Mitigating supply chain disruption risks from natural disasters

Mitigating supply chain disruption risks from natural disasters

Damage from the 2011 floods to industrial areas, such as this one in Ayutthaya, ran into the tens of billions of baht. Photo: Surapol Promsaka na Sakolnakorn
Damage from the 2011 floods to industrial areas, such as this one in Ayutthaya, ran into the tens of billions of baht. Photo: Surapol Promsaka na Sakolnakorn

Natural disasters are increasingly disrupting supply chains and leaving great economic damages in their wake worldwide. We all recall the Great Flood in Thailand in late 2011, which stalled global supply chains with almost 10,000 factories affected. Global and regional business across industries -- among them big names including Honda, Goodyear, Canon and Sony -- cut production and lowered revenue forecasts because of the flood.

In fact, the 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 economic impact of US$97 billion and almost 8,000 casualties. The five countries that faced the most serious impact were China, the United States, India, the Philippines and Indonesia.

By category, hydrological disasters -- floods, landslides and waves -- accounted for more than half of all disasters reported, although with less economic impact and fewer casualties when compared to earthquakes and tsunamis.

In Thailand, floods are the most commonly occurring natural disaster but droughts have greater impacts. Between 1989 and 2013, there were more than 230 flood incidents, with economic losses estimated at 158.5 billion baht in total. In 2014 alone, there were four major floods affecting almost 2 million people with economic losses of 325 million baht.

In contrast, droughts occur less often but affect on average 10.8 million people each time, almost two times as many as are affected by floods. Fluctuations in agricultural output are also more pronounced in periods of drought.

Lower quality or yields are a significant consequence of extended and unusually dry conditions. For example, variations in sugar content in sugarcane and flavour variations in fruits can be substantial. Exports of these products could decline as a result, leading to a loss of market share in the global market.

Processing plants also face difficulties during and after a drought. Competition to secure raw materials intensifies, resulting in higher procurement prices and thus lower margins -- if your plant is able to secure enough raw materials to run its machinery at all.

The impacts of natural disasters on non-agricultural economic activity are also substantial. A study of the impacts on construction industry in Malaysia, by Universiti Teknologi MARA, shed light on how different businesses could be affected by a single event. In 2011, severe floods in Malaysia led to an 18 month-delay for a double-track railway construction project. The total financial loss was estimated at 150 million ringgit. In this case, only 20% of construction businesses were found to have been prepared to deal with the interruption. This is much lower than other sectors generally understood to have experienced direct impacts from natural disasters.

In Thailand, although rainfall and other seasonal factors are usually included in construction planning, it has become more difficult for contractors to estimate and forecast weather, resulting in delays and, in some cases, court cases when contractors cannot meet agreed targets and schedules.

A more thorough project planning system that includes a sophisticated weather database is recommended for more effective planning and execution of projects. Insurance should also be considered as there is still very low awareness in this area; for example, it was reported that only $35 billion out of the $210 billion in damage from the 2011 Japan earthquake was insured.

Disrupted transport is a further complication arising from the impact of natural disasters. Transport is critical for manufacturing firms, especially those with high reliance on a few large suppliers. The 2011 flood in Thailand was a good example -- even where factories could be protected from rising water, many companies still suffered because impassable roads prevented their suppliers from making deliveries.

The country's strategically important hard-disk drive (HDD) industry is a case in point. Not all HDD producers were in flood zones, but there were constraints on how parts could be delivered for assembly or how finished products could be delivered for shipment to global markets. As a result, supply plunged, global prices doubled and it took almost two years to get back to pre-flood levels.

Impacts can also be indirect, and can be seen cascading from adjacent tiers. The 2011 Japan quake, for example, was followed by many aftershocks over a longer time period, while the tsunami triggered by the original quake and the subsequent failure of a nuclear plant resulted in huge waves of damage to the economy for several years.

A study conducted by the Policy Research Institute of Japan's Ministry of Finance showed that impacts occurred both downstream and upstream. Companies with at least one earthquake-hit supplier underperformed the control group, as did firms with at least one customer in a disaster area.

Simply put, the impacts of major disasters cascade to suppliers' suppliers and customers' customers. This ripple effect is especially pronounced when the lack of one critical part can halt production of an entire line of products. For example, there was only one production plant in the world for Xirallic, a pigment used in automotive coatings, and it was located in the damaged area of Japan. The resulting shortage of this essential raw material sent the ripples throughout the automobile industry around the globe, as it was used in about 20% of all units sold.

The lessons are clear: Businesses should cooperate more to prepare for and mitigate risks. Only a few preventive measures are needed to prepare in case of droughts or floods. In the agriculture and food sector, selection of crops appropriate for weather cycles, acquisition of water pumps, or protection of cultivated produce could be conducted collaboratively 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, such as crop insurance, is also needed to reduce financial damage. Adoption of such coverage in Thailand, however, is still at a very early stage, with coverage focusing only on farmers. Further public adoption is needed to expand coverage to the whole supply chain, as in many other countries. Studies have shown that agricultural insurance that covers the whole supply chain not only promotes collaboration, but also has direct links to more stable output.

Business should also consider mitigation measures for impacts cascading from other tiers. Buffer stocks, for example, could be invested in to reduce impact once a disaster strikes some critical suppliers. Alternative sources of certain parts should also be identified in preparation for times of disruption. This would involve a long-term strategy, as resource allocation is needed to consider which production process has top priority. This is not an easy task when one has to take into account interconnected businesses across the whole supply chain. The bigger the business, the more challenges arise.

An automaker, for example, might 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 mitigation to the most optimal degree is a truly daunting managerial challenge.

EIC, a unit of Siam Commercial Bank Public Company Limited, offers in-depth macroeconomic outlook and sectoral impact analyses. For more information, please visit www.scbeic.com or contact eic@scb.co.th

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