How to Mitigate Supply Chain Disasters

The major natural disasters in Japan and Thailand in 2011 underscored the global electronics industry's vulnerability to production disruptions. However, these calamities also served as a crash course for high-tech enterprises, providing important lessons on how component and system suppliers should prepare and react to such challenges.

In this age of globally connected supply chains, it's critical for semiconductor suppliers and buyers to understand the nature of the risk, and to have effective plans to deal with production disruptions of any magnitude in any region of the world. While much attention has been lavished on the impact of the major catastrophes in 2011, the truth is that disasters come in all shapes and sizes, ranging from war to fires, to epidemics and political upheavals, to terrorist attacks and power outages, to computer hackers and viruses.

The direct impact of such disasters on a company's business can be huge. The destruction of a manufacturing facility, for instance, can result in a loss of production that takes 18 months or more to recover. The indirect effects of a disaster can be just as painful. Disasters tend to accelerate the end-of-life of components. They also change buying behaviors of purchasers, causing them to seek alternative sources for parts. Such developments can have adverse impacts on both suppliers and buyers.

Because of this widespread impact, Wall Street will be looking to see how effective companies' disaster mitigation plans are. Stock analysts loathe earnings uncertainty as a rule and will reward companies that prepare properly while punishing those that don't.

Although disasters can affect any business, the electronics and semiconductor industries can be particularly susceptible to such problems, given their widespread use of just-in-time, lean manufacturing, and build-to-order methods. These systems stress the importance of minimizing inventories, which can lead to critical part shortages amid supply disruptions.

Furthermore, production of semiconductor and other electronics components and systems are located in several Asian locations that are exposed to disaster risk -- both natural and manmade. These areas include Japan, South Korea, and Taiwan.

Finally, the trend toward rationalized production is creating single points of failure that can result in supply disruptions for semiconductor makers and their customers. Many key semiconductors are single-sourced and cannot be easily obtained from alternative suppliers. Also, the expense of building new wafer fabs has soared into the billions of dollars, causing the concentration of production into a few campuses.

Despite these challenges, some electronics firms in recent years have employed successful strategies to contain the effects of disasters on their operations. One notable example was Fujitsu Semiconductor's management of the Japan earthquake disaster. Less than three months after the quake disrupted production at five facilities, the plants had returned to full production.

For Fujitsu Ltd. (Tokyo: 6702; London: FUJ; OTC: FJTSY), the key to success lies in its disaster planning efforts. Three years before the major disaster of 2011, the company suffered a quake that impacted production at its semiconductor fab in Iwate prefecture. In response to the disaster, the company established a system where fabs in different parts of the world can pick up slack if one facility is hit by a calamity.

Fujitsu also instituted a business continuity plan designed to restore electricity, water, and other utilities following a disaster. The plan involved the installation of equipment that can limit seismic damage to wafers.

Disaster preparedness is critical for both suppliers and buyers. However, the two sides often have different considerations when developing their respective plans. From the seller's perspective, the central question is one of cost: How can my company remain a world-class supplier without incurring too much expense? For the buyer, the main issue revolves on dependability: How does my firm maintain reliable supply while keeping costs manageable?

But for both semiconductor suppliers and buyers, disaster preparedness involves a two-step process comprising the creation of a disaster risk profile and development of a mitigation plan.

A disaster risk profile is defined as the measure of a company's exposure to one or more disasters based on a number of metrics, including:

• Depth of sourcing, i.e., if a product is sole sourced or thinly sourced
• Geographic production diversity
• Geographic diversity of inventory storage
• Transport mode and route diversity
• Geographic robustness of information technology system
• Lifecycle status of products, regarding accelerated phase-outs and counterfeiting
• Country of production, accounting for geopolitical and economic risk