60 pallets of contact lenses under the English Channel to Spain for a flight to Singapore, and chartering a cargo ship from Dublin to Tokyo in case the ash cloud lingered.91

Similarly, Dutch mail and express group TNT rapidly switched from its usual air hub in Liege, Belgium, to an air gateway in Madrid.92 BMW was trucking transmissions to Spain in hopes of flying them to South Carolina.93 Even with airports and air space closed over broad swathes of Europe, companies found ways to move goods.

Growing Maturity of Enterprise Risk Management

The 2005-2015 decade has seen a growing awareness of the need for systematic enterprise risk management (ERM) practices. In the wake of the 2001 Enron accounting scandal in the United States, the Sarbanes-Oxley Act of 2002 pushed companies to adopt more formal risk management procedures by requiring a top-down risk assessment and improved internal risk controls. The ERM Initiative at North Carolina State University has traced the rising adoption of ERM with annual surveys beginning in 2009.94 In 2009, only 8.8 percent of companies claimed to have “a complete ERM process.” By 2013, the number had risen to nearly one quarter (24.6 percent).

ERM is becoming more standardized, too. In 2004, COSO (Committee of Sponsoring Organizations of the Treadway Commission) expanded its corporate accounting risks framework to encompass enterprise risk management. The original COSO framework arose to manage financial controls, accounting audits, and associated compliance risks. The core of the new expanded framework is known as the COSO cube,95 which segments risk management activities on three dimensions: risk management components, risk management objectives, and entity/scope levels. Specifically, the objectives include strategy and operations, in addition to reporting and compliance.

In 2009, the International Standard Organization (ISO) published the ISO 31000 standard for risk management.96 Unlike COSO, ISO 31000 encompasses both negative and positive excursions in possible future events, scenarios, and conditions. Furthermore, in addition to ISO 31000, ISO maintains a host of related standards that address specific categories of risks such as ISO 28000 (security risk management systems for the supply chain), ISO 27001 (information security), ISO 26000 (social responsibility), ISO 14000 (environmental management), and ISO 9000 (quality management).97

These and other risk standards establish a top-down governance structure with internal feedback loops to manage risks as well as the risk management process. It begins at the board level. The initial component of the ISO 31000 framework calls for a “mandate and commitment” by the board. The board has overall responsibility for risk management, ensures that risk management is embedded into all processes and activities, and reviews the organization’s risk profile. The board helps define the organization’s risk appetite and manage serious crises. According to PwC’s 2014 Annual Corporate Directors Survey, risk management expertise ranked as the fourth most important attribute of board members, behind financial, industry, and operation expertise but ahead of international, technical, marketing, and legal expertise.98 Similarly, companies providing a “formal report to the board describing top risk exposures at least annually” have risen from 26.3 percent in 2009 to 47.5 percent in 2013.99

Darwinian Winnowing Begets Systemic Strength

The stories in this book demonstrate that individual companies are vulnerable to supply chain risks. While the strong companies can survive and even thrive as a result of preparation and effective disruption management, many others lose market share, lose money, suffer brand diminution, and even go out of business as a result of a disruption in their supply chains. Yet industries as a whole seem to be very robust, and examples of systemic supply chain risk are relatively absent from history.100 The answer to this seeming paradox is that systemic resilience exists because specific companies are vulnerable and because they operate in a competitive marketplace.

To understand this phenomenon, one can go back to the theory of evolution. Individuals compete for survival, and the weak ones fail. It is the fear of failure during competition that ensures that each element of the system keeps innovating and striving, thus making the winners and the entire system stronger. Therefore, with each disruption the survivors become stronger and more resilient, in the same way that the surviving species are those that are flexible and can adapt.

In his book Antifragile, Nassim Taleb101 uses the restaurant industry as an example. Individual restaurants are among the most failure-prone businesses—about 60 percent fail in the first three years.102 In highly competitive New York City, about 80 percent of restaurants fail in the first five years.103 Despite the high rate of disruption of individual restaurants, however, diners can always find a good quality restaurant in New York City. In fact, the quality of many New York City restaurants is exceedingly high.

