MGT 492 What were the effects of the earthquake

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Ye, Linghe; Abe, Masato

Working Paper

The impacts of natural disasters on global supply chains

ARTNeT Working Paper Series, No. 115

Provided in Cooperation with: Asia-Pacific Research and Training Network on Trade (ARTNeT), Bangkok

Suggested Citation: Ye, Linghe; Abe, Masato (2012) : The impacts of natural disasters on global supply chains, ARTNeT Working Paper Series, No. 115, Asia-Pacific Research and Training Network on Trade (ARTNeT), Bangkok

This Version is available at: http://hdl.handle.net/10419/64267

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The impacts of natural disasters

on global supply chains

By Linghe Ye and Masato Abe

ARTNeT Working Paper Series No. 115/June 2012

ARTNeT Working Paper Series

Asia-Pacific Research and Training Network on Trade

  © ARTNeT 2012

The ARTNeT Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about trade issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. ARTNeT working papers are available online at www.artnetontrade.org. All material in the working papers may be freely quoted or reprinted, but acknowledgment is requested, together with a copy of the publication containing the quotation or reprint. The use of the working papers for any commercial purpose, including resale, is prohibited. Asia-Pacific Research and Training Network on Trade (ARTNeT) is an open regional network of research and academic institutions specializing in international trade policy and facilitation issues. IDRC, UNCTAD, UNDP, ESCAP and the WTO, as core network partners, provide substantive and/or financial support to the network. The Trade and Investment Division of ESCAP, the regional branch of the United Nations for Asia and the Pacific, provides the Secretariat of the network and a direct regional link to trade policymakers and other international organizations. Disclaimer: The opinion, figures and estimates are the responsibility of the authors and should not be considered as reflecting the views or carrying the approval of the United Nations, ARTNeT members, partners or authors’ employers.

ARTNeT Working Paper Series

No. 115/June 2012

The impacts of natural disasters on global supply chains

By Linghe Ye and Masato Abe*

*Linghe Ye is a consultant and Masato Abe is an Economic Affairs Officer in the Private Sector and Development Section of the Trade and Investment Division of the United Nations Economic and Social Commission for Asia and the Pacific in Bangkok. The technical support of the ARTNeT Secretariat is gratefully acknowledged. Diana Dai edited the manuscript and the copy-editing was by Ellie Meleisea. The views expressed herein are those of the authors and do not necessarily reflect the views of the United Nations. It is acknowledged that Marc Proksch, Pisit Puapan, Heini Amanda Salonen, Shaina Hasan and Yoko Ono provided very useful inputs and comments to this paper. Any remaining errors are the responsibility of the authors, who can be contacted at tel: +6692881483, fax: +6622881027 email: [email protected]

Please cite this paper as: Ye, Linghe and Masato Abe, 2012. The impacts of natural disasters on global supply chains. ARTNeT Working Paper no. 115, June, Bangkok, ESCAP. Available from www.artnetontrade.org.

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Table of contents Acronyms ……………………………………………………………………………………………………………………………..5 

1. Introduction ……………………………………………………………………………………………………………………….6 

2. Development of global supply chains …………………………………………………………………………………6 

3. Supply chain disruptions and increasing risks……………………………………………………………………..9 

4. Case studies: Japan earthquake and Thailand floods ………………………………………………………….11 

5. Policy options to enhance disaster resilience ……………………………………………………………………..18 

6. Conclusion……………………………………………………………………………………………………………………….21 

References …………………………………………………………………………………………………………………………..23 

List of Tables

Table 1. Losses for earthquake damages in 2011, Renesas Electronic Corp …………………………..12

Table 2. The impact of the Thai 2011 Floods on Japanese enterprises……………………………………15

List of Figures Figure 1. Overseas production network of Toyota…………………………………………………………………..7

Figure 2. Comparison of national and global supply chains …………………………………………………….8

Figure 3. Disaster impact spill-over from the Great East Japan earthquake…………………………….13

Figure 4. Disaster impact of the Southeast Asian floods on Japan’s manufacturing sector………16

