Floods, Companies and Supply Chain Risk
Global companies with long supply chains could do a much better job of managing climate disaster risk, according to a recently published study from Masahikio Haraguchi and Upmanu Lall, researchers at the Columbia Water Center.
According to the study, published in the International Journal of Disaster Risk Reduction, even as the impact of natural hazards on the global supply chain increases, the impact on at-risk businesses varies widely, depending on how alert, prepared and responsive to risk an individual company is. Using the 2011 Thai floods as a case-study, the researchers examined impacts on different companies and identified factors in investment decision-making that could affect individual supply-chain resilience.
In 2011, rain deluged Thailand. For months, soaking downpours saturated the countryside, inundating more than two-thirds of the nation, killing hundreds of people and devastating the economy.
However, because of its outsized role in global manufacturing, the impact of the disaster was not limited to Thailand. According to the United Nations Office for Disaster Risk Reduction, the country’s 2011 floods actually reduced global industrial production by 2.5 percent; and damages cost the world’s top three non-life insurance companies $5.3 billion in claims, an amount greater than the cost of Japan’s massive earthquake and tsunami earlier the same year.
While the floods impacted a number of industries, electronics manufacturers and auto companies were particularly hard hit: Western Digital—producer of one-third of the world’s hard disks–lost 45 percent of its shipments, while Toyota, Honda and Nissan lost 240,000, 150,000 and 33,000 cars respectively.
According to Masahiko Haraguchi, lead author on the study, in industrial, emerging and developed nations, deaths from flooding have actually fallen in recent years—even as economic damage has skyrocketed. “There are two trends,” he says. “When natural disasters hit less developed countries, the death toll still tends to be high. But if you look at the developed countries—industrial or emerging nations—their economic model has been to concentrate in urban areas. If disaster hits those areas, which are economically dense, where the economic assets have been concentrated, the economic damage is going to be larger than in previous disasters,” even if improved emergency response reduces deaths.
According to Haraguchi, place-based risk from economic density leads to global systemic risks from economic interdependence; flood damage in one key node flows through an entire supply chain. This is especially true in today’s lean but complex manufacturing systems in which system resilience comes second to cost-efficiency.
In the automobile sector, Japanese firms were most heavily affected by the 2011 floods; these firms and their family companies account for some 90 percent of sales and exports of automobiles in Thailand. Honda, Toyota and Nissan each had to shut down operations, either because factories were inundated, or due to lack of parts from suppliers.
However, the three companies suffered different impacts, with Toyota and Honda suffering greater losses than Nissan; Nissan also recovered faster than its competitors. The study attributes this difference to several factors.
First, flying in the face of Japanese tradition, Nissan had begun dissolving it’s “Keiretsu” system of tightly linked business alliances and diversified its suppliers nearly a decade earlier, after French car manufacturer Renault bought a controlling interest in the company. As a result, it was able to execute a more flexible response by switching key parts suppliers. Also, Nissan had a larger inventory prior to the flooding to make up the demand gap.
Perhaps more instructive are the different outcomes for Toyota and Honda. Of the three manufacturers, Honda was the only one that actually had to stop production due to direct flooding of its operations—on Oct. 8, 2011, its Rojana Industrial Park factory was inundated—but Toyota lost almost the same amount of operating profit, due to supply chain disruptions from key suppliers.
“If a company has a supplier relationship with only one company, it’s very easy to be affected by that supplier,” says Haraguchi. “But if a company diversifies suppliers—meaning they have multiple choices of suppliers—they are less likely to be affected by a disaster.”
The other industry that was heavily impacted by the 2011 floods was electronics—specifically hard-disk manufacturers. Before the floods, Thai production was responsible for nearly 43 percent of global hard-disk manufacturing; Western Digital, which produced one-third of the world’s hard disks, lost 45 percent of its shipments when its factory in Bang Pa-in Industrial Estate was inundated. Toshiba, Samsung and Seagate were also impacted. However, as with the car industry, impacts varied greatly—with Western Digital’s losses allowing Seagate to capture market share and actually reap record profits.
So what supply-chain characteristics make the difference between a company that takes major losses from a natural disaster and one that weathers the storm? Haraguchi and Lall identify four: dependence, visibility, substitutability, and portability.
Dependence, says Haraguchi, refers to how dependent a company is on a particular supplier. Visibility is about awareness: How aware is a company of the location, operations and vulnerabilities of its first and second tier suppliers?
Substitutability refers to the degree to which a particular part is standardized and easily replaceable from another supplier. (This was, in part, one reason that in spite of large losses, electronics companies were able to recover faster than automobile manufacturers, according to Haraguchi—electronics parts are more substitutable than modern automobile parts).
Portability refers to the ease with which physical equipment can actually be moved in the case of disaster.
So what’s next? The study reports that even in light of recent events, a large number of companies have no plan to change their behavior; according to a survey conducted by the Japan External Trade Organization, 78 percent of companies that were directly impacted by the floods are still operating in the same location, and financial constraints would prevent some of these companies from transferring to different facilities even if they wanted to.
On the other hand, companies like Seagate have received praise for their efforts to better plan for disaster. According to Haraguchi, Seagate is currently conducting research into their own supply-chain vulnerabilities by plotting their factories and transportation routes, and assigning disaster probabilities to each.
By incorporating recent advances in seasonal forecasting and climate risk assessments into analyses like these, companies may have the opportunity to better mitigate supply-chain risks.
Unfortunately, says Haraguchi, accurate historical weather data in the developing world is often difficult to acquire, which makes developing seasonal disaster risk forecasting challenging. A more promising area of research lies in global climate pattern modeling. If risk in certain areas of the world is correlated—for example, if parts of China were statistically likely to experience extreme flooding at the same time as parts of India—companies could mitigate their disaster risk by not sourcing key supplies from both of those locations.
More generally, says Haraguchi, the growing business and public sector risk from extreme weather suggests that both businesses and governments need to enter a new era of collaboration and cooperation. If businesses that have similar supply chains can form partnerships with different suppliers, “they could get help from a different supply chain and recover more quickly from a disruption.”
And, he insists, the public sector must be involved as well. “What we are trying to propose is not only for private companies preparing for disaster; it is very important to have an information-sharing system between private companies and government or public infrastructure companies so that each can prepare more efficiently.”