The Split-Second Disruption to the Supply Chain

Stephen DeAngelis

December 14, 2010

In 2005, Professor Yossi Sheffi from the Massachusetts Institute of Technology wrote a seminal work entitled The Resilient Enterprise that examined disruptions in corporate supply chains. The very first chapter in that book was entitled “Big Lessons from Small Disruptions.” It unfolds a story about how a St. Patrick’s Day (17 March 2000) lightning strike in Albuquerque, New Mexico, started a fire in Fabricator No. 22 of a Phillips NV chip manufacturing plant which led to unforeseen long-term consequences. Alert plant employees and automatic sprinklers put the fire out in less than ten minutes. Sheffi wrote, “A routine investigation showed that the fire had been minor. Nobody was hurt and the damage seemed superficial. The blaze did not make headlines in Europe, did not appear on CNN, and did not even appear in the Albuquerque newspapers.” So why did Sheffi select this story to begin his book? The answer lies in the effect the fire had on two Scandinavian companies: Nokia and Ericsson.

 

Sheffi explained that chip manufacturing plants must maintain ultra-clean conditions so that chip defects are minimized. The fire had directly ruined only eight trays of wafers but smoke from the fire spread beyond the immediate area and, along with soot spread by workers and firefighters, contaminated much of the rest of plant. A minor fire had turned into a major disaster. Sheffi reported that Phillips notified its 30-plus customers about potential delays in chip production but predicted the delay would only be about a week. Nokia’s chief component purchasing manager, Tapio Markki, took the news in stride but quickly notified other company executives. As a result, the company kept a close eye on the situation and as soon as it realized that the delay was actually going to be weeks or months, it took action. Sheffi wrote:

“The Nokia team dug into the capacity of all Phillips factories and insisted on rerouting that capacity. ‘The goal was simple: For a little period of time, Phillips and Nokia would operate as one company regarding these components,’ [said Pertti Korhonen, Nokia’s top troubleshooter]. The Finns’ earnestness got results. … Through its extraordinary efforts and intensive collaboration with its suppliers, Nokia was able to avoid disrupting its customers. Handsets ultimately kept rolling off Nokia’s assembly lines, onto store shelves, and into the hands of customers.”

Ericsson wasn’t quite so lucky. Sheffi reported that Ericsson executives received the same telephone call from Phillips as Nokia but they reacted very differently. They believed that the delay would be a short one and they were content to let the situation play out. Sheffi wrote:

“By the time Ericsson realized the magnitude of the problem, it was too late. When it finally asked Phillips for help, Phillips couldn’t provide it because Nokia had already commandeered all of Phillip’s spare capacity. Ericsson then turned to other chip makers for parts. But, unlike Nokia, the company didn’t have alternative suppliers available for the chips that had come from the stricken Albuquerque plant. With semiconductor sales running hot in the spring of 2000 and Nokia’s lock on all spare capacity, Ericsson failed to obtain needed parts from other sources. ‘We did not have a Plan B,’ conceded Jan Ahrenberg, Ericsson’s marketing director for consumer goods.”

According to Sheffi, Ericsson’s lack of a Plan B cost the company around half a billion dollars. Let’s turn the pages of the calendar forward ten years. When I read last week that a brief power outage had affected a Toshiba chip manufacturing plant in Japan, I immediately thought about the Phillips fire detailed in Sheffi’s book [“Power Blip Jolts Supply of Gadget Chips,” by Don Clark and Juro Osawa, Wall Street Journal, 10 December 2010]. Clark and Osawa report:

“A split-second power disruption at a Toshiba Corp. factory in Japan could hurt shipments and raise prices for one of the world’s most widely used computer chips, a mainstay of devices like smartphones, tablet PCs and digital music players. Toshiba said the power outage could cause a 20% drop in its shipments over the next two months or so of chips known as NAND flash memory, which are used to store music, photos and data in products such as Apple Inc.’s iPhone and iPad. Toshiba, which makes the chips in partnership with Silicon Valley company SanDisk Corp., represents about a third of the market as the second-largest supplier of the chips after Samsung Electronics Co.”

