Stress Test for the Global Supply Chain

A disruption in silicon wafer production can then stall makers of memory chips and, ultimately, consumer products.

By STEVE LOHR

Published: March 19, 2011

TONY PROPHET, a senior vice president for operations at Hewlett-Packard,was awakened at 3:30 a.m. in California and was told that an earthquakeand tsunami had struck Japan. Soon after, Mr. Prophet had set up avirtual “situation room,” so managers in Japan, Taiwan and America couldinstantly share information.

Haruyoshi Yamaguchi/Bloomberg News

At Hewlett-Packard, which builds computers in Tokyo,the disaster response has been described as “doing triage.”

Mr. Prophet oversees all hardware purchasing for H.P.’s$65-billion-a-year global supply chain, which feeds its hugemanufacturing engine. The company’s factories churn out two personalcomputers a second, two printers a second and one data-center computerevery 15 seconds.

While other H.P. staff members checked on the company’s workers in Japan— none of whom were injured in the disaster — Mr. Prophet and his teamscrambled to define the impact on the company’s suppliers in Japan and,if necessary, to draft backup plans. “It’s too early to tell, and we’renot going to pretend to predict the outcome,” Mr. Prophet said in aninterview on Thursday. “It’s like being in an emergency room, doingtriage.”

The emergency-room image speaks volumes. Modern global supply chains,experts say, mirror complex biological systems like the human body inmany ways. They can be remarkably resilient and self-healing, yet attimes quite vulnerable to some specific, seemingly small weakness — asif a tiny tear in a crucial artery were to cause someone to suffer heartfailure.

Day in and day out, the global flow of goods routinely adapts to allkinds of glitches and setbacks. A supply breakdown in one factory in onecountry, for example, is quickly replaced by added shipments fromsuppliers elsewhere in the network. Sometimes, the problems span wholeregions and require emergency action for days or weeks. When a volcanoerupted in Iceland last spring, spewing ash across northern Europe andgrounding air travel, supply-chain wizards were put to a test, jugglingproduction and shipments worldwide to keep supplies flowing.

But the disaster in Japan, experts say, presents a first-of-its-kind challenge, even if much remains uncertain.

Japan is the world’s third-largest economy, and a vital supplier ofparts and equipment for major industries like computers, electronics andautomobiles. The worst of the damage was northeast of Tokyo, near thequake’s epicenter, though Japan’s manufacturing heartland is farthersouth. But greater problems will emerge if rolling electrical blackoutsand transportation disruptions across the country continue for long.

Throughout Japan, many plants are closed at least for days, with restartdates uncertain. Already, there are some ripple effects worldwide: forexample, a General Motorstruck plant in Louisiana announced on Thursday that it was shuttingdown temporarily for lack of Japanese-made parts. More made-in-Japansupply-chain travails are expected.

“This is going to be a huge test of global supply chains, but I don’tthink it will be a mortal blow,” says Kevin O’Marah, an analyst atGartner-AMR Research. “I think that over all we’ll see how resilient andquick-learning these networks have become.”

THE good news for the world’s manufacturing economy is that the sectorswhere Japan plays a vital role are fairly mature, global industries.Consider computing and electronics. For major components, likesemiconductors, production is now spread across several countries. Bycontrast, in the early 1990s, virtually all 486-microprocessors — theengines of the most powerful personal computers of the time — were madeat a single Intel factory near Jerusalem.

Japan’s importance in the semiconductor industry as a whole has recededin recent years, as more production has shifted to South Korea, Taiwanand even China. Japan accounts for less than 21 percent of totalsemiconductor production, down from 28 percent in 2001, according to IHSiSuppli, a research firm.

Still, Japan produces a far higher share of certain important chips likethe lightweight flash memory used in smartphones and tablet computers.Japan makes about 35 percent of those memory chips, IHS iSuppliestimates, and Toshiba is the major Japanese producer. But South Korean companies, led by Samsung, are also large producers of flash memory.

Apple,like all major companies these days, treats its supply-chain operationsas a trade secret. But industry analysts estimate that Apple buysperhaps a third of its flash memory from Toshiba, with the rest comingmainly from South Korea. The lead time between chip orders and deliveryis two months or more. A leading customer like Apple will be first inline for supplies, and it has inventories for several weeks, analystssay. So there will be little immediate impact on Apple or its customers,but even Apple will likely be hit with supply shortages of crucialcomponents in the second quarter, predicts Gene Munster, an analyst atPiper Jaffray.

