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Case Study JIT Failure at Sony Ericsson

Once one of the world's leading cell-phone manufacturers, Ericsson knows only too well how painful a disruption in the supply chain can be. It is a story that has become something of a legend in supplychain circles. In March 2000, a lightning bolt struck a Philips Electronics semiconductor plant in Albuquerque, N.M., triggering a small fire in a chip-processing machine that took the plant offline for months. Although the plant was Ericsson's sole supplier of chips for use in its cell phones, the company responded slowly to the problem and then found itself unable to secure an alternate source for the chips. Without the chips, the Swedish company was unable to keep up with the demand for its products, and ended up losing more than $2 billion in connection with the incident. In October 2001, less than two years after the fire, Ericsson cut its cellphone business exposure by entering into a joint venture with Sony. Considering Ericsson's tale of woe, it hardly comes as a surprise that supply-chain risks rank high on the list of corporate concerns in today's global marketplace. RISK RANKS HIGH Operational risk was identified as the most important risk that executives face today in a study titled "A Study of Corporate ERM in the U.S.," released by Towers Perrin last November. While the specific nature of a firm's operational risk varies, supply-chain risk emerged in the study as a particularly important issue across industries. One of the reasons for such a high level of concern is that supply-chain disruptions can have a profound impact on a manufacturer's sales and market share. Toyota, for example, lost production of 20,000 cars--at a cost estimated at $200 million in revenue-after the 1995 Kobe earthquake disrupted production at a plant that was the automaker's sole source supplier of brake shoes for domestic cars. While the stakes are high, the risk of a disruption has been escalating, as well, as a result of efforts to strip costs out of the system. Manufacturers have been wringing costs out of their supply chains by moving to just-in-time inventory management. This has made supply chains more vulnerable than ever before. "The more they have integrated just-in-time into their manufacturing processes, the more vulnerable they are," says James H. Costner, senior vice president of the property practice at Willis Risk Solutions. "Because what they do in just-in-time is remove all of the redundancies, and redundancies actually provide some margin for error." At the same time, manufacturers now rely on supplies from all across the globe, meaning that bad weather or political unrest in some distant foreign country could ground planes or halt production on critical components. "Certainly what we've seen in a much more accelerated fashion has been the globalization of the supply chain, where the interdependencies are spread throughout the world," says Gary Lynch, global leader of risk intelligence strategies and resiliency solutions at Marsh & McLennan Cos.

Over the last few years, there has been so much emphasis on increasing productivity and keeping operations lean that it has created huge single points of failure exposure, Lynch says. IDENTIFYING THE SUPPLY-CHAIN RISKS Identifying those points of failure has become ever more important as companies work to keep their lean supply chains running. While companies have spent a lot of time and energy over the last couple of decades trying to set up efficient, cost-effective supply networks, there hasn't been as much emphasis, until recently, on risk management of the supply chain. Supply-chain risk management focuses not on how to set up a supply network but rather on how and where a supply chain might fail, says Prakash Shimpi, the practice leader with global responsibility for enterprise risk management at the Tillinghast business of Towers Perrin. "What are the points of failure, what are the costs of failure and how do you mitigate that?" he says. "The risk management is to look forward and anticipate and think beyond, and the whole economics around that." There are three sources of risk to anticipate, speaking very broadly, Shimpi says. The first is the risk to the network itself, the second is pricing risk and the third is something called volumetric risk. The risk to the network itself is the most familiar and has been studied and written about at great length, he says. These are the common supply-chain issues: a problem with a supplier, a plane that can't get off the ground or a utility service disruption. The second source of risk, pricing risk, enters the picture because everything going through the network has a price for passing through, paid out in charges and tolls along the way. Those risks are often managed through the use of hedges in the capital markets, Shimpi says. Then there is volumetric risk. This refers to the amount of goods flowing through the network and is a function of how fast a company can manufacture its goods and how strong the demand is for a company's products. A company may not be able to manufacture a product fast enough to keep up with demand. Or a company may overestimate demand and make too much of a product. Sony Corp., for instance, had a problem during this past Christmas season keeping up with the demand for its new PlayStation 3 consoles after a parts shortage slowed production. Airbus lost billions in sales with some of its biggest customers as a result of delays on its A380 superjumbo jets. Although the company said that the delays were a result of internal problems and electrical wiring issues, and not the fault of its suppliers, the case shows how any disruption in the manufacturing process can lead to loss of business. SUPPLY-CHAIN RISK MANAGEMENT To try to avoid becoming another ease for the textbooks, manufacturers have been taking a closer look at their operations and are trying to look for new ways to understand and manage the risk. Some insist, for instance, that their suppliers in the Gulf Coast region have at least two rail lines into their plants, as well as two electrical transmission lines coming in from different directions. If one