Corporations and their supply chains also compete with each other. When disruption strikes a company’s manufacturing facility or one of its suppliers, that company may go out of business. But because competitors rush in to take market share, the industry as a whole remains very robust. Furthermore, the surviving players learn from the experience of the failing company as well as from their own efforts. They strengthen their defenses, improve their processes, and become less likely to fail during the next disruption.

Signs of Emerging Systemic Risks (Maybe)

“There’s no reason to think the trend towards more unforeseen events [affecting supply chains] is going to end,” said Bo-Inge Stensson, vice president for purchasing at SKF, the biggest maker of industrial bearings in the world.104 History cannot be a definitive guide to the future because the worst earthquake, flood, or industrial accident ever could always happen tomorrow or at some other point in the future. The disruptions of the past have known and bounded magnitudes, but the magnitudes of future events are unknown and unbounded. The properties of the power law distribution discussed in chapter 2 imply that as time marches ever onward, new opportunities for more, bigger, or worse disruptions appear. This property of the bounded past and the unbounded future is why world records are broken (in the future, somebody will run faster, jump farther, or lift heavier than anybody before).

For example, Eyjafjallajökull was a modest eruption by volcanologists’ standards and even by Icelandic standards. Katla, a larger mountain near Eyjafjallajökull, might be awakening, and its last eruption produced five times as much ash as did the 2010 eruption of Eyjafjallajökull.105 Other Icelandic volcanoes have produced 100 times the expelled material and erupted for months on end.106 The largest volcanic eruptions in world history were 1,000 times larger. Many locations have latent risks for very large disruptions. Seismologists’ models suggest that massive earthquakes are “overdue” in places such as California,107 the Pacific Northwest coast of the United States,108 Tokyo,109 and even London.110

Financial advisors often utter a common refrain that “past performance is no indication of future performance.” In that sense, the fact that past disruptions did not create systemic shortages is no guarantee that the future holds no surprises for the global supply chain systems. Even though the probability of systemic supply chain disruption may be very small, several trends hint at a nonzero probability of future systemic risks. These include the concentration of suppliers, new material requirements, contagion among supply chains inside and across related industries, and the geographical clustering of sources of supply.

Growing Global Diamonds

After a 1997 fire destroyed the Aisin factory that made proportional valves for car braking systems, all Toyota automotive manufacturing plants in Japan ground to a halt. Interestingly, however, no other car company in Japan was affected because Aisin belonged to Toyota’s keiretsu (i.e., a close affiliation of suppliers with that one brand). Reliance on a single supplier and a JIT manufacturing system made Toyota fragile to Aisin’s disruption.

Ten years after the Aisin fire, a 6.8 magnitude earthquake in central Japan severely damaged the Kashiwazaki City plant of Riken Corp., a supplier who made piston rings and other automobile components. Again, Toyota was forced to shut down all 12 of its domestic assembly plants. But Riken’s failure also caused the immediate shutdown of eleven other major Japanese automotive and truck companies, including Nissan, Mitsubishi, Mazda, Suzuki Motors Corp., and Fuji Heavy Industries Ltd. This disruption of just one supplier of a $1.50 part forced the closure of nearly 70 percent of Japan’s automobile production.111

The increased fragility of the Japanese automakers was due to the gradual dissolution of the keiretsu system (in which each supplier kept a strong relationship with only one OEM) to a more open, best-of-breed procurement strategy, in which all suppliers compete to sell to all OEMs and each OEM picks among all suppliers. For example, Toyota spun off Denso Corporation in 1949 but retained the supplier in Toyota’s keiretsu for many years. Today, however, Denso supplies most of the automotive, trucking, and heavy equipment companies around the world and has revenues exceeding $40 billion. Similarly, General Motors and Ford spun off their Delphi and Visteon units, respectively, with the expectation that these large suppliers would serve all the automotive companies. Around the world, the level of vertical integration (either via keiretsu cross-holdings like Denso or captive suppliers like Delphi) decreased.

