The Japanese Crisis and Supply Chain Risk Management

Stephen DeAngelis

May 24, 2011

As the Japanese begin to rebuild areas devastated by earthquakes and the tsunami, supply chain analysts continue to examine the consequences of supply chain disruptions that resulted from those devastating events. For example, Bob Ferrari wrote, “The after-effects of the earthquake in Japan will have far reaching impacts on multiple industry and global value-chains.” [“The Aftereffects of the Japan Disaster- Reflections on the Strategic Business Implications,” Supply Chain Matters, 15 April 2011] Ferrari continues:

“The Japan event will ultimately seed a number of significant watershed changes for industry supply chain strategies and capabilities going forward. The open question is how significant and how deep. … Jason Busch of Spend Matters called attention to a Paul Martyn, commentary published on Forbes.com that noted an estimate that it would be 9 to 12 months before production can return to pre-disaster levels. That seems to be a reasonable general estimate and there certainly could be some outlier exceptions, particularly in electronics and automotive sectors. In his commentary, Martyn predicts three major shifts as a result of this crisis:

“1. A lessoning of the rigidity of zero inventory policy that many companies have been following these past few years.

“2. The entry of new players takes advantage of the crisis to seize new revenue opportunities.

“3. Bullish upside for U.S. and perhaps North American based manufacturers that stand to gain in the short-term as alternative suppliers.

“Regarding point three, Jason Busch opines that then again, U.S. manufacturers may once again be unable to respond to the new business opportunities because of a lack of required capabilities in key people skills such as machining, welding, design and other specialized manufacturing. Needs for updated capital equipment are also expressed.”

Busch may be correct when he asserts that there are not enough skilled workers for U.S. companies to take advantage of opportunities that may come their way. James R. Hagerty reports, “U.S. manufacturing companies, long known for layoffs and shipping jobs overseas, now find themselves in a very different position: scrambling for scarce talent at home.” [“Help Wanted on Factory Floor,” The Wall Street Journal, 6 May 2011] Ferrari concludes his post with this prediction: “When the dust [from this crisis] finally settles, … the very foundations of procurement and outsourcing strategies [will be challenged] which will cause product development, strategic sourcing and supply chain management teams to reassess their policies and processes in product and component sourcing.” Bill McBeath, from ChainLink Research, asserts, “Considering how devastating disruptions can be to the brand, shareholder value, competitiveness, and a firm’s ability to trade, we continue to assert that building a resilient supply chain is one of the most important assets and competitive foundations that a company can develop.” [“2011 Supply Chain Risk Survey Results: Part One,” 3 May 2011]

If the Japanese crisis is going to have the profound effect predicted by Ferrari and “building a resilient supply chain” is as critical as McBeath claims, how are businesses responding? According to McBeath, supply chain resilience is still not a priority. He continues:

“The devastating 2011 Japanese tsunami was a wakeup call for many companies. Even many of those not immediately affected have been rattled by the events. … Unfortunately, we have seen over and over that for most companies the memory of this will fade, and the executive team’s attention will be consumed by other matters that are deemed higher priority. This is understandable, because top executives’ metrics, compensation, and the firm’s stock price are usually not impacted much (or at all) by the company’s level of supply chain resilience … until after a disruption occurs. Our past research has shown that executives’ tolerance for risks tends to be quite a bit higher than many of us would consider reasonable. In late March and early April 2011, in the wake of the Japanese tsunami, we conducted a survey about supply chain risk. Our survey found that supply chain resilience tended to be reviewed and managed ‘down in the trenches’ by the people with immediate responsibility for operational functions, as well as by the head of those functional units, such as the VP supply chain. … Review by executives in charge of the business unit or by corporate executives is considerably less common. … This shows that for about 80% of companies, supply chain resilience is not yet a priority at the executive level, except for those executives directly responsible for supply chain functions.”

Gary S. Lynch, Marsh Inc.’s supply chain risk management expert, claims that even companies that have a disaster mitigation plan or a continuity of operations plan on the shelf it isn’t really a plan if it’s not exercised. [“Wake Up Call,” Industry Today, 30 March 2011] He writes:

“This is the moment of truth. Did or would your organization’s continuity plan effectively address business disruptions resulting from the confluence of the Japanese earthquake, tsunami, and radiation events? Did the volcanic eruption in Iceland put the brakes on your business because of inadequate or incomplete planning? For most organizations impacted by these events, typical business continuity planning was inadequate. When attempting to address business recovery and supply chain flows, most organizations failed.”

Why did these plans fail? During interviews with company executives, Lynch was told “that not only were their recovery plans incomplete or inadequate, but they also were not aligned with, nor reflected, the needs of a globally interconnected and interdependent organization and economy.” He claims the greatest shortcoming of most recovery plans was that they “fell short when considering key interdependencies.” For example, Lynch says that “events in Japan displaced and/or destroyed the die casts – critical molds for the large scale and precision creation of critical components. The casting equipment and metal dies are an essential element in the mass manufacturing of intricate metal parts.” This planning shortfall, Lynch claims, is the result of complacency and a willingness to accept the bare minimum when it comes to planning. He continues:

“Some might claim success because they have a plan in a binder on the shelf, or they’ve checked all the boxes to comply with good business continuity management standards. Often these efforts simply bolster a thinly veiled attitude of complacency. To achieve true resiliency in today’s interdependent and continuously changing world, traditional continuity planning needs to be re-engineered or ‘blown up.’ Managing resiliency today is as much about avoiding or minimizing exposure to risk as it is expediting recovery or adjusting to events. Over the last several years, many organizations have focused on optimizing efficiency but not resiliency, which was completed as a separate and disconnected effort. Concurrently optimizing resiliency and efficiency requires discipline, analytics, decision modeling, and the involvement of a broad cross-section of business, technology, and operation leaders both inside and outside the organization.”