Figure 5. The price history of two HDD products………………………………………………………………….17

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Acronyms

APEC Asia-Pacific Economic Cooperation

ASEAN Association of Southeast Asian Nations

FDI Foreign Direct Investment

GDP Gross Domestic Product

HDD Hard Disk Drive

ICT Information and Communication Technology

JCCB Japan Chamber of Commerce Bangkok

JETRO Japan External Trade Organization

M&A Mergers and Acquisitions

MNC Multinational Corporation

ODI Overseas Development Institute

OECD Organisation for Economic Co-operation and Development

R & D Research and Development

SMEs Small and Medium-sized Enterprises

THB Thai Baht

TISN Trusted Information Sharing Network

TNC Transnational Corporation

UNESCAP United Nations Economic and Social Commission for Asia and the Pacific

USD United States Dollars

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1. Introduction

Globalization has transformed business environments worldwide, including in the Asia- Pacific region. The fast expansion of global supply chains (typically comprised of firms, suppliers, distribution links and labour), which are cross-border business and production networks, allows firms to allocate scarce resources more efficiently than ever before. The advancement of information and communication technology (ICT), the development of international logistics systems and the reduction of trade barriers have all facilitated the integration of economies through the web of global supply chains. Recent disasters in Japan and Thailand demonstrate, however, that the development of global supply chains have also changed the risk profile of business and could potentially increase economic vulnerability in Asia and the Pacific through higher direct and indirect disaster risks. This paper explores how global supply chains expand the risks of natural disasters and how natural disasters affect supply chain operations in the Asia-Pacific context. The paper will first discuss the emergence and development of global supply chains in the Asia-Pacific region and will then examine how these new developments globalize disaster risks and bring extra vulnerability to businesses, particularly to their production networks. Following this, the paper will describe the impact of natural disasters on the global supply chains, on the basis of two natural disasters that occurred in 2011 in the region: the Great East Japan earthquake and the South-East Asian floods (focusing on the flood of Thailand). Finally, policy options are proposed to enhance disaster resilience for business in the context of globalization.

2. Development of global supply chains

Driven by trade and investment liberalization and continued cost reduction pressures from customers, businesses have been extending worldwide to make the most of each location’s comparative advantage. Many industries have adopted highly integrated global supply chains in which products are supplied, manufactured and distributed across national boundaries through offshore activities and outsourcing strategies. At the same time, economies of scale have driven the consolidation and agglomeration of firms in the supply chains, which have also promoted logistic consolidation. As a result, supply chains are becoming more complex with wider geographical coverage, which has increased the invisibility of the supply chains. Offshore activities refer to activities that utilize facilities located in a country other than where the enterprise is based (incorporated) and can include production, service and sourcing (Vitasek, 2006). The motivation for offshore activities has primarily been cost, including lower labour, setup and ongoing costs, higher cost efficiency with larger production scale, and possibly lower financial costs such as borrowing costs and tax rates. An example of offshore activities is the overseas production network of Toyota. As shown in Figure 1, Toyota conducts its business in 26 countries and regions, with 50 overseas manufacturing operations. As of 2011, Toyota's vehicles from these production bases were supplied to more than 170 countries and regions (Toyota, 2012).

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Figure 1. Overseas production network of Toyota

Source: Toyota, 2012

Outsourcing represents one of the greatest changes to global business practices. Today, firms do not just procure materials and parts from overseas suppliers, but also outsource various functions such as product design and logistics services (e.g. turnkey products1 and third-party warehousing) that were conventionally provided in-house. The logic behind this trend is that outsourcing can enable firms to focus on their core value added activities, where they have a distinct advantage. Overall efficiency increases because each firm in the supply chain can maximise its competitive advantage through strategically focused resource allocation (Christopher, 2011). Consequently, the supply chain becomes a web involving multi-tier suppliers and service providers. Focal firms2 are at the centre of an international production network (global supply chain), linked with several interrelated but independent entities. As a result of outsourcing, to take advantage of the lower costs in each location as well as to penetrate untouched foreign markets, supply chains have been extended from one side of the globe to the other (Christopher, 2011). As described in fragmentation theory, a whole production process is now split into separate nodes in different locations (Jones and Kierzkowski, 1990). These production nodes are connected by distribution links, which refer to activities coordinating the operation between these nodes such as administration, transportation, warehousing and financing among participating firms (Jones and Kierzkowski, 1990). The final products are produced across the borders and then sold beyond the borders to consumers worldwide. Unlike a local (national) supply chain, a global supply chain involves transporting large amounts of supplies across long distances, which increases the frequency of using multi- modal distribution facilities. Figure 2 illustrates national and cross-border supply chains.