This movement, in part, was due to the desire to create competition among suppliers (rather than be tied to internal capabilities), thereby reducing the costs of parts and subassemblies as well as tapping into more innovation from across the supply base. The result put significant cost pressures on suppliers, culminating in several bankruptcies, such as Delphi’s in 2005. Retailers were also growing in size during the same period, and giants like Walmart, Target, Tesco, and Carrefour were pressuring their suppliers to reduce prices.

Although suppliers did grow by serving multiple customers, the pricing squeeze caused them to merge and grow even larger in order to strengthen their ability to withstand OEM’s cost-cutting pressures. Suppliers such as Riken worked to improve efficiencies and economies of scale—including Riken’s decision to locate all of its factories in one strategic (but earthquake-prone) location.112 Hitachi, Mitsubishi Electric, and NEC Electronics merged their capacity to produce automobile microcontrollers into a single keystone facility, run by a company named Renesas, which was heavily damaged in the 2011 quake.113,114 Furthermore, as suppliers grew, they were able to invest more in research and development, and start to offer more specialized, innovative, and unique parts to their customers. For example, Bosch was founded in 1886 as a maker of ignition systems and grew into a $65 billion German automotive conglomerate with 350 subsidiaries supplying most automotive OEMs with electronic and electric components, gasoline and diesel fuel systems, car multimedia, control components, steering technology, and many other systems.

Suppliers’ consolidations and their expanded capabilities are increasing the risk of “diamond structures” in supply chains. In other words, a large fraction of a specific industry may depend on a single keystone supplier, who may be buried in a deep tier of the bill-of-materials. This keystone supplier may be disrupted as a result of a strike, sabotage, financial distress, or cyber-attack, thereby affecting its entire operation, even though it may have multiple plants. Such a failure may create a systemic risk for that industry—affecting all consumer-facing enterprises, be they OEMs, brand owners, or retailers.

Supply Contagion and Interdependency

It’s not every day that the CEO of one major company makes an impassioned plea for a government bailout to save his fiercest competitors. Yet that’s exactly what Ford CEO Alan Mulally did in front of the Senate banking committee on November 18, 2008. He said, “If any one of the domestic companies should fail, we believe there is a strong chance that the entire industry would face severe disruption. Ours is in some significant ways an industry that is uniquely interdependent—particularly with respect to our supply base, with more than 90 percent commonality among our suppliers. Should one of the other domestic companies declare bankruptcy, the effect on Ford’s production operations would be felt within days, if not hours. Suppliers could not get financing and would stop shipments to customers. Without parts for the just-in-time inventory system, Ford plants would not be able to produce vehicles.”115

“Our dealer networks also have substantial overlap. Approximately 400 of our dealers also have a GM or Chrysler franchise at their dealership. The failure of one of the companies would clearly have a great impact on our dealers with exposure to that company. In short, a collapse of one of our competitors here would have a ripple effect across all automakers, suppliers, and dealers—a loss of nearly three million jobs in the first year, according to an estimate by the Center for Automotive Research,” Mulally concluded.116

During the financial crisis, Ford did far more than just send its CEO to Washington to lobby for support for competing OEMs. Ford reached out to other automakers to explore “how we could work together where legally permissible to prevent a collapse of the supply chain,” said Ford spokesman Todd Nissen.117 Concerns about antitrust issues caused GM to decline to participate.118 In the end, Ford, Toyota, Honda, and later Nissan agreed to coordinate their efforts to support suppliers that were critical for each OEM.119 According to Detroit News automotive reporter Bryce G. Hoffmand, “It was like Protestants and Catholics coming together to work on a downtown redevelopment plan for Belfast.”120 In Europe, a similar collaboration took place with BMW, Audi, and Mercedes jointly aiding several suppliers with money and other support.121

