Mitigating risks of supply chain disruption from natural disasters

Author: EIC | Economic Intelligence Center
Published in Bangkok Post/Asia In Depth: Asia Focus section, 21 August 2017

Natural disasters have increasingly stunned supply chains and left great economic damages worldwide. Many of us would be able to recall the Great Flood in Thailand at the end of 2011 which has stalled global supply chains with almost 10,000 factories affected. Global and regional business across industries such as Honda, Goodyear, Canon and Sony had cut production and lowered revenue forecasts because of the flood. In fact, Center for Research on the Epidemiology of Disasters reported that in 2016 alone, there were 301 natural disasters recorded worldwide, affecting more than 400 million people with 97 billion USD economic impact and almost 8,000 casualties.  The top five countries with largest hits were China, the US, India, the Philippines and Indonesia. By category, hydrological disasters, i.e. flood, landslide and wave, have occurred more than a half of all disasters combined, although with less economic impact and casualty when compared to earthquakes and tsunami.

In Thailand, floods are the most occurred natural disasters but draughts have greater impacts. During 1989 – 2013, there were more than 230 flood incidents, with economic loss estimated at around 158.5 billion Baht totally. In 2014 alone, there were four major floods affecting almost 2 million people with economic loss registered at around 325 million Baht. In contrast, draughts occurred less often but affecting in average 10.8 million people each year, also most two times that of floods. The fluctuation of agricultural output is also more evident in draught cases. Lower quality or yield could be significantly observed during the periods of draught. Sugar contents in sugarcane and flavor variation in fruits are substantial. Exports of these products could be directly decreased, thus leading to the loss of market share in the global market. Processing plants were also hit in the next round. Competition to secure raw materials intensifies, resulting in higher procurement prices and thus lower margin, if your plant could get enough raw materials to run the machine at all.

Impacts on non-agricultural sectors are substantial. A study of impacts on construction industry in Malaysia, by Universiti Teknologi MARA, shed light on the nature of how different businesses could share impacts from a single event. In 2011, floods also occurred in Malaysia, causing an 18 month-delay for Double Track Construction Project. The total financial loss was estimated at 150 million Ringgit. And only 20% of construction business is found to be prepared to deal with the interruption. This is much lower than other sectors generally understood to have direct impacts from natural disasters.  In Thailand, although rainfall and other seasonal factors are usually included in construction planning, it has been more difficult for contractors to estimate and forecast weather, resulting in delays and accompanied court cases. A more thorough project planning engaging weather database is recommended for more effective planning and execution. Insurance should also be considered as there is very low awareness; it is reported that only 35 out of 210 billion USD damage from 2011 Japan earthquake was insured.

Disrupted transportation further complicates the impact of natural disaster. Transportation is very critical for manufacturing firms, especially ones with high reliance on a few large suppliers. 2011 flood was a good example that even though factories could be protected, impacts arise when deliveries could not be made due to road cuts. Not all hard disk producers were in flood zones, but there were constraints on how parts were delivered to assembly or how finished products were delivered for shipment to global market. As a result, supply shocked, global prices doubled and it took almost two years to get back to the pre-flood level.

Impacts could also be indirect, and cascading from adjacent tiers. 2011 Japan quake, for example, could mean several shakes across long time periods, the triggered tsunami and the following failure of a nuclear plant, continually causing huge waves of damage to the economy for several years. There was a report that an automaker delayed the launch of two new models. A study conducted by Policy Research Institute of Japan’s Ministry of Finance showed that impacts hit both downstream and upstream. Firms with at least one earthquake-hit supplier underperformed control group, as well as firms with at least one customer in disaster area underperformed control group. Simply put, impacts have cascaded to suppliers’ suppliers and customers’ customers. This ripple effect is especially emphasized when a lack of one critical part could halt the whole production. There was only one production plant of Xirallic in the world, located in damage area, and the shortage of this simple pigment has sent the ripples to all car makers around the globe. This color constituted for up to 20% of total car sales.

Business should cooperate to prepare for and mitigate risks. Only a few preventive measures could be done to prepare in case of draughts or floods. However, selection of crops appropriate for weather cycles, acquisition of water pumps, or protection of cultivated produce could be collaboratively conducted throughout the supply chain. Processing plants could, for example, collaborate with farmers in forecasting required output in accordance with the projected weather in each crop season, or assist with needed equipment. Mitigation of risks could also be done to reduce financial damage such as crop insurances. Adoption of such insurances in Thailand, however, is at a very beginning stage, with coverage only focusing on farmers. Further public adoption would be needed to expand coverage to the whole supply chain as in many countries. Studies have shown that such agricultural insurances that cover the whole supply chain could, not only promote collaboration, but also have direct linkages to stable output.

Business should consider mitigation measures for impacts cascading from other tiers. Buffer stocks, for example, could be invested to reduce impact once a disaster strike some critical suppliers, or identification of alternative sources of certain parts for the time of disruption. This would involve long term strategy as resource allocation is needed to consider which process of production has most top priority. This is especially not an easy task when going through interconnected businesses across whole supply chain. The bigger the business, the more challenge. An automaker, for example, would have around 50 plants globally, 10 tiers of suppliers, with around 1,500 companies in each tier across more than 5,000 locations worldwide. Balancing investment in risk mitigations at the most optimal degree is truly a managerial challenge.