How the Japanese earthquake is shaking up an auto supplier

A few weeks ago we had a post on how Toyota is revamping its supply chain in anticipation of the next natural disaster. Now the Wall Street Journal has a story on how an auto supplier is trying to recover from March’s earthquake (Quake Still Rattles Suppliers, Sep 29).

Take, for example, the tussle over a pearl-luster pigment called Xirallic that makes car paint sparkle. Merck KGaA produces 100% of the global supply at a factory in an area of northeastern Japan that was hit hard by the quake, forcing a temporary suspension of operations. The German company said it caught up on back orders Sept. 1, after reopening the factory in May, and remains committed to manufacturing in Japan. …

The closure of Merck’s Onahama, Japan, plant for two months after the March 11 quake set off a search for scarce stockpiles or substitutes. Many of the world’s auto makers, including Toyota, Nissan Motor Co., Ford Motor Co., Chrysler Group LLC, Volkswagen AG and General Motors Co., used metallic paints made with Xirallic, an aluminum-oxide-crystal compound, for at least some vehicles in their product lineups.

The acute Xirallic shortage nevertheless illustrates how much the global auto industry came to rely on just a handful of producers for key components and materials, many of which are made in Japan. The post-quake crisis has prompted auto makers to seek ways to diversify their supply chains for critical components, which ranged from humdrum rubber O-rings to advanced semiconductors. …

Many auto makers had been surprised to find their standard two-supplier rule for critical parts had been circumvented further down the supply chain. As a result, “traceability” of lower-tier suppliers has become an industry watchword following the earthquake, a senior Toyota executive said.

So Merck is effectively now being vilified for being really good. They had  a great product and delivered reliability. As long as they did that, no one cared that everything came from one factory. Indeed, it may have had some advantages in having just one production location since this would allow for economies of scale and assured consistent production processes.

Now, according the article, it is setting up a second production line in Germany. There are then obvious question about what scale it will operate. While the German facility provides a hedge against another natural disaster, will it generally be able to produce cost effectively?

I have to think that scale really matters here. Merck has supplying a global market from Japan leaving them exposed to swings in the yen. If you don’t think that’s a risk, do a quick search on yen and Toyota or Nissan and you will find plenty of articles with auto execs whining about the high value of the yen. So Merck and its partners may not have accounted for the risk of an earthquake driven disruption in the past, but Merck has to have worried about its exposure to the yen. Maybe Xirallic is a sufficiently small part of their business that they could effectively hedge that risk in the currency markets. But if physically hedging that currency risk were sufficiently cheap, they would have done it already.