Yet Mulally may have been wrong in his belief of being “uniquely interdependent.” The contaminated peanut scare and German E. coli cases showed the interdependence of food producers in which quality failures at one producer can severely disrupt the sales of all producers. The acetonitrile/acrylonitrile case shows the interdependence between the housing and pharmaceuticals industries. It also demonstrated the fragility of coupled production, in which a manufacturing process creates two or more different commodities simultaneously. If demand for one commodity drops, then supply of the other commodity falls, too. Issues such as rare earths, conflict minerals, and RoHS-obsolete122 parts create interdependence among many companies, industries, and regions.

Finally, the economic events of 2008 proved that the global financial system was the biggest diamond of them all. Most companies discovered just how dependent they were on their suppliers of capital—the banks—to support themselves, their suppliers, and ensure customer demand. Ultimately, government bailouts did avert a systemic cascading failure in the banking system and major industries. Yet the trillions of dollars handed out to support the weakened firms left a bitter taste in voters’ mouths and the unanswerable question of whether another financial crisis would prompt a similarly lavish bailout.

Industrial Clusters

“Why do we put all our suppliers on a little island in the Pacific where it rains and floods nine months of the year?” asked a representative of a technology company at a supply chain risk management conference. A 40-mile stretch of Taiwan—from Hsinchu to Taipei—designs and fabricates almost a quarter of the world’s integrated circuits. Taiwan is also home to almost 70 percent of the world’s IC foundry capacity as well as most of the global capacity for packaging and testing integrated circuits. A 1999 earthquake gave a taste of the effects of a disruption in this key region: the spot-price of computer memory climbed fivefold all over the world, disrupting operations at many electronic suppliers and hampering the launch of certain Apple laptops. The World Bank rated Taiwan as the most vulnerable place for natural hazards, with 73 percent of its land and population exposed to three or more hazards.123

Similarly, Japan makes 100 percent of the world’s supply of protective polarizer film for LCD displays, 89 percent of aluminum capacitors, and 72 percent of silicon wafers.124 Four companies in Japan have a near-monopoly on digital compasses—the tiny magnetic field sensors that sit inside almost every new phone, tablet, laptop, and navigation system device.125 Recall the damage to the disk drive industry in Thailand because of the fact that the country contributed almost half the world’s disk drives and most of it was disrupted during the 2011 floods. North Korea’s belligerent stance toward South Korea threatens 78.5 percent of the global DRAM capacity.126

Much as Silicon Valley is a cluster of information technology companies, Hollywood is a cluster of entertainment companies, and Cambridge, Massachusetts, is a cluster of biotechnology research, so is Northern Taiwan a cluster of chip fabrication and testing and Thailand a cluster of disk drive manufacturing. The long-term trends toward global procurement from “best of breed” (best-performance/least-cost) suppliers were paramount in creating concentrations of suppliers in industrial clusters around the world. Moreover, governments have been pursuing industrial cluster strategies, seeding certain industries and fomenting the self-reinforcing positive feedback loop of industrial agglomeration in order to grow these economic clusters. A positive feedback loop occurs because the bigger the cluster becomes (i.e., if more companies of the same industry agglomerate in a certain geography), the more attractive the cluster becomes to even more companies, and thus it keeps growing. Clustering has caused the concentration of specific manufacturing (and service) industries in specific locations around the globe. (The mechanisms and impacts of industrial clusters are described in my 2012 book, Logistics Clusters.127)

Clustering increases the vulnerability of companies that rely on cluster members as suppliers or customers. The reason is that disruptions that affect a cluster—such as earthquakes, volcanoes, labor unrest, or political instability—hit many companies in the same industry at once, making it more difficult to find alternative sources of supply when all the industry players are scouring the globe looking for the same things. “The floods in Thailand in the fall of 2011 showed us how dangerous it is when a component that is needed at manufacturing facilities around the world is mainly procured from only one region,” said Martin Bellhäuser, head of governance framework, at Siemens.128

