Risk factor #5: Supply chain concentration in Asia

What if these stories were in today’s news? Widespread Destruction The morning after China was struck by the most powerful earthquake to hit the nation in recorded history the disaster’s massive impact is only beginning to be revealed. Rescue efforts began with first light as military helicopters plucked survivors from roofs and carried them to safety. The 8.9-magnitude temblor, centered near the east coast of China, killed hundreds of thousands of people, caused the formation of 30-foot walls of water that swept across rice fields, engulfed entire towns, dragged houses onto highways, and tossed cars like toys. “The earth shook with such ferocity,” said a US visitor “I thought things were coming to an end … it was simply terrifying.” Buildings shook, heaved and collapsed by the score, and numerous fires ignited. Chinese media reported, hundreds of thousands of people were missing and millions were displaced. Countless households are without electricity, said China’s ambassador to the United States. Nuclear Meltdown A nuclear reactor near Qinshan, south of Shanghai, may be starting to melt down after China’s biggest earthquake on record hit the area yesterday. Fuel rods at the No. 1 reactor at the plant run by China Electric may be melting, Nuclear and Industrial Safety Agency, spokesman said by phone today. “If the fuel rods are melting and this continues, a reactor meltdown is possible,” an inspector said. A meltdown refers to a heat buildup in the core of such intensity it melts the floor of the reactor containment housing. Luckily winds in the area of Qinshan plant are blowing at less than 18 kilometers per hour mostly in an offshore direction, according to a 4 p.m. update from the China Meteorological Association. Supply-chain Impact Companies both in China and around the world have already begun feeling the sting of supply chain disruptions resulting from the catastrophic earthquake and its aftermath. In addition to the damage done to factories in northeastern China by the quake itself, companies must contend with ruined roads, fuel shortages, and rolling power blackouts. Many companies are not sure when some of their facilities will be able to resume production, creating uncertainty for companies further up and down the supply chain. “This is serious and it’s still difficult to evaluate; you have the earthquake, you have the tsunami, rolling blackouts, and fuel shortages hitting at the same time.” The sectors hardest hit are consumer goods and electronics companies, both well-represented in China. “We still don’t know the full extent of what can be done to substitute for the affected parts,” a spokeswoman said. Electronics Companies Zapped Many companies in China have closed their plants and generally aren’t sure when they will resume operations. Typical is XYZ, which said on Tuesday that it would partially restart operations at one facility while six other plants remain idle with no estimate of when they will come back online. Part shortages are a major issue. “If the shortage of parts and materials supplied to these plants continues, we will consider all necessary measures, including a temporary shift of production overseas,” they said on Tuesday. Another local company managed to get one factory back into production this week, while several others remain closed. Additionally, ABC, one of the world’s largest chipmaker, has only managed to restart four of its 22 facilities. The company said the rolling power outages were disrupting production at many of its plants. “There are a huge number of little bits of the high-tech food chain which are done nowhere but in China,” Jane Doe, senior investment manager of MMM Equity said. “Nobody else has the capacity, and in some cases the technology, to do it.” Hopefully by this point you’ve realized that these news articles were actually from the horrible catastrophe that struck Tohoku, Japan on March the 11th, 2011. The only thing we’ve changed in the copy was the geographic location, the scale of impact (i.e. increased the numbers in these stories to reflect the differences in the populations in these two areas) and the names of the entities cited. But what if it really had happened in China instead of Japan? What would the impact have been on the global electronic industry? We are not going to argue the proportional concentration of electronics related resources in Japan versus China or quote endless statistics on what percentage of this type of material or that type part are controlled in which geography. Everyone has their favorite source for this data and we encourage the reader to select whichever they feel most comfortable using; we all know what the reality of the situation is. Over the past decade the global electronics supply-chain has migrated to Asia with the majority of it concentrated in the river delta, industrial hubs of China. Bottom-line: if a Tohoku type of event occurred in one of these regions of China today it wouldn’t be weeks or months for the industry to recover, it would be years. Global businesses would lose billions if not tens of billions of dollars in revenue, lay-offs would be in epidemic proportions, even enterprises with rock-solid balance-sheet would immediately switch to a survival mode of operation (i.e. meaning there would be widespread failure of any supplier/service provider whose business was related to either discretionary or B to B spend) and some significant percentage of OEMs reliant on a commodity-based business model would simply go out of business. It’s harder to think of things that wouldn’t be impacted, than to think of those that would. We have a model for what happens when a critical resource is concentrated in just a few areas, like oil. Supply and demand is artificially managed (to control prices), geopolitics vs. the market dynamic becomes the basis of distribution and strategic interests are protected (read: wars are fought). Not a pretty picture. Are we overstating the probable outcome? Perhaps, but to be honest we don’t think so. What we do know for certain is that a gentleman named Edward Aloysius Murphy, Jr. once said “Anything that can go wrong will go wrong.” I just hope the term “China Syndrome” doesn’t end-up taking on a whole new meaning. Closing note: We apologize to anyone we may have offended by using the consequences of the Tohoku tragedy in this article to make a literary point. Our hearts go out to the people of Japan and those around the world who were impacted by this cataclysmic event. We recognize that it was not only a natural disaster but a human one as well. ----- Note: More information can be found in CBA's website. Follow this link. NEXT ARTICLE: Risk Factor #6: Loss of institutional continuity