Supply Chains At Risk

Sept. 21, 2006
Manufacturers need to guard against disruptions in the flow of materials. With so many things that can -- and do -- go wrong, contingency planning is no longer a luxury... it's a necessity.

From 2000 to 2001, the high-tech industry, having spent hundreds of millions of dollars on sophisticated supply chain management software, got blindsided by an acute shortage of certain electronic components.

One such device, the tantalum capacitor, was in such short supply and high demand for use in both computers and cell phones that one high-tech manufacturer was forced to cut its earnings estimate for the quarter. A leading PC maker, "gaming" the market the way the Hunt brothers cornered the silver market in the 1980s, saw fit to place orders for 10 times the amount they could use of these 15-cent to 25-cent devices. Yet another high-tech manufacturer bought up cell phone handsets to remove the capacitors for use in a new product.

"The huge spike in demand for cell phones caused unprecedented demand for these components," says Bud Mathaisel, senior vice president and CIO at Solectron, a contract manufacturer for various electronics original equipment manufacturers (OEMs). Solectron found a creative solution to the shortage, with engineering teams working with suppliers to redesign the component. "We began to shift suppliers to ceramic capacitors that cost $1.25 each," Mathaisel says.

After the 1995 earthquake in Kobe, Japan, the Osaka plant of Sumitomo Metal Industries Ltd. lost all water and gas. The plant was the sole source of brake shoes for Toyota's domestic cars. Toyota's vulnerability to a supply cutoff -- operating with only minimal inventories of parts -- caused the company to halt production at most of its plants in Japan. Toyota lost production of 20,000 cars, costing it an estimated $200 million in revenue.

Phillips N.V., the Dutch electronics giant, suffered a fire at a chip plant in Albuquerque, N.M., in 2000. The company lost about $40 million in sales as a result. In a ripple effect, a major customer of the plant, cell phone manufacturer Ericsson, came up short of millions of chips it needed for its latest generation of cell phones. The impact was devastating for Ericsson, which took a $2.34 billion loss in its mobile phone division, citing not only component shortages, but a poor product mix and marketing troubles as well.

These are just a few examples of the mayhem a supply chain disruption can wreak on a manufacturing company's operations and financial health. Whether it's a natural disaster, a strike or a labor slowdown at a major port, the potential risks facing global manufacturers today are further magnified by the progressive leaning out of inventories that has taken place in recent years.

"The supply chain is getting leaner, with less buffer and more inventory being held in other countries," observes Steve Phillips, CIO, Avnet Inc., a distributor of electronic components and computers. "This means there is less ability for the supply chain to soak up the shocks that occur."

In fact, the inventory-to-sales ratio for the U.S. economy has been consistently declining, evidence of a much leaner supply chain. "There is a greater potential for the effect of disruptions in the supply chain to be amplified as a result," says Mark Hillman, senior research analyst at AMR Research in Boston.

Strategic Concern

The end result is that logistical worries have escalated from shipping to the board room. "Risk management is a strategic imperative for any large company with a global supply chain," says Scott Singer, director of global supply management at United Technologies Corp.

AMR's Hillman identifies four types of supply chain risks:

  • Natural disasters
  • Market risk, including the ripple effects of strikes and bankruptcies among suppliers
  • Commodity risk, such as the impact of geopolitical factors on the price and supply of oil
  • Transportation risk, including port congestion.

Given that the unexpected will happen and frequently does, how can manufacturers prepare for these worst-case scenarios?

"When thinking about reducing a company's vulnerability to disruption, executives need to look at increasing both security (thus reducing the likelihood of a disruption) and resilience (thus building in capabilities for bouncing back quickly)," writes Yossi Sheffi in The Resilient Enterprise (2005, MIT Press).

Sheffi, director of the MIT Center for Transportation and Logistics, observes that "the essence of most disruptions is a reduction in capacity and therefore inability to meet demand." Thus, he concludes, most supply chain interruptions are not dissimilar from large supply/demand imbalances that result from an unanticipated spike in demand.

Backup Plan

For most manufacturers, having a backup plan in place can help. "We test our plants with dry runs, so that when an event happens, we know what to do," says Solectron's Mathaisel. "Having a backup plan enables us to be more efficient in the way we are able to respond."

More On Bird Flu

Plan For Worst-Case Scenarios
For example, Solectron has a plan in place for dealing with a possible outbreak of Asian bird flu. The company's what-if scenarios include dealing with a localized bird flu outbreak, a regional event and a widespread pandemic.

Mathaisel likens an avian flu pandemic to the Sept. 11, 2001, terrorist attacks in its potential to disrupt the flow of supplies. "After the 9/11 disaster, our supply chain in the air was disrupted and we rented vehicles to expedite supplies from Mexico," he notes.

Often a solid fallback strategy will include redundant sources for at least the most critical parts and components. For instance, AMR's Hillman recommends that manufacturers carefully assess the degree of risk they would incur if supplies of a certain part were cut off for a week. "They need to determine what things are critical versus what are less critical, and then define a different strategy for each part," he says.

Manufacturers also should have a backup plan for their transportation networks. "We make sure that we have built in redundancies for our networks and transportation logistics," Singer says.