Yet, the feedback loops and the success of governments’ cluster strategies are likely to lead to further geographic concentration of supply sources, thereby leading to possible future vulnerabilities.129 “Many organizations are more or less forced to put all eggs in one basket because of the clusters of suppliers for various goods around the globe,” said Damien Pang, regional manager, claims, at Allianz Global Corporate & Specialty Asia/Pacific.130

The Best Decisions Can Create the Worst Outcomes

When Queen Elizabeth asked why nobody had foreseen the 2008 financial crisis, a group of economists and constitutional experts explained, “Everyone seemed to be doing their own job properly on its own merit. And according to standard measures of success, they were often doing it well. The failure was to see how collectively this added up to a series of interconnected imbalances.... Individual risks may rightly have been viewed as small, but the risk to the system as a whole was vast.”131 This pattern of locally correct decisions but globally perilous consequences is the epitome of systemic risk and global vulnerability.

This pattern of individual decisions vs. shared consequences is often referred to as the “tragedy of the commons,” a term coined in 1968 by ecologist Garrett Hardin132 based on a concept first articulated by William Lloyd in 1833.133 Lloyd envisioned a pasture open to multiple cattle herds. Each herd owner has an incentive to add more and more animals even if the growing herds degrade the quality of the pasture. The benefit from each extra animal goes directly to the herder whereas the cost of the impact on the pasture is everybody’s problem. The herds keep growing because all the herd owners behave in the same way. At some point, however, the pasture turns to dust and everybody loses. Thus, while each individual entity “does the right thing” in its own best interest, the common ecosystem can fail, to the detriment of everyone.

Bullwhip dynamics, discussed in chapter 5, exemplify this kind of systemic risk created by individual companies each making the best local decision. A bullwhip can form if demand volatility affects each company’s rational ordering and inventory decisions in ways that create even higher apparent demand volatility in the next upstream tier. Volatility can amplify to irrational levels in the deeper tiers of a supply chain.

My Risk vs. Our Risk

After Superstorm Sandy, AT&T sent signal-measuring vans around New York City. But AT&T didn’t check only its own performance; it checked the performance of other cell phone providers, too. AT&T was concerned about relative performance, wanting to ensure that it wasn’t lagging relative to the other carriers as had been reported. AT&T found negligible differences in performance of the wireless networks, said John Donovan, AT&T’s technology chief. 134

Similarly, the 2011 Japan quake made the head of operations at Blue Coat, a manufacturer of electronic Internet equipment, realize how exposed the company was to Asian suppliers, especially if a major disruption hit the southern Chinese province of Guangdong. “I’m not sure what we’d do,” he said. “The only compensating factor is that all our competitors would be in the same position.”135

Tom Linton, chief procurement and supply chain officer at Flextronics, likewise said, “There will always be risks in supply chains, and the best you can do is really manage them well. The difference between winners and losers comes from an analogy. If you look at sports like soccer or football, the best coaches of all time only won 60 percent of their games. The best baseball players of all time only bat 0.400. So the best you can hope for in supply chain management is to beat the average.”136

In all three cases, the focus is on risks relative to competitors, rather than absolute risk avoidance. From the point of view of a company, this is a rational choice. A company can never know exactly how much it should invest in disaster recovery and resilience, because this includes preparations for low-probability, high-impact events and unknown-unknown black swans. Thus, one benchmark for “enough” investment in preparedness is the “industry standard”—doing what competitors and others in the industry are doing. Consequently, although all companies may have similar levels of preparation, none of the companies may be prepared for unforeseen, extremely large, industry-affecting disruptions.

The Collective Fragility of Individual Business Continuity Plans

At a 2012 MIT roundtable on ocean freight transportation,137 forty participants discussed their companies’ plans for handling potential labor strikes at US East Coast ports. More than half of the participants planned to divert shipments to Canada, Mexico, and the West Coast if the East Coast was closed.

