2011-11-10

The Economics of Disaster: Fragile Supply Chains Tossed By The Storm

Almost all the world’s hard drives are made in one Thai plant, and that plant is underwater. Are we going to keep facing economic disaster as a result of natural disasters, or will global supply chains have to adapt to a more dangerous, post-climate change world?

The city of Bangkok is underwater and it’s likely to stay that way for weeks. Besides the myriad Thai people displaced, there are other concerns: hard drive manufacturers are swamped. Western Digital is the world’s largest maker of disk drives, and it’s Thai factories account for 60% of its total production. They’ve been closed now for nearly a month. Global shipments are expected to fall by nearly 50 million units in the fourth quarter, according to IHS iSuppli, a drop of 30%.

Analysts at iSuppli and Gartner have repeatedly warned of higher disk prices in the new year (when the shock will have rippled through the entire supply chain), lower prices (and profits) for other component manufacturers squeezed by the likes of HP and Dell, and even a race to lock up high-capacity storage for the brewing arms race in the cloud between Google, Facebook, Amazon, and Apple.

“Surely one of the inevitable impacts of this is that never again will so much be concentrated in so few places,” Gartner’s John Monroe told The New York Times this week. But that only raises the question of how Thailand became the weakest link in the first place--and whether the computing industry (or, really, any industry) can still afford to situate itself entirely in the path of climate-related disasters.

“It’s just by chance that Western Digital has the majority of its production there,” says Fang Zhang, an analyst for iSuppli. She adds that hard drives have been a mainstay of Thailand’s technology industry for decades. “It wasn’t planned.”

It never is. “When an industry has chosen a locality for itself, it is likely to stay there long,” the economist Alfred Marshall noted more than a century ago in explaining economies of scale. Increasing specialization not only bolsters overall production (as described by Adam Smith in his example of the pin factory) but also the competitive advantage of local manufacturers through various spillover effects. The gains from specialization are only limited by market size, so when the market for Thailand’s hard drives is a global one, you end up with a single, submerged Western Digital plant producing a quarter of the world’s magnetic disk head sliders. (And it’s not limited to Thailand: 30% of the heads themselves are assembled at a single factory in Dongguan, China.)

If that wasn’t enough, the recent wave of consolidation sweeping through the storage industry--in March, Western Digital acquired Hitachi’s storage business for $4.3 billion, followed a month later by Seagate’s purchase of Samsung’s storage operations--has further shrunk the number of factories. “Major manufacturers typically have two or three locations,” Zhang says. “There are geopolitical issues there. Labor cost issues. Shipping and manufacturing issues.”

To which it might be time to add a new set of issues: the potential for climate change-related disasters. Thailand’s monsoon flooding, which follows on the heels of Japan’s earthquake in March, has insurers and other risk-management experts weighing the benefits of scale economies against the increased probability of disaster. Gartner’s Monroe is certain a shift is already underway; Zhang is less sure. But the threat is real.

In his 2005 book End of the Line, the New America Foundation’s Barry C. Lynn recounts a litany of past disasters which have nearly brought entire industries to a halt: the 1999 Taiwan earthquake which killed 2,500 people and damaged the world’s most important semiconductor manufacturing park; the four-day closure of U.S. airspace following 9/11, and so on.

Lynn concluded that economies of scale had gone too far, and recommended requiring firms to double- or even triple-source components from different firms in different countries, in order to avoid shocks like the on Western Digital is currently experiencing. Needless to say, no one listened. It remains to be seen just how high the losses of a particular disaster have to mount before it’s seen as more than just the cost of doing business.

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1 Comments

  • David Kaiser

    This is bigger than climate change. disasters happen. They just do. Firms need to know that and be prepared to deal. Having the government order triple -sourcing is most likely a recipe for trouble. Insurance firms, on the other hand, would do well to require that their clients follow certain best practices in order to manage risk, like having multiple locations for their facilities, and building and operating facilities in a way that manages the local risk (everyplace has something). Even then, sh*t happens, and this becomes an opportunities for competitors to jump in, during a game-changing moment. This is not a bad thing. 

    David Kaiser, PhDExecutive Coach & CEOwww.DarkMatterConsulting.co...