The effects from last week’s earthquake and tsunami and the ongoing nuclear crisis in Japan are beginning to disrupt global supply chains. Yesterday, it was reported that GM had to halt production of vehicles at several plants, due to parts shortages from Japanese suppliers. Toyota has suspended production of parts in the mother country that were intended to be shipped overseas. Finally, most Japanese automotive assembly plants remain closed (source: HIS Automotive)
The automotive supply chain is as complex as it gets. There are approximately 20,000 parts in a car, and if only one of those parts is unavailable, then the finished product cannot be shipped. At the top of the pyramid are Tier 1 suppliers that furnish major components, such as engines, that go into a vehicle platform. The Tier 2 suppliers furnish the parts that the Tier 1 suppliers require, such as the piston rod assembly that is part of the engine. As shown in the following schematic, there are typically 3-5 levels in the automotive supply chain, which is comprised by 1,000s of suppliers:
Japanese companies produce many of the components that all OEMs require. For example, the transmissions for the new Chevrolet Volt plug-in-hybrid are sourced from the Land of the Rising Sun. In addition, Japan is a major source of electronic components, furnishing many of the over 30 microprocessors that are found in a typical car. The art and science of managing such a complex global network, spread out over dozens of countries, is challenging even under the best of circumstances. But the Tsunami’s external shocks to the global supply chain are testing the mettle of even the strongest producers. For example, supply chain management at Honda is being stress tested, given that at least 113 of its suppliers are located in the affected areas. As of Tuesday, it had been unable to establish contact with more than 40 of them (Source: Automotive News).
Furthermore, many Japanese components are transported by container ships, which take 30 days to reach U.S. and European docks. So, it is likely that many problems will show up a month in the future when automakers run into parts bottlenecks.
But more than meets the eye is at work here. As reported in Industry Week magazine, the dominant operations strategy of US manufacturers has been Just-in-time (JIT) inventory control or lean operations. Although producers have benefited greatly from these approaches, this latest disaster sheds light on JIT’s inherent risks.
For example, well-functioning JIT systems operate with less inventory, because inventory—in excess of what is needed—is wasteful. Another implication of JIT is reducing the number of suppliers for each component, which results in significant economies of scale. Some firms have reduced the number of suppliers to sole-sources of components. For instance, Somic, a Japanese firm, made all of Toyota’s steering linkages.
But when a critical supplier is unable to produce material, the entire system breaks down. For example, several years ago a fire broke out in Aisin Seiki, a supplier that produced more than 99% of Toyota’s brake valves. Most of the 506 machines used to produce the valve were inoperable. Toyota maintained only a 4-hour supply of the valve, so, the world’s #1 car maker’s production lines quickly shut down. This resulted in Toyota losing production of 70,000 cars. But Saturday after the fire, Toyota and Asin officials summoned many of Toyota’s other suppliers, gave them blue prints, and assigned them the task of making the critical valves. Toyota was able to survive.
But the current calamity has affected not just one sole-supplier of a relatively mundane component designed for a single automotive OEM. Rather, the fate of dozens of factories in northern Japan is unknown. And these firms furnish 100s of different components for many OEMS. In effect, the scale of this current disaster is far more massive than what Toyota encountered with its brake valve.
Clearly, automotive OEMs must rethink risk mitigation strategies to deal with large scale disruptions of their supply chains. There are number of avenues open to them, including:
- Challenging suppliers to develop disaster plans so that they can make provisions to move to alternate sites for production, in the event that they are unable to produce product at their main plant.
- Eliminating sole-source suppliers, and developing the capabilities of additional companies. Having one supplier is probably too few, but having five suppliers is too many in terms of achieving economies of scale. One strategy would be to give 80% of the work to the primary supplier, and 20% to a secondary vendor that is located in another country. Part of contingency planning should include provisions for ramping up production of the second supplier, in the event of a calamity.
- Analyzing where suppliers are located, and limiting the number of critical component suppliers that are geographically situated in a risky area. For example, an analysis of Volvo’s supply chain indicated “10% of their parts came from 33 Japanese suppliers, 7 of which were located in the catastrophe area,” according to the New York Times.
- Review insurance policies and consider taking-out contingent business interruption insurance that protects against losses relating to the inability of suppliers to deliver. Although some of the OEM’s had this coverage, the WSJ suggested that there were so many limitations and exclusions attached to their policies that claims will probably be insignificant.
In light of Japan’s deepening nuclear crisis, it is time that global manufacturers reassess the design of their networks to mitigate against risks associated with large scale disasters. Those suppliers that do reassess their supply chains, can only benefit by reducing their exposure to the next calamity that will surely occur.
What other actions could be taken to reduce risks in the operation of a global supply network?