The ocean carriers at the meeting, however, cautioned that all these diversion plans might not be viable because of port capacity limits at the time. None of the diversion options was through a very large port, and many ports had limited spare capacity. For example, Prince Rupert in Canada had only one open berth per week at the time. Moreover, even if the diverted ships could dock, there might not be dray chassis, long-haul trucking, and rail capacity to move the containers from the diversion ports to their final destinations. Diversions to Mexico and Canada might also face congestion or delays at the border. At the time, the Panama Canal was congested on both sides, so diverting from coast to coast could be problematic. To the extent that multiple companies create contingency plans that all tap the same resources, those contingency plans could readily fail if the plans need to be simultaneously activated.

The Whack-a-Mole Game of Risk Mitigation

Many of the common risk mitigation strategies described in this book have side effects that increase other kinds of risks. For example, a very large number of companies use dual sourcing or multisourcing to mitigate the incontrovertible supply interruption risks of sole sourcing. Yet multisourcing increases the risks of CSR issues by increasing the number of suppliers; a CSR failure at just one supplier will diminish the company’s brand. Moreover, second sourcing with competitive bidding can weaken the finances of both suppliers and increase the risks of supplier bankruptcies.

Southwest Airlines flies only Boeing 737s, a decision that reduces a wide range of operational risks such as the availability of air crew and spare parts. Yet if some design defect were uncovered in the 737, the entire airline might be grounded. Standardization, consolidation, and risk pooling can all help manage some types of risks, but they introduce vulnerable single-points-of-failure into the organization.

Similarly, added inventory can provide redundancy but may also mask quality problems, hamper their detection, and increase the costs of fixing them. Even hedging—a risk mitigation tactic—can backfire when prices or exchange rates do not move as forecasted. “It’s like you can’t win,” said Betsy J. Snyder, an industry analyst with Standard & Poor’s Ratings Services when discussing Southwest Airlines’s loss on its fuel hedging practice (see chapter 10). “People bother you when you don’t hedge, and when you do, and prices go down, you get hit.”138

Finally, risk management costs money and time. Those resources may be a very sound investment based on any reasonable analysis of the cost of risk management versus the expected value of averted disasters, mitigated consequences, and retained market share. Yet investing in risk management generally implies investing less in other areas—such as R&D, marketing, capacity, and talent—which can also carry risk. At some level, risk mitigation is like a whack-a-mole game: a company can beat down one type of risk only to have some other type of risk rise.

What Does Not Kill Me

The Eyjafjallajökull eruption and air travel disruption led to numerous projects to improve European air traffic control, refine volcanic ash flow models, create a better warning system, and learn how to avoid ash clouds in flight.139 And Walmart’s experiences with post-hurricane recovery led to more than a 3X improvement in the efficiency of its response. Better staging of inventory and a mobile command center help the retailer quickly serve post-disaster customers without excessive costs. Chapter 4 described how companies learn from disaster, and chapter 6 described how companies learn from drills.

Supply chain risk may be growing as a result of increasing globalization, product specialization, supplier consolidation, industrial clustering, and lean supply chain processes, but companies are also improving their abilities to handle large-scale disruptions such as those that faced Japanese suppliers, Thai factories, or Evonik. Furthermore, governments at all levels are partnering more with companies to prepare for crises. And the collaborative framework evident in the automotive industry during both the 2008 financial crisis and the Evonik fire proves that companies can, under grave circumstances, collaborate with competitors to avoid potentially systemic disruptions. “Big ones” have happened in global supply chains, and “bigger ones” may occur at any time. The future will determine whether companies have learned sufficient lessons from past disruptions or whether some hidden fragility or coupling induces a systemic impact.

Copyright © 2015 Massachusetts Institute of Technology. (All rights reserved.)

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