goes down, the other is there, Costner says. Other manufacturers are working to improve their own resiliency, or ability to bounce back from a disruption. Sole source suppliers, in particular, are becoming a thing of the past. Several large automobile manufacturers have appointed high-level task forces to study their supply-chain risk, Costner says. "Single source suppliers are a particularly bad source of vulnerability. I'm not aware of any large auto assembly companies that will tolerate a single source supplier any more," he says. Supply-chain risk is also beginning to gain the attention of top-level corporate executives in addition to middle management, and there is growing interest in using enterprise risk management to help companies gain a better understanding of their organization's supply-chain risk, Shimpi says. Enterprise risk management experts bring expertise outside the traditional risk management skill set, Shimpi says. They might have specialized knowledge of financial markets and arcane capital-market instruments that could help with things such as the pricing and volumetric risk. In spite of these efforts, however, there are points of failure that are still often overlooked by manufacturers. Many manufacturers have spent a lot of time working with their top 10 suppliers but pay little attention to the remaining suppliers, which may be just as important. "There's a tendency for the organization to kind of prioritize and work with those top 10 suppliers and focus on continuity and planning and resiliency and supply-chain efforts on those folks and forget the small suppliers," Lynch says. Another risk that tends to be overlooked by manufacturers is the issue of supply-chain concentration, says Corey Gooch, associate director, enterprise risk management, in the consulting division at Aon in the United Kingdom. Each individual business unit within a larger organization may have examined its supply-chain network and may believe it has its supply-chain issues under control. But an organization's other business units and subsidiaries may also be using those same suppliers, he says. If they lose one of those suppliers, then it's not just one subsidiary that suffers, but the entire organization. "Many organizations still don't have a full handle on the supplier concentration issue," Gooch says. "They may have streamlined their supply chains, but what they may not be looking at is across all the different businesses of the organization," he says. INSURING AGAINST SUPPLY-CHAIN LOSSES In addition to their risk management efforts, manufacturers also rely on insurance to help them mitigate potential supply-chain losses. Until a few years ago, property insurers--especially business-interruption insurance underwriters--did not pay much attention to supply-chain risks, Costner says. But after Ericsson's loss, that changed. "That one loss caused everyone to realize how vulnerable the systems are," Costner says. "And it also caused the underwriters to start underwriting that exposure." Underwriters now want more information before they are willing to provide business-interruption insurance.

"Underwriters, frankly, are scared to death of the exposure because they don't know what tiny little plant located off in some small town in Oklahoma somewhere could cause a whole big company to go down," Costner says. Underwriters will no longer provide the blanket, unscheduled contingent-business-interruption coverage, in which the underwriters agree to cover losses arising from all of an insured's suppliers no matter where they are. "But if you go in and say, 'I have 10 critical suppliers, and here's a list of who they are and where their plants are, and here's how much business-interruption loss I'll suffer if that plant goes down,' then the underwriters will consider and--in my experience--they will write you some coverage," Costner says. By better understanding their business-interruption exposure, manufacturers restructure their property and business-interruption insurance programs and save money. One client did just that, and when it went through its renewals, it saved more than 20 percent on its property premiums, Gooch says. "In addition to the derisking of the business, there was real value on the insurance side as well," he says. Although insurance can help to mitigate a loss, it's always better to avoid a loss in the first place. Manufacturers can try to work with suppliers to gain assurances, run simulations and businesscontinuity plans, and reduce their reliance on sole source suppliers. But with the supply networks so vulnerable, some manufacturers are beginning to build in a little bit more of a safety net. "We've seen the needle shift back a little bit," Lynch says. "In some cases we can say they've actually built that cost into the production of the product in the same way credit-card companies have built loan failure, credit-card default, into the rates themselves. "There's just a lot more awareness. There seems to be a lot more discussion, more training, and there certainly seems to be a lot more collaboration," he says.