Lynch goes on to provide some good advice about how to start over crafting a meaningful and resilient recovery plan for your company. He asserts that “black swan” events are now so common — “Christchurch (earthquake), Brisbane (floods), Iceland (volcano), New Orleans (hurricane) and Japan (earthquake, tidal wave and nuclear disaster)” — that they should no longer be placed in the “highly improbable” category. He then provides some recommendations for improving resiliency. He writes:

“Strategies for managing continuity and providing greater resiliency can be divided into four categories:

  • Insurance driven/asset-based programs
  • Compliance driven/functional-based programs
  • Threat driven/event-based programs
  • Value driven/flow-based programs

“The first three categories represent the majority of today’s practices. They take into consideration only a small portion of exposure, and risk investments are typically aligned by a physical resource (a plant, for instance). Insurance-driven continuity typically does not take into account non-physical damage perils such as the failure of a supplier or of the public infrastructure. The fourth category signals a rapidly emerging and business-aligned trend. It represents an integrated, end-to-end view of the extended supply chain (beyond the boundaries of the physical organization) that is viewed in the context of a given product, product category, or product family. Industries embracing this value-based strategy include those with the most highly complex and advanced supply chains, such as automotive and high-tech manufacturing. The strategy begins with a clear articulation of the market and product/service families or categories that are of greatest organizational value: i.e., revenue, strategic, liquidity, brand, and/or compliance. For example, the auto manufacturer might identify the pickup product line to be sold in the Chinese market as its number-one value driver. Essentially, the organization must ask: If all of our capabilities were destroyed and we were starting from scratch, which market and associated products/services would we build out first? Once the priority is articulated, the value/supply network can be mapped.”

This approach is very similar my company’s Enterprise Resilience Management Methodology™ (ERMM). It is essential to know what assets and processes are the most critical for your company. Having identified the most critical characteristics of your company, Lynch then states that you can intelligently select the best “risk mitigation and financing options” which “would include—but not be limited to—diversification, buffering, repurposing or substitution, segmenting and inventory allocation, internal alternate sourcing, multi-sourcing, insurance, or even exiting the business.” His last recommendation is that company’s recognize “that supply chain optimization involves resiliency optimization.” He concludes:

“If we accept that the ‘disruptive economy’ is the new norm—and we acknowledge that catastrophic events can occur anywhere in business networks and supply chains—then we need definitive responses to a list of remaining questions. In this way, the resiliency objective remains in sharp focus. Those remaining questions include:

  • “Are we—in conjunction with our partners—continuously evaluating, evolving, and improving the resiliency programs that support value-creating activities as determined by stakeholders (investors, customers, etc.)?
  • “How do we monitor volatility in our organization in relation to stakeholder behaviors, SPOFs, and supply chain interdependencies? What levels of volatility are acceptable? When do we react?
  • “What are the complete sets of resources (labor, technology, physical assets, relationships, and processes) needed upstream and downstream to deliver each product/service family to the market? Have we mapped the extended supply chain?
  • “Are we collecting business intelligence about our SPOFs, including the maximum financial, brand, strategic, compliance, liquidity, and asset impact at each point?
  • “Are the people, infrastructure, and suppliers that we depend on managing their market, financial, operational, and behavioral risk, at a minimum, to our expectations?
  • “Are we real-time monitoring the most critical supply chain dependencies for value-creation activities?
  • “Have we created decision models that support resiliency options at the time of the event?
  • “Have we created a collective culture along our supply chains that is risk conscious, intelligent, and motivated?

“With discipline, analytics, decision modeling, and the involvement of a broad cross-section of business, technology and operation leaders in and outside the organization, we can answer these questions and optimize the resiliency of our organizations.”

Malory Davies, editor of Supply Chain Standard, takes a contrary view to those expressed above. [“Supply chain resilience: common sense or waste of money?” 3 May 2011] He writes:

“You’ve probably noticed already, but there is something of an argument going on in the investment community about the supply chain lessons to be learnt from the Great East Japan Earthquake, as it is now being described. The impact of the earthquake and ensuing tsunami on supply chains around the world has been widely reported and analysed. Where the disagreement arises is over what is the correct lesson to be learnt from it. One view is that companies need to look again at the resilience of global supply chains and reduce their reliance on single source suppliers. The corollary to this is that making the changes that such a reassessment would indicate would result in new business investment fuelling further economic growth. It almost makes it sound as though you have a duty to the global economy to invest in changing your supply chain. And some commentators are predicting big changes in sourcing patterns over the next four or five years with some companies shifting up to a third of their production away from low-cost economies to somewhere closer to home. The other side of the argument is that to change now would be an admission of failure. Making major changes to supply chains would simply swallow up money that could be invested more profitably elsewhere in the business. My view is that it would be foolish to bet the business on a supply chain which has demonstrable weaknesses.”

Davies admits he doesn’t know which view will win out and neither do I. I suspect that the answer to the question “Is supply chain resilience: common sense or waste of money?” is: it depends. If your company can absorb disruptions and survive, then spending too much time or money developing and testing recovery and continuity of operations plans may be a waste of money. If your company can’t absorb disruptions without significant costs, you would be foolish not to spend the time and money to prevent or mitigate disruptions. With volcanic eruptions in Iceland once again causing concern, I’m sure this is a topic that I’ll be addressing again.