1 A turnkey product or service is one that is installed fully complete and ready for a user to operate. The term implies that the user just has to turn a key and start using the product or service (TechTarget, 2002). 2 A focal firm is the initiator of an international business transaction, which conceives designs and produces goods or services (Cavusgil, Knight and Riesenberger, 2008).

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Figure 2. Comparison of national and global supply chains

Another prevailing trend is supplier consolidation, which refers to the reduction by firms of their total number of suppliers while increasing business with individual suppliers (EIU, 2005). In some cases this corporate strategy has been extended to “single sourcing” whereby one supplier would supply one business input (e.g. a part, component or module). With this strategy, focal firms aim to build strong partnerships with their suppliers and achieve price advantages from the economies of scale and bargaining power while utilizing suppliers’ expertise in research and development (R&D), design, production and distribution. It also lowers transaction costs, with fewer orders to be managed by the focal firms. An example of supplier consolidation can be seen in the automobile industry, in which the number of automotive parts suppliers dropped from over 30,000 in 1998 to around 4,500 in 2008 (KPMG, 2009). Mergers and acquisitions (M&A) among major suppliers have facilitated supplier consolidation.

A similar trend is production agglomeration, which refers to the geographical concentration of production facilities and activities (cf. Healey and Ilbery, 1990). Firms in the same industry tend to locate themselves very close to one another, leading to geographical concentration of the industry. The producers of substitutable products locate in close proximity to each other so as to reduce production costs. Production agglomeration is also driven by economies of scale. Agglomeration in a particular location is also generally related to accessibility to natural resources (such as petroleum or sunny weather) or other resources (such as low cost labour) or because of favourable business

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conditions in that location. This process also enhances cooperation between firms (e.g. development of industrial clusters and estates). Supplier consolidation and production agglomeration have also increased the importance of certain production bases in the supply chain, which provide necessary supplies and business and logistics related services. In order to be close to transportation and logistics facilities and to lower transport costs, production centres are often established and developed in coastal areas and river basins with high population concentrations (Clay and Benson, 2005). The benefits derived from production agglomeration include knowledge spill-over, labour market pooling, input sharing and lower product shipping costs (Rosenthal and Strange, 2001).

Another trend is logistics consolidation, which refers to the combination of two or more shipments in order to realize lower transportation costs. For example, inputs and components from a number of suppliers for one production site can be combined into a single delivery rather than each supplier delivering small quantities separately. This enables the suppliers to share the costs of transportation, warehousing and administration. This trend has been accompanied by the emergence of third-party distribution and logistics firms, including various turnkey service providers specializing in providing an in-bound consolidation service (Christopher, 2011). The expansion of the global supply chains combined with logistics consolidation has also increased the dependence of distribution links on selected international distribution facilities including transport infrastructure, logistics systems and communication infrastructure.

While streamlining production networks, supplier consolidation and production agglomeration have increased the importance of certain suppliers and locations by concentrating physical assets and production facilities, the structure of the supply chains is becoming more complex, with more individual production nodes and distribution links involved across borders. Consequently, it has become more difficult for focal firms to identify the risks in the supply chain.

3. Supply chain disruptions and increasing risks

A supply chain disruption is defined as a major breakdown in a production node or a distribution link that is part of a supply chain. Natural disasters are one cause of disruptions to supply chains. They usually result in widespread damage to several firms and facilities at the same time. This has a severe impact on an industry and significant time is often required for recovery from natural disasters.

With the globalization of supply chains, the exposure of firms to risks of disasters has been expanded across national borders as a natural disaster in one geographical location can also affect firms in other locations. Furthermore, with offshore and outsourcing activities, the level of interdependence among firms has increased, which has increased vulnerability because disruption of even one part of the global supply chain can result in operational failure of the other parts. Though the focal firm may be able to recognize some disaster-prone nodes or links within the supply chain, fragmented production has reduced the degree of control and monitoring of the focal firm over production nodes and distribution links (Kimura and Ando, 2005).

At the same time, with supplier consolidation and production agglomeration and consequent high density of production assets and economic activities in certain locations,

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the risks have been centralized in those locations. When disasters affect areas where production facilities are concentrated (particularly those located in areas vulnerable to storms and flooding, such as coastal areas or areas close to rivers), supply chains are disrupted, which results in significant structural losses to the whole production network and even to related industries. During the disaster and recovery period, other firms in the supply chain may encounter difficulties in finding proper substitute suppliers or customers elsewhere, making the impact of the disaster last longer. Furthermore, dependence on international distribution facilities has increased vulnerability to disaster as damage to these facilities can easily lead to supply chain disruption.

Some widely adopted supply chain management strategies also increase the risks of problems in situations of natural disasters. Examples include the “just-in-time” practice and lean supply chain management, which require more frequent deliveries of supplies, minimizing the non-value-added time and inventory. These efficiency maximization models in business increase the level of interdependence between firms and correspondingly raise the chances of a supply chain disruption. Also, the compression of non-value-added time in inventory transfer and storage may remove the essential risk buffer between the production nodes and deepen the negative impact when natural hazards occur in the global supply chain. For example, when a disaster hits a supplier or a distribution link and disrupts the supply chain, the focal firm that adopts “just-in-time” practices will suddenly encounter production suspension due to supply shortages and the negative effect will transmit quickly to the downstream supply chain.

In addition to the loss due to direct damage and recovery cost, natural disasters may cause cash flow problems among participating firms if the partners in the supply chain cannot settle their payables in time, and thus pose threats to the financial situation of a firm. Negative financial outlooks may raise the concerns of financial institutions and pose obstacles for firms in obtaining external financial resources during the recovery phase. If the firm is publicly traded, a supply chain disruption may negatively impact their reputation and cause underperformance in the market (Hendricks and Singhal, 2005).

Financial institutions can also be affected by disruptions to the supply chain caused by natural disasters. In addition to losses in the insurance industry, financial difficulties of client firms caused by disasters and the subsequent supply chain disruptions may create unexpected problems in the repayment of loans and in turn undermine the stability of financial institutions.

An increasing number of small and medium-sized enterprises (SMEs) are involved in global supply chains. SMEs are generally suppliers of labour-intensive parts and components or providers of other basic services, usually on a subcontracting basis (Abe, 2012). Larger partners in the global supply chain often take advantage of the greater flexibility of SMEs and their adaptability to local economic conditions and capacity to serve orders for smaller quantities, but SMEs have been identified as a highly disaster-vulnerable group in the supply chain. The small market share and weak bargaining power of individual SMEs places them in a disadvantaged position in negotiations with supply chain partners to obtain resources and support to deal with the impact of disasters. Lack of output diversification also limits the ability of SMEs to cope with supply and demand shocks and market volatility generated by disasters. Studies have revealed that few SMEs are adequately prepared for natural hazards.3 SMEs have

3 cf. Alesch et al. 2001; Wedawatta, Ingirige and Amaratunga, 2010

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been identified as the top sector of underinsurance, and they usually do not conduct risk assessments or implement business continuity plans (CERNO, 2010; CII, 2009). This lack of preparation consequently increases the difficulty of recovery from disasters and the subsequent supply chain disruptions (Wedawatta et al., 2010).

4. Case studies: Japan earthquake and Thailand floods

The natural disasters that hit Japan and Thailand in 2011 were among most devastating in the Asia-Pacific region in recent history. In March 2011, a massive earthquake (known now as the Great East Japan earthquake) hit the northeast part of Japan and was followed by devastating tsunami. Then, in late 2011, floods in Thailand caused huge damage to the country. Given the important positions of Japan and Thailand in the global supply chains for many economic sectors, the two disasters caused large disruptions both domestically and worldwide, thus highlighting the interconnected nature of world markets and economies.

The two cases highlight the different types of impacts of natural disasters on the global supply chain. Japan not only acts as a major supplier in many industries (e.g. automotive parts, chemicals, electronic parts and steel) but also as a producer of end products to the mass market. As a result, the Great East Japan earthquake impacted both upstream suppliers in developing countries and end customers in developed countries, as both demand signal and supply flows were severely disrupted. In comparison, Thailand is a major supplier in the global supply chain, particularly in the auto and electronic sectors. Therefore, downstream partners in the supply chain were adversely affected by the disaster as they were unable to source parts and components from Thailand during the flood.

4.1 The Great East Japan earthquake

In March 2011, an earthquake struck Japan triggering a devastating tsunami, which led to the meltdown of nuclear reactors in Fukushima. The disaster caused a record 210 billion United States Dollars (USD) in economic damage, representing 3.8 per cent of Japan’s Gross Domestic Product (GDP).4 Production sites in affected coastal areas experienced one and half times as much damage as inland areas (Okada, 2011). The combination of the earthquake and tsunami damage and the meltdown of the Fukushima nuclear reactors affected broad areas and caused severe damage in various sectors, especially in the manufacturing and chemical industries. As a result of this disaster, individual firms suffered huge direct losses, and the disaster could have a long- term impact on the ability of firms to produce and deliver their products or services.

4 EM-DAT, the international disaster database, Available from http://www.emdat.be/ (Accessed 30 March 2012)

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Box 1. Earthquake damage of Renesas Electronics Corporation

Renesas Electronics Corporation is a Japanese semiconductor manufacturer and the world’s largest manufacturer of microcontrollers. The corporation’s Naka Factory and other manufacturing facilities were severely damaged by the earthquake. In addition to the cost for restoring damaged properties, Renesas had to dispose of damaged stock and other fixed assets as well as compensate the loss of leasing contracts. Renesas also needed to cover fixed expenses in spite of production stoppage. Although the company carried insurance, it recovered less than one quarter of the total loss on the disaster as the insurance only covered part of the disaster risks. Table 1 presents the corporate loses to Renesas caused by the earthquake.

Table 1. Losses for earthquake damages in 2011, Renesas Electronic Corp

Items Amount

(USD millions) Repairs to property, plant and equipment (expenses for restoring to the original condition)

535.8

Loss on disposal of stock 90.7 Loss on disposal of fixed assets 77.1 Fixed expenses during suspension of operations (loss for inability to operate)

73.3

Loss on cancellation of lease contracts and others 37.3 Total loss on the disaster 814.2 Insurance payments received (198.9) Net loss on the disaster 615.3

Note: Calculated based on 1USD = 80.5 Japanese Yen Source: Renesas Annual Report 2011

Some firms, although they were not hit directly by the earthquake and tsunami,

experienced the disaster impact indirectly due to damaged infrastructure in the country. The power supply in the northern part of Japan was severely disrupted due to the failure of the Fukushima nuclear power plant. As a result, the production of many industrial plants stagnated (Davis, 2011). Furthermore, many roads and railways were destroyed and almost all major sea ports in the affected areas were closed (Wassener and Nicholson, 2011). This rendered the mobility of final products, components and raw materials very difficult, thus causing various supply chain disruptions.

The catastrophe also generated several impacts on human capital and the labour market. In the directly-affected region, the number of applications for unemployment insurance rose sharply in the first few months (Berkmen et al., 2011). The disaster also had a nationwide impact on the labour market due to increased bankruptcies and loss of employment. In addition, the disaster forced a reallocation of human capital to different geographical locations and industrial sectors (Kirchberger, 2011). As a consequence, gaps between labour demand and supply in terms of quantity and skills further raised unemployment.

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In response to the disaster, the Government of Japan implemented a number of employment promoting programmes, such as “Hello-works” and the “Japan as One” work project, to facilitate job creation and job matching (Rokumoto, 2012; Japan Ministry of Heath, Labour and Welfare, 2012). Therefore, affected firms, especially those in the manufacturing sector, rapidly regained their levels of employment, as they were working to recover their production to the level prior to the earthquake and tsunami (Thompson, 2012). In March 2012, employment in the finance, insurance, real estate, mining, construction and services sectors exceeded the level of March 2011 (Thompson, 2012).

As the economy of Japan is highly integrated into the world economy, the direct and indirect supply disruptions caused by the disaster were experienced globally. Following the Great East Japan earthquake, Japanese automobile production and electrical component production declined by 47.7 per cent and 8.25 per cent, respectively.5 As Figure 3 illustrates, the ill effects of the Japanese catastrophe spilled over to other countries in the region. This was most clearly evident in the cases of Thailand (-19.7 per cent), the Philippines (-24 per cent), Indonesia (-6.1 per cent) for automobile production, and the Philippines (-17.5 per cent) and Malaysia (-8.4 per cent) for electrical component production. Disruptive impacts from the Great East Japan earthquake had a longer impact on the automotive sector (about three months) than on the electrical sector (about two months).

Figure 3. Disaster impact spill-over from the Great East Japan earthquake

Auto production after Japanese earthquake

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