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The Aftershocks of Vulnerable Supply Chains

By Kathleen Ellis | June 27, 2011

The massive earthquake and tsunami that hit Japan in March has led to supply chain disruptions around the world, sending a wakeup call to companies that do not have viable business continuity plans in place for themselves and their suppliers.

Because Japan is a major manufacturer of sophisticated electrical components, the automotive and electronics industries have been hit particularly hard by the supply chain disruptions.

A number of companies, such as GM, Toyota, Nissan and others, have experienced shortages and have had to slow down production and, in some cases, shut down factories. Other companies suffered physical damage to their facilities and had to repair them, resulting in shortages and delays for their customers.

Disruptions to the supply chain can have serious consequences. Businesses that are unprepared to manage such disruptions risk not only production delays, but also potentially crippling competitive disadvantages, and harm to the company’s brand and shareholder value.

The price of a stock drops, on average, about 25 percent following an identifiable supply chain disruption, according to a study done in 2003 by Kevin B. Hendricks at the Richard Ivey School of Business at the University of Western Ontario and by Vinod R. Singhal at the DuPree College of Management at Georgia Institute of Technology.

The risk of a disruption, meanwhile, has increased dramatically over the last two decades as supply chains have become longer and leaner.

Although businesses are coming under increasing pressure from customers, regulators and from their own boards to address supply chain resilience, many businesses have given this issue little attention.

To reduce the risk of a significant loss, companies must make supply chain resilience a top priority and make sure that they and their suppliers have prepared business continuity plans that are tested and capable of responding to any number of potential crisis scenarios.

Supply Chain Vulnerability

In recent years, many businesses have moved to a just-in-time production strategy that encourages businesses to keep inventories low. While this approach helps reduce costs, low inventories increase the vulnerability of businesses to supply chain disruptions.

Faraway events can have repercussions throughout the globe and businesses that have not stockpiled enough inventory can begin to experience shortages quickly.

The earthquake and tsunami in Japan, for instance, resulted in shortages and shutdowns for a number of multinational businesses. The earthquake, for instance, led to the suspension of as much as 25 percent of the world’s production of silicon wafers used to make semiconductors, according to research firm IHS iSuppli in El Segundo, Calif. This was expected to have a particularly big impact on the global supply of memory processors, such as Flash memory and DRAM.

Sony Ericsson reports suffering from component shortages following the earthquake, which has limited volumes in its new smart phone offerings and has delayed the wider launch of its neo model to the third quarter, according to Reuters.

Toshiba, meanwhile, said an assembly plant in Japan making small liquid crystal displays would be closed for a month and computer maker Lenovo Group voiced worries over parts, according to a Reuters report.

The auto industry also has been affected. In March, just after the earthquake, Japan’s seven big automakers shutdown production due to growing concern about supply chain interruptions, power shortages and export difficulties. General Motors also cut production at two U.S. plants due to a shortage of Japanese-made parts.

A month later, Toyota said the number of parts at risk for shortages was shrinking, but nevertheless extended its North American production slowdown through early June, according to a Reuters report.

Although this is the most recent supply chain disruption, it is not the first. After the terrorist attacks of Sept. 11, 2001, and then again after Hurricane Katrina in 2005, a number of companies suffered from shortages and disruptions. After those events, some companies took action and began strengthening their supply chains and developing business continuity plans.

Even so, many companies are still unprepared and are at risk.

For about 80 percent of companies, supply chain resilience is not yet a priority at the executive level, except for those executives directly responsible for supply chain functions, according to a survey conducted by ChainLink Research, a supply chain research and advisory firm based in Newton, Mass.

It’s not just their own supply chains that are at risk, however. Any weakness in a supplier’s supply chain is also a problem.

Although supplier disruption risk is frequently a part of the supplier selection process, thoroughness of the risk assessment varies greatly, according to the ChainLink survey.

The majority of companies do not consider risk beyond immediate suppliers. Although almost 90 percent of companies surveyed have been assessing supplier disruption risk, fewer than 30 percent have a published set of resilience and risk mitigation standards for their suppliers.

Almost 40 percent of respondents never conduct assessments or do so less than once a year, even for their most critical suppliers, according to ChainLink.

A Plan of Action

Businesses can minimize the risk of a loss by focusing on supply chain resilience and preparing well in advance of a disruption.

Businesses that do not already have a business continuity plan need to begin working on one. Those that do have a plan in place should revisit it, make sure it is reflective of current conditions and includes assessments of suppliers and the supplier’s suppliers.

Certain key points are critical.

Design Scenario-Based Business Continuity Plan — Every business should have a business continuity plan that will help the organization respond to a scenario no matter what the specific event might be. A scenario-based plan, for instance, will help a company respond if there is a power shortage, or a shortage of a certain part or supply, regardless of whether the reason for the shortage is an earthquake, a wildfire or a hurricane.

Seek out the help of professionals who are familiar with supply chain resilience and business continuity planning. Many insurance brokers and insurance carriers specialize in business continuity planning and can provide advice, recommendations and other services.

Identify Possible Single Point Failures — Businesses need to build flexibility and adaptability into their continuity plans. Organizations that are too dependent on any one provider, part or ingredient put themselves at risk if there is ever a problem that results in a supply disruption. Develop emergency contingency plans that will allow production to continue using alternative products obtained from different suppliers if necessary to make sure that operations continue uninterrupted.

Audit Suppliers and Suppliers of Suppliers — It is not enough to simply ask suppliers to have a business continuity plan. Businesses must audit their suppliers to make sure they are in compliance and must check on the preparedness of their suppliers’ suppliers. These plans also must be tested to make sure that they are viable.
Businesses should make sure that they include their standards and requirements in writing in any contracts with their vendors.

Build Up Inventory Stockpiles — In recent years, the mantra has been to keep supply chains lean and inventories low to avoid the cost of storing excess inventory. But when inventories are too lean, any disruption to supply chains could lead to a delay or disruption in operations. Companies that maintain healthy inventories are at less of a risk of running short of supplies and having to scale back operations.

Test the Plan Regularly — A written business continuity plan is not enough. The plan should be tested on a regular basis to identify any weaknesses and to make sure the plan will work as expected. A written plan is only good if it works in actual practice.

Use Insurance to Help Offset A Loss — Insurance can help to offset a loss, but businesses cannot rely on insurance alone to protect them from a loss arising from a supply chain disruption. Policies respond only under certain specific circumstances. For example, business interruption and contingent business interruption insurance will help offset income losses in the event of a property loss that results in a shutdown of operations. However, many policies that provide such insurance do not respond when the property loss only results in a slowdown of operations.

As businesses grow ever more global, working with suppliers from around the world, supply chains are being stretched and becoming increasingly vulnerable. At the same time, with inventories reduced as part of a strategy to keep costs low, businesses are less able to tolerate any delay in parts or supplies.

Businesses should take this latest event as a warning and use it to create more resilience in their supply chains and protect themselves from the consequences of a major disruption. By developing a business continuity plan, auditing suppliers and suppliers of suppliers and building up inventories businesses can reduce the risk of a delay in production as well as damage to their brand and shareholder value.

Ellis is a senior vice president of Chubb & Son, and manager of Multinational Risk Group – Global Accounts.

 


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