Natural Disasters - How to Mitigate Unavoidable Risks

Supply Chain Risk Briefing (Part 3)

This is the third in a series of short papers covering some of the most important supply chain risks. Natural disaster
risk relating to suppliers is one risk type that is mostly unavoidable, and when the topic of supply chain risk is raised,
this is often the first example that comes to mind. It arises when a suppliers business is affected by a natural event
of some sort, and that impact has a negative knock-on effect for the customers of that supplier.
The Allianz Risk Barometer consistently has natural disasters in the top handful of risk types, and says that this
accounted for $175bn in economic losses in 2016, a four-year high, with insured losses totalling some $50bn.
Businesses are also more concerned about climate change and increasing weather volatility impact year-on-year. A
report by the ClimateWise coalition warns of a $100bn protection gap from the rising impact of climate risks, and
according to analysis by Munich Re, 2016 saw more floods in the US than in any year since records began in 1980.
Natural events are often weather-related, but some of the most dramatic are caused by earthquakes. According to
long-term records, the world can expect about 17 major earthquakes and one great earthquake (8.0 or above) in
any given year (source: USGS). Volcanoes are a more unusual risk, but in 2010 Eyjafjallajokull in Iceland erupted,
causing huge problems for many businesses. BMW was forced to stop production due to missing components, for
example, with the temporary halt in production resulting in delayed manufacture of around 7000 vehicles.

Earthquakes in Japan in 2016 caused damage to car plants for several manufacturers. Chipmaker Renesas
Electronics said that there had been damage to equipment at its Kumamoto plant, which produces micro-
controller chips for cars. Toyota had to suspend much of its production at plants across Japan and may see its
operating profit reduced by about $277 million. (Various sources including Fortune and the BBC).

What Drives This Risk?

Issues here arise naturally; that is, without any human driver or cause. While it is possible to question whether
a firm should build a factory on a geological fault-line or on a flood plain of a river known to flood every ten
years, the direct trigger for the risk is not man-made in any sense. What that means is these risks cannot be
absolutely avoided or mitigated. However, some of those natural drivers are known, and there is relevant
evidence and data available, so buyers can take some precautions when selecting suppliers and placing
contracts. They can also take appropriate actions once a risk event commences, as discussed later.

Consequences for Customers

This type of risk can lead to many negative outcomes for customers, ranging from the slightly inconvenient to
the devastating.
Supply interruption natural disaster-type events often lead to short or longer-term supply interruption for the
buyer when suppliers premises such as factories, transportation routes or even their own supply chain are
affected by flood, earthquake or other natural events.
Loss of short-term sales such supply interruptions may cause just inconvenience for the buying organisation,
but often they lead to production shortfalls or even shut-downs, which ultimately drive a loss in sales and profit.
Need to re-source materials buyers find themselves having to secure additional supply from other unaffected
existing suppliers, or find, verify and approve new suppliers quickly to maintain production. This in itself carries a
number of challenges and risks for all parties.

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Loss of good suppliers / market dynamics change at the extreme, supplying firms may even disappear
altogether or operate at reduced capacity for a considerable time. This can change the balance of power in the
market, leaving other suppliers in a more powerful position to the detriment of the buyers.

Suggested Actions and Mitigation Strategies

No buying organisation can avoid this risk entirely because it is based on natural events. But steps can be taken
to reduce the impact it will have on the business. There are two types of action that can be taken here. The first
set of actions relates to how the organisation can reduce or minimise the risk in the first place. This means
careful analysis and paying attention to the risks based on an understanding of supplier locations, and the
probability of related issues arising from floods, earthquakes, or extreme weather conditions. Trusted third-
party data from various sources can be invaluable to aid understanding.
Understanding that situation and the probability of events means the buyer can look to achieve a spread of
supply, certainly for mission-critical items or services. It may be that the buyer chooses to accept the risk that an
excellent supplier is situated on the San Andreas Fault, but it would probably make sense to ensure that the
back-up supplier is not also in the same vicinity. Insurance is another potential mitigating action.

The devastating floods in Thailand will cause a 28 percent quarter-on-quarter drop in hard disk drive (HDD)
production in the fourth quarter Toshiba and Western Digital have announced so far the temporary
shutdown of their factories in the country, while Seagate Technology said the supply of components to its
factories in Thailand was disrupted. (PC World, 2011, quoting research firm HIS iSuppli)

The second set of actions relates to the response to risk events when they happen. We can illustrate a key point
here with an old joke. Two men are walking in the woods. A large bear appears and acts in a threatening
manner. One man gets running shoes out of his rucksack and puts them on. What are you doing, says the other
man - you cant outrun a bear even with running shoes! No, the first man says. But I dont need to run faster
than the bear. I only need to run faster than you!
If an earthquake hits a particular supplying firm, then the key is how quickly and effectively the different
customers of that firm, the buyers, respond. That might mean securing preferential supply from the affected
firm itself. Or it could mean contacting alternative suppliers, existing or new, to obtain and secure supply (which
may become tight very quickly).
Clearly, there may be many customer firms trying to do this, so speed is essential, as well as having risk plans in
place that identify in advance what the alternative options are for each vulnerable supplier or material. Using
market and general intelligence and risk alert tools can help buyers respond more quickly and appropriately than
the competition. That can secure competitive advantage the equivalent of running from the bear faster!

A major publishing company has had 4 cases of disruption to key raw material supply chains in the last 2 years
because of flooding affecting supplier premises around Chennai, India. In each case, the alert to the company came
from risk management solution provider riskmethods rather than the affected supplier, and the firm was able to
make alternative sourcing plans in order to maintain scheduled production dates. (riskmethods, 2017)

Conclusion
Natural disasters drive a major category of supply chain risks, and one that appears to be increasing as the global
climate changes. Whilst such risks cannot be avoided completely, there are sensible actions which should be
taken by buyers. Understanding the risk profile of the supply base in terms of the likelihood of their premises
being affected is the first stage. Developing contingency plans in case of such events occurring is then also key.
Then, getting the earliest possible notification of such events is also vital, so that steps can be taken to reduce
the potential effects; time is very much of the essence when these natural disasters take place.
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