The tsunami and earthquake in Japan have produced soul-searching about how the industry should react. But there will not be a knee-jerk reaction, and well-established practices will not be thrown into reverse

Japan’s devastating earthquake and tsunami in March put a significant proportion of the world’s automotive supply chains out of action. Honda, Toyota, Nissan and Fuji Heavy Industries (maker of Subarus) all had plants in or close to the affected zone, and were forced to close them. Other Japanese plants, in many cases far less directly affected by either the earthquake or the tsunami, were also forced to stop production because of parts shortages caused by logistics difficulties or by earthquake or tsunami damage to tier suppliers’ plants.

Both Toyota and Honda’s Japanese-built vehicle output in March were down 63%. Suzuki lost 60% of its production for the month, Mazda 54%, Nissan 52% and Mitsubishi 26%. Output levels in April, as plants started to trickle back online, were even lower. Toyota’s volumes were down 74% in the month, Honda’s 81% and Nissan 49%.

disaster-2Within weeks the shutdown had spread to assembly plants abroad. En masse, Toyota’s plants in China, Europe and North America, for instance, ceased production or went onto short time working, in some cases for up to three months. Honda, for instance, cut production at its UK factory by 50% for seven weeks, while three Nissan plants in the US shut down completely. According to IHS Automotive, global car production will be reduced by 3.6m units in 2011 and although 3.01 million will be added in 2012, a net loss of 640,000 units over the two-year period is expected.

It was not just the Japanese who suffered. From Ford to Volvo, and General Motors to Renault, carmakers found themselves struggling with shortages. Peugeot-Citroën cut production 40-70% at most of its European plants because it lacked an engine airflow sensor imported from Japan. Chrysler stopped taking dealer orders for vehicles in 10 paint colours, where the pigments were sourced from Japan.

From electronics equipment to paint, and from engines to gearboxes, huge numbers of components turned out to be sourced from Japan and its intricate supply chains. Worse, many of these were single-sourced, often not just to a single company, but to a single plant within that company. Even Volvo turned out to source 10% of its parts from Japan, including a shade of metallic paint sourced from the world’s sole supplier, a factory in the Japanese city of Onahama.

Across Asia, North America and Europe, the story was the same– shuttered assembly plants, crippling shortages, a scramble to source parts and revise production schedules around whatever vehicles could be produced with the components, materials and paint colours available.

Nor were emergency response plans much help. Premium freight providers, for instance, saw relatively little business.

“Emergency shipments weren’t as extensive as one might imagine,” says Brad Brennan, managing director of premium freight provider Evolution Time Critical. “The problem wasn’t a shortage of freight capacity, but the fact that the parts weren’t being produced. A small percentage of tier one suppliers and carmakers shipped pallets of parts by air to Europe, but they were very much the exception.”

However, as production came back online, demand for airfreight began to pick up. Within a few weeks of the event, Neal Williams, managing director of premium freight operator Priority Freight, said that the company saw an impact on supply of parts and availability of airfreight services.

“There is a sizeable backlog of freight at Japan’s airports as exporters attempt to win back time lost due to factory shut down, but also for freight that would otherwise have been shipped by sea,” he says.

Williams adds that Priority Freight had seen an increase in priority shipments that would otherwise have been moved by more regular services. However, he admits that the volume of premium freight in the months following the catastrophe had not been as high as some had expected, but that increased freight was likely later in the year as manufacturers ramped up production to try to make up for volume lost.

Key industry positions questioned

Critical questioning soon began–it wasn’t supposed to be like this, after all. Coming hard on the heels of the ash cloud that spread across Europe from the Icelandic volcano less than a year earlier, the finger of blame was soon picking out a number of the automotive industry’s key tenets.

Just-in-time replenishment, for instance, which sees supply chains run very light on inventory, was an obvious target. As was globalisation, which calls for supply chains that once rarely stretched over a hundred miles to instead be replaced by supply chains circling the world. Also criticised was the practice of single sourcing, which renders the carmakers critically vulnerable to disruption when that source is disabled or its logistics processes impeded.

However tempting these are as targets, says Alan Braithwaite, a visiting professor of logistics at Britain’s Cranfield School of Management and the chairman of logistics consultancy LCP Consulting, they are simply too hard-wired into the thinking– and the cost structure–of the industry.

“The costs of dual-sourcing and enhanced resilience on the scale that people are talking about are simply likely to be unacceptable,” he says. “It’s the pursuit of economies of scale that has driven the industry to where it is, and you can’t throw away that concentration of output without sharply driving costs up.”

Any post-tsunami changes to supply chains are taking place on a much bigger stage, orchestrated by growth in emerging markets, oil prices, exchange rates and relative labour costs, points out Bill Olver, vice-president of automotive at DHL Global Customer Solutions.

“There is anecdotal evidence that some non-Japanese companies are looking to diversify their sourcing or production–or both–but there are limits to the strategy,” he says. “Other natural disasters, such as the volcanic eruption in Iceland, haven’t resulted in a large-scale supply chain re-think, and nor will the Japanese earthquake and tsunami.”

The industry itself has also already come to similar conclusions, says Francesco Lucciola, principal and automotive supply chain expert at top-tier consulting firm Booz & Co.

disaster-3“We’re seeing a strong level of interest from auto manufacturers in helping them respond, but they don’t want to simply add inventory,” he says. “That said, they need to take a much more rigorous view of the tradeoffs involved in building more resilience into their supply chains–especially as the proportion of overseas-sourced content in vehicles has risen sharply in recent years.”

Take Toyota. Perhaps the hardest-hit Japanese carmaker, the global giant is blunt about how it will and won’t respond.

“Toyota realises that we need to rethink some of our procurement practices,” says company spokesperson Paul Nolasco. “But we’re not going to discard just-in-time [production], because we believe that lean production and minimal inventories are key to our global competitiveness. So let me repeat–Toyota intends to stay with just-in-time.”

Nor, he adds, will a knee-jerk rush to localisation help. The problem? You can’t–without inordinate cost–localise the entire supply chain involved in the production of a component.

“Although we are already localised in many regions of the world, and are procuring parts made in the countries in which we make vehicles, it has turned out that in many cases our tier one suppliers in the countries involved procure parts from tier two suppliers in Japan,” he says. “So localisation–in itself–is not the answer, either.”

So what will change, post-tsunami? There’s a lot of talking, but will the outcome of such deliberations really change anything? In five years’ time, will the world’s automotive supply chains be configured any differently?

What seems to be happening is a move towards better preparedness for disaster, rather than trying to make automotive supply chains disaster-proof. The distinction may be subtle, but it’s important. It stems every bit as much from looking at what went right in the aftermath of the earthquake and tsunami as well as looking at what went wrong.

The starting point is the realisation of just how interconnected the industry’s supply chains are. Despite a quarter of a century of supplier consolidation and the pursuit of economies of scale, it still seems to have taken industry management by surprise.

It turns out, says Toyota’s Nolasco, “That there are often cases in which multiple tier ones procure parts or materials from the same tier two supplier. And if that tier two supplier should encounter trouble, the multiple tier one suppliers would all be in the same boat, meaning that the diversification of our direct sources, alone, would not solve anything.”

Post-tsunami, plenty of tier two–and tier three–suppliers did encounter trouble. Renesas Electronics, the world’s largest maker of microcontrollers, with around 40% of the global market for automotive microcontrollers, saw its output for the automotive industry plunge 70%. Output was suspended at seven of the company’s 22 plants, with the worst affected remaining offline until July.

Companies that many supply chain executives had never heard of suddenly became the subject of intense interest as these businesses battled to restart operations or move production to other sites. Even so, it wasn’t until late April that Renesas Electronics was able to announce–far less implement– plans to shift production of some components from its badly-damaged factory in the coastal city of Hitachinaka to a number of other sites around the country.

Minimising impact of disasters

Understanding the supply chain at such a level of granularity is only one part of the picture. Actively doing something with that new understanding is necessary if the impact of future tsunami-like disasters is to be minimised.

“It’s all about risk management, and recognising potential issues early enough so as to be able to do something about them,” says Wolfram Schmid, director of marketing for the automotive sector at enterprise applications company Infor.

Nick Wildgoose, global supply chain product manager at Zurich, agrees. Like other insurance companies, he points out, Zurich offers risk assessment surveys and tools that routinely identify if companies are overlooking supplier-generated business interruptions as a source of risk.

“Talk to them about business continuity, and their concerns are about their own operations, and not those of their suppliers,” he says. “The industry has become more risk-aware in recent times–and the tsunami will only help that process– but it needs to do more to ensure that supply chain plans include assessments of supplier vulnerability.”

And in particular, says Razat Gaurav, European senior vice-president at enterprise applications vendor JDA, there needs to be a stronger focus on contingency planning. “When something happens, it’s too late to start thinking about what to do,” he says. “Consider possible scenarios in advance, and for each scenario have a ready-prepared playbook, so as to be able to say: ‘If this happens, this is what we’ll do.’ In other words, it’s about modelling possible scenarios, and examining the effects.”

With its strong supplier-customer relationships, the automotive industry is well placed to mandate business continuity planning among suppliers, adds Jayne Hussey, a partner specialising in supply chain contracts at international law firm Pinsent Masons.

“Write a business continuity plan into the contract, and be very clear about the level of detail that it must go into,” she urges. “Also, be explicit about the frequency of update, and how often the plan should be tested.”

Such a plan must include an alternate sourcing capability– the ability to seamlessly switch output to an alternative facility in the event of disruption at the primary facility. Not weeks later, as at Renesas Electronics and other badly-affected tier two and three suppliers, but more or less instantaneously.

Nissan, for instance, will in future ask tier two and three suppliers to do just this, Nissan chief executive Carlos Ghosn has said recently. Electronics suppliers, particularly those involved with semiconductors, will be especially targeted.

Nissan said in May that about 20 parts remained on its critical short supply list. Toyota, had about 30 parts in short supply at the same point in time, down from 150 in April and 500 in March.

Going forward, says Nolasco, the company is actively considering modifying its product development processes so as to make it easier to use alternative parts.

Toyota, too, has learned lessons, he insists. “Rather than change the supplier landscape or our production approaches, what we need to do is understand better who supplies who,” he says. “It is easier said than done, but that is what we have learned that we need to do.”

The eventual upshot could be automotive supply chains with more resilience, but not at the cost of economies of scale, or abandoning principles such as just-in-time.

The process has started. German-owned Japanese paint pigment manufacturer Merck KgaA, for instance, which supplies Honda, Ford and Chrysler from its seven plants in Japan–including the earthquake-damaged plant that was the world’s sole source of a paint pigment used by Volvo–has announced that it is planning to set up production facilities in Germany as an alternative source.

“Japan has set a whole set of hares running,” sums up Garth Parker, chairman of specialist automotive supply chain planning and execution vendor ProAct International. “The inevitable result will be supply chains that are more complex than those of today. There will be more use of alternates and backup facilities, but also a lot more in-built resilience.”