Probability Theory and Assessing the Impact of the Japan Disaster

Posted on March 16, 2011


Global supply chains in the process industries are usually very large scale systems that can be comprised of up to hundreds of or even thousands of production facilities,
distribution centers and customers. Due to competition in the global marketplace, process industries are facing increasing pressure to manage their supply chains so as to
reduce costs and risks.  To achieve this goal, effective mathematical tools for large-scale supply chain optimization, particularly for cost reduction and risk management, have drawn significant attention.

from the paper Risk Management for a Global Supply Chain (Planning Under Uncertainty: Models and Algorithms) by Fengqi You, John M. Wassick, Ignacio E. Grossmann

As I read an article today from BBC News (Japan supply chain fears rattle world stock markets), I could not help but wonder how much of the uncertainty regarding both the immediate as well as mid to long-term impact of the Japan earthquake and tsunami could have been more readily understood or quantified had senior supply chain managers and executives took the practice of risk assessment modeling more seriously than what was indicated in a McKinsey 2006 survey.

Despite the fact that nearly two-thirds of the executives who responded to the survey had indicated that the risk(s) to their supply chains had increased dramatically, a “significant number” expressed the belief that their respective companies had not made the necessary investment of time and resources to mitigate said risk(s).  Five years later, there is little evidence to show that there has been any meaningful improvement in both understanding and responding to unexpected events such as what happened this past Friday.

Of course no one could have predicted that Japan would be hit with the country’s worst earthquake in 140 years but, based on the 1995 Kobe earthquake which according to some reports diminished its prominence has a port city, the possibility of a significant natural disaster of a similar or greater magnitude would logically be a factor that one would consider in formulating a contingency plan.  Especially since Japan, according to the BBC article, is a dominant player in the microchip market, supplying about 20% of global semiconductors and 40% of flash memory chips.

Not surprisingly, the automotive industry is another sector that is heavily dependent on the fluency of the Japanese supply chain.  However, the fact that the BBC News article is reporting that  it is now becoming evident that many international manufacturers depend on Japan for parts supplies, particularly electronic components and batteries for hybrid vehicles, would lead one to believe that this is an unexpected revelation.

Again this is somewhat disconcerting but not entirely unexpected if you are to put any stock in the McKinsey Survey.  That being said I cannot understand how, with the advent of forecasting and planning tools, contingency strategies were not developed given that manufacturing processes are assumed to be stochastic processes in which a probability theory can be used to take into account and calculate the impact of any number of variables.

My familiarity in the area of probability theory is based largely on the extent of my experience in the service industry, which employs a similar-type approach to that of the manufacturing industry relative to the process variables surrounding service level agreements or SLAs.

Let’s once again go back to the high tech market, and in particular memory chips.  According to reports, the price for the NAND chips used in smartphones and tablet computers shot up 20% on Monday, and another 3% today.  Depending on existing inventory levels of what is usually a Just-In-Time industry, combined with the potential length of time that Japanese production will be down, it is not out of the realm of possibility that the everyday consumer will ultimately pay the price.  The question I have is simply this, did companies dependent on Japan for NAND chips have alternative supply options in place based on the potential for this level of interruption and its adjunct consequences so has to minimize the impact on the end user customer?

As far as I am concerned, and acknowledging the fact that it is not always possible to plan for every conceivable risk, with the computing power that is so readily available today, there should be no excuse for the magnitude of surprise expressed in the BBC report.  Or to put it another way, an earthquake and tsunami hitting the US Midwest could be considered a major surprise of unexpected proportion.  However, taking into account Japan’s proximity to the Pacific Plate, as well as recent history, contemplating the possible risks of an event such as the one that occurred last week would be both reasonable and prudent.

One can only hope that the majority of those executives referenced in the McKinsey Survey, have finally taken notice of their true exposure in a global marketplace and will be moved by what has happened in Japan to take a better look at their organization’s level of risk, including, the steps they will need to take to protect the interests of their organizations, partners and customers.


Posted in: Commentary