Tracking Supplier Health

United Technologies keeps an eye on both its extensive supplier network and on its critical parts to avoid having supply troubles sneak up on it. The conglomerate uses a supplier tracking service provided by Open Ratings Inc. "This is an important tool for us, serving as an early warning system to alert us to possible problems with a supplier so that we can do proactive follow up," Singer says.

In one instance, the Open Ratings service helped a United Technologies aerospace unit to identify a financially ailing supplier. It turns out the supplier had a cash flow problem, so United Technologies was able to help put together a solution between it and a raw materials supplier. "We put in a temporary work-around plan for that supplier that got them back on course," Singer says.

About 40 manufacturers use Open Ratings to keep tabs on the health of suppliers. "If you know which supplier is likely to have a problem, you can go fix it, but you need lead time," says Jim Lawton, vice president of marketing at the supplier information service in Waltham, Mass.

The biggest risk manufacturers face, in Singer's view, lies two or three tiers down in the supply network. "It's getting a handle on those issues that may happen three levels deep into the supply chain," he says.

United Technologies hedges against the impact of possible disruptions by having redundant sources for critical parts. "At a plant level, we define those critical materials that would mandate a secondary source," Singer says. "It is absolutely critical to have redundant capability for critical components."

It gets more dicey, though, when a part is so intricately designed and engineered that a large investment is required for a supplier to produce it. Few suppliers are eager to bear the cost of setting up production, only to "sit on the bench" until the first-string gets injured. As Singer observes, "If it is a highly engineered component, there is a question whether you incur the cost of having a secondary supplier."

Toyota Bucks The Trend

In some instances, too, manufacturers simply prefer to soldier forward with a single major supplier.

When a fire at an Aisin Seiki plant in Kariya, Japan, destroyed most of the more than 500 precision tools used to make proportioning valves (P-valves) for automotive brakes, Toyota quickly ran out of valves and had to shut down two-thirds of its assembly lines.

Purchasing and setting up replacement machinery would have taken months, so Aisin and Toyota worked with their keiretsu supplier networks to come up with a solution. More than 50 companies stepped forward, working with engineers to find ways to make P-valves using alternative equipment and machining practices. Within a few days, Toyota was able to start reopening plants.

Although most manufacturers would avoid the single-source approach in an effort to avoid such a materials disruption, Toyota viewed the incident as proof its system works. "The fire and its aftermath," notes MIT's Sheffi, "have left Toyota executives convinced that they have the right balance of efficiency and risk." Even so, few manufacturers enjoy the kind of close collaborative relationships that Toyota has with its supply base.

The supply chain has become more unwieldy to manage, but United Technologies' Singer thinks today's technology evens things out a bit. "The supply chain is more global and complicated, but we have more technological solutions to monitor it and stay on top of things," he says.

Technology, in fact, is especially useful by providing manufacturers with visibility into the whereabouts of parts and materials shipments, as well as the critical paperwork that must accompany them.

"The failure of a key document to be received at a custom house broker may mean that your materials do not clear customs, and your product will not be available to meet a customer delivery," says John Urban, president of GT Nexus, an online ocean shipping portal used by manufacturers to book and monitor their shipments. "The flow of these documents is as critical from a risk standpoint as the physical flow of the goods."

Going Local

Avoiding possible logistical snafus -- as well as the two weeks or more it can take to obtain supplies shipped from overseas -- is one reason some manufacturers in the aerospace, high-tech, automotive and healthcare industries pay a premium to source critical parts locally.

For example, Electronic Source Co., an assembler of circuit boards in Van Nuys, Calif., has built its business on fast turnaround and high reliability. Customers of ESC, which obtains most of its components from U.S. distributors, lie within a 150-mile radius, so that finished boards are shipped via company truck or UPS.

"We do a lot of electronics for military contractors," says Scott Alyn, president and founder of ESC, with 65 employees and revenues of about $3 million annually. Customers include Raytheon Co. and a subcontractor to Boeing Space and Intelligence Systems, who install ESC's circuit boards in jet fighters and military satellites.

Despite the fact that more than 90% of all printed circuit boards are manufactured overseas, ESC is growing. One reason is its dependability as a U.S.-based supplier to the Los Angeles region's large network of aerospace and defense contractors and subcontractors. According to a National Research Council study, the U.S. could be vulnerable to sabotage or a cutoff of circuit boards for military applications if producing nations suddenly became undependable as American allies.

Fast turnaround also makes this small Los Angeles Basin company, located in the San Fernando Valley, the choice for high-tech OEMs that are hungry to obtain early stock to fill the front-end of their customer pipeline. "We have several customers that split their production runs between us and offshore plants," Alyn explains. ESC typically will produce the first 1,000 motherboards for a new piece of electronics with a two-day turnaround, while a Chinese manufacturer will bring in the next 5,000 units in two weeks.

ESC shrewdly capitalizes on its speed advantage over

Chinese manufacturers. China may be low-cost, but even its fastest manufacturing plants can't produce and deliver an order via air freight to a California customer in less than a week. On a rush basis, ESC can knock out an order in 24 hours. "Manufacturers will come to us just to get their product to market faster," Alyn says.

And, he might add, with a lot less logistical risk.

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