The field of buying and shipping supplies has been transformed in thelast decade or two. Globalization and technology have been the drivingforces. Manufacturing is outsourced around the world, with eachcomponent made in locations chosen for expertise and low costs. Sotoday’s computer or smartphone is, figuratively, a United Nationsassembly of parts. That means supply lines are longer and far morecomplex than in the past.

Molly Riley/Reuters

Apple products have components from around the world.The new iPad has at least five parts from Japanese suppliers.

The ability to manage these complex networks, experts say, has becomepossible because of technology — Internet communications, RFID tags andsensors attached to valued parts, and sophisticated software fortracking and orchestrating the flow of goods worldwide.

That geographic and technological evolution, in theory, should makeadapting to the disaster in Japan easier for corporate supply chains.“In the past, when you had a disruption, the response was regional,”says Timothy Carroll, vice president for global operations at I.B.M. “Now, it’s globalized.”

Most anything can be tracked, but it takes smart technology, investmentand effort to do so. And as procurement networks become more complex andsupply lines grow longer — “thin strands,” as the experts call thephenomenon — the difficulty and expense of seeing deeper into the supplychain increases.

“Major companies have constant communications and deep knowledge ofprimary suppliers,” says David B. Yoffie, a professor at the HarvardBusiness School. “It’s in the secondary layers of suppliers — thingsthat are smaller, barely noticed — where the greater risk is.”

Indeed, supplies of larger, more costly electronic components, likeflash memory and liquid crystal displays, tend to grab the mostattention. But, says Tony Fadell, a former senior Apple executive wholed the iPod and iPhonedesign teams, “there are all kinds of little specialized parts withoutsecond sources, like connectors, speakers, microphones, , batteries andsensors that don’t get the love they deserve. Many are from Japan.”

Lacking some part, even if it costs just dimes or a few dollars, can mean shutting down a factory, Mr. Fadell adds.

A recent analysis by IHS iSuppli, taking apart a new Apple iPad2,identified five parts coming from Japanese suppliers: flash memory fromToshiba, random-access memory for temporary storage from Elpida Memory,an electronic compass from AKM Semiconductor, touch-screen glass fromAsahi Glass, and a battery from Apple Japan.

Further down the supply chain lie raw materials. Trouble for a supplierto a company’s parts supplier can cascade across an industry. Forexample, reports that a Mitsubishi Gas Chemical factory in Fukushima wasdamaged by the tsunami have fanned fears of a coming shortage of aresin — bismaleimide triazine, BT — used in the packaging for smallcomputer chips in cellphones and other products.

Two Japanese companies are the leading producers of silicon wafers, theraw material used to make computer chips, accounting for more than 60percent of the world’s supply. The largest is the Shin-Etsu ChemicalCorporation. Its main wafer plant in Shirakawa was damaged by theearthquake, and the factory is down. “The continuing violent aftershocksare complicating the inspection work,” said Hideki Aihara, a Shin-Etsuspokesman in Japan, on Friday. “Right now we can’t say how badly it wasdamaged or how long it might take to get started.”

Shin-Etsu does have factories outside Japan. “But the most advancedmanufacturing and silicon-growing processes are done in Japan,” saysKlaus Rinnen, a semiconductor analyst at Gartner. And growing siliconingots, which are then sliced into wafers, is a lengthy, delicateprocess that will be hampered by power failures or other disruptions, hesays.

Big chip makers like Intel, Samsung and Toshiba typically holdinventories of silicon wafers for four to six weeks of production. “Butafter that, it will get tougher,” Mr. Rinnen says.

THE Japan quake, some experts say, will prompt companies to re-evaluaterisk in their supply chains. Perhaps, they say, there will be a shiftfrom focusing on reducing inventories and costs, the just-in-time model,pioneered in Japan, to one that places greater emphasis on bufferingrisk — a just-in-case mentality.

Adding inventories and backup suppliers reduces risk by increasing theredundancy in a supply system. It is one way to enhance resilience,experts say, but there are others.

They point to an example that is well known to supply-chain mavens. In 1997, there was a fire at a plant of one of Toyota’smain suppliers, Aisin Seiki, which made a brake valve used in allToyota vehicles. Because of the carmaker’s just-in-time system, thecompany had just two or three days of stock on hand. So the firethreatened to halt Toyota’s production for weeks.

But Toyota and teams of suppliers in the company’s supply-chain networkworked round the clock for days to design and set up alternativeproduction sites. Toyota’s assembly plants reopened after being shutdown for just two days.

“That kind of resilient capability, I think, is what we’ll see in Japanover the weeks and months ahead to put these supply chains back on theirfeet,” says Charles H. Fine, a professor at the Sloan School ofManagement at the Massachusetts Institute of Technology.