Layers of supply chain risk

Things are just not getting better fast enough in Japan for the country’s automakers — particularly Toyota. Akio Toyoda, the company’s CEO, held a press conference last week saying that it will likely take until the end of the year for Toyota to be back to full strength. As the New York Times notes, Toyota is in worse shape than other Japