Last week David Pilling wrote an interesting column in the Financial Times about disruptions the global supply chain has suffered as a result of natural disasters this year, and how the disruptions have prevented the companies affected from bringing their products to market. The column reminded me of one of my favorite essays of all-time- I, Pencil- which I’ve republished here.
For those of you who have never read I, Pencil, it illustrates how for a single pencil to be made thousands of people from all over the world must come together to provide the wood, graphite, paint, chemicals, components for industrial machinery, and so on. As the essay observes, the multitudes of people from all over the world who contribute to the manufacturing of the pencil rarely know who each other are, but the competitive market draws them all together into a spontaneously choreographed industrial endeavor: the production of a pencil.
Implicit in the essay is how incredibly complex the global supply chain is, and how a high level of specialization is needed to produce the tiniest parts of the simplest products. Pilling explicates the complexity of the global supply chain by describing how the tsunami in Japan earlier this year, and the recent flooding in Thailand, have stopped parts of the global supply chain in its tracks, making it virtually impossible to produce certain products.
“It takes a crisis for the inner workings of the supply chain to come to light. Before the March tsunami, even most Japanese were unaware that the Tohoku region produced anything other than rice and fish. It turned out that several essential components were made there, including 40 per cent of the world’s microcontrollers at a factory owned by Renesas. These days, few cars can run without at least 50 of these “little brains”. When the Renesas plant was knocked out, car production was temporarily halted in several factories around the world.
Japanese companies did a remarkable job at getting Renesas and others back up and running. Yet the disruption has unsettled buyers. Daiki Takeyama, technology analyst at Goldman Sachs in Tokyo, says customers are pressing Japanese suppliers to move some production out of Japan. That would make the supply chain even more complex.
Thai floods are also having a disruptive effect. Honda Motor stopped production in Malaysia due to a lack of parts from Thailand. The computer industry is braced for a shortage of hard-disk drives after Thai factories were flooded.
The floods have washed up a third revelation. Almost nothing could be made these days without Asian parts. Greg Sutch of Intralink, a UK technology consultancy, says US and European manufacturers would struggle to match Asian producers of some parts even if they wanted to. He cites capacitors and connectors, without which much of the modern world would grind to a halt.”
As the global supply chain has grown and matured it’s actually grown even more complex than it was when I, Pencil was written in 1958. Specialization in the manufacturing of the tiny components that go inside so much of what we buy in the West has been dispersed throughout the entire world. Modern products are complex enough that it’s virtually impossible for a widget factory in Vietnam to suddenly start manufacturing thingamabobs if the thingamabob factory in Cambodia is unexpectedly shutdown.
The fragility of the global supply chain is further exacerbated for companies that employ a Just In Time (JIT) manufacturing strategy (like Apple, for example). A JIT manufacturing strategy basically does what its name implies: a company manufactures smaller batches of its product, and sells it quickly, avoiding the buildup of excess inventory and the associated carrying costs. The strategy has been lauded by management gurus in recent years, but it also makes companies much more sensitive to shocks in the global supply chain.
In the case of the iPhone, Apple* aggregates the phone’s components from nine different countries to factories in China, where the phones are assembled and shipped to retail stores around the world. The fact that Apple’s supply chain is so large, and that Apple never sits on more inventory than they can sell quickly, makes the company very susceptible to shocks- such as natural disasters- that can take some of the factories that supply Apple with iPhone components offline for extended periods of time.
Despite its vulnerabilities, a complex global supply chain does have many, many benefits. It’s enabled companies to become ruthlessly efficient in manufacturing their products. There are thousands and thousands of people throughout the developing world who are earning a living from manufacturing tiny components that 99.9 percent of us have no clue exist. Western consumers pay far less for products produced through the global supply chain, compared to products produced by expensive domestic labor. This frees up resources, and drives up Western purchasing power, while helping pull millions of people out of- sometimes extreme- poverty in the developing world.
Still, businesses should keep in mind that it is possible to overspecialize. Nassim Nicholas Taleb, author of The Black Swan, makes this point often in his work. Too much specialization leads to fragility, leaving companies overly exposed to rare, unforeseen events- or Black Swans. Businesses should still strive to squeeze as much efficiency as possible out of their supply chains, but they should make sure to hedge their positions with suppliers- that is, they should strive to add an extra layer of “robustness” (as Taleb coins it) to their supply chains. A company with a robust supply chain might not always be a world-beater, but it will be a survivor whenever the next disaster hits.
*Note: I don’t mean to second guess Apple’s manufacturing strategy. Their vast, complex supply chain combined with JIT manufacturing has been central to making them one of the world’s most valuable companies. I use the iPhone as an example because it’s a product that everyone is aware of, and that’s highly sensitive to global supply chain disruptions.