Although it may sound incredible that a split second disruption in power could generate a two month delay in chip supplies, the Phillips’ story is evidence that big disruptions can result from small events. Clark and Osawa explain:

“Toshiba’s troubles started … when, according to power supplier Chubu Electric Power Co., there was a sudden drop in voltage that caused a 0.07-second power interruption at Toshiba’s Yokkaichi memory-chip plant in Mie prefecture. Even the briefest power interruption to the complex machines that make chips can have an effect comparable to disconnecting the power cord on a desktop computer, since the computerized controls on the systems must effectively be rebooted, said Dan Hutcheson, a chip-manufacturing analyst at VLSI Research in San Jose, Calif. For that reason, chip companies typically take precautions that include installing what the industry calls uninterruptible power supplies. Part of Toshiba’s safeguards didn’t work this time because the voltage drop was more severe than what the backup system is designed to handle, a company spokesman said. Power outages frequently cause damage to chips, which are fabricated on silicon wafers about the size of dinner plates that may take eight to 12 weeks to process, Mr. Hutcheson said. Wafers that are inside processing machines at the time of an outage are often ruined, he added, though many that are in storage or in transit among those machines are not. In some cases, a shutdown of the air-purifying and conditioning system that keeps air in a chip factory free of dust also could contaminate chips. Mr. Hutcheson compared the situation to cutting off the power to an artificial heart machine in the middle of an operation. ‘You lose the patient,’ he said. On the other hand, he said that Toshiba’s estimate of the impact is a worst-case scenario that may wind up to be substantially less.”

Analysts say that the disruption in the chip supply couldn’t have come at a worse time. That said, it’s my experience that there is never a good time to experience a disruption. Clark and Osawa continue:

“After the next couple months, the outage isn’t expected to have a significant impact on world-wide shipments of flash memory. Some big buyers of the chips, such as Apple, have long-term supply arrangements with multiple chip makers. But the temporary disruption comes as demand for NAND flash is surging, notably from companies hoping to offer new tablet computers to challenge the iPad. Market watchers say some companies could face tight supplies and higher prices just as they are trying to ramp up production.”

Undoubtedly, manufacturers like Apple learned a lesson from the Phillips’ fire; which is why they “have long-term supply arrangements with multiple chip makers.” The question is: How much extra capacity do those other chip makers have? Clark and Osawa explain the potential long-term effects of the Toshiba shortfall:

“Toshiba estimated that its shipments of NAND flash memory could decline by as much as 20% through February as a result of the outage. Based on the company’s share of the market, such a reduction would translate into a 7.5% cut in world-wide shipments over that period, but a much smaller percentage for all of 2011, estimated Michael Yang, an analyst at the technology market research firm iSuppli. ‘The impact for the year is nothing,’ Mr. Yang said, though he added it could temporarily raise NAND prices.”

Clark and Osawa report that the Toshiba event is not “unprecedented.” We, of course, know about the Phillips’ fire in spring of 2000, but Clark and Osawa also report that in August 2007 there was “a power outage at Samsung’s memory-chip plant near Seoul [that] forced the company to temporarily halt some production lines.” The price of chips temporarily increased following that event and the same thing will likely happen over the next couple of months. Clark and Osawa indicate that the benefactors of these increased prices will be Toshiba’s rivals Samsung and Micron Technology Inc. Clark and Osawa conclude:

“One mitigating factor is that chip demand is typically lighter in January and February than other parts of the year, which could reduce the chances of a shortage. On the other hand, demand for NAND chips has been rising at an unusual rate, driven largely by sales of smartphones and tablets. ISuppli in September predicted that global shipments of NAND flash-memory chips by volume would jump 70% next year.”

If manufacturers supplied by Toshiba didn’t have a Plan B in place before the outage, my suspicion is that it is too late to do anything now. In the concluding section of his first chapter, Sheffi noted that few companies today are content to let an emerging situation play out. They are proactive because they face a “tougher competitive environment.” He concluded:

“The very complexity of global supply networks means that, in most cases, it is difficult to assess a priori vulnerabilities. … The number of possible disruptions to the global supply chain is endless. Manufacturing can be disrupted directly because of a problem in a plant, a disruption at a supplier’s plant, a glitch in the transportation system, a disruption to the communication and information system, or a snag with a customer. … When thinking about reducing a company’s vulnerability to disruption, executives need to look at increasing both security … and resilience. … Robust supply chain designs … are not enough. Resilience is also dependent on a set of collaborative relationships with trading partners, since each enterprise is only as resilient as the weakest link in its supply chain.”

I agree with Sheffi that resilience is improved as collaboration increases. In fact, I believe that most business processes are improved as collaboration increases. The fact that a split second disruption in a power supply can affect a supply chain for weeks or months is a good reminder of why flexibility and agility are becoming modifiers frequently associated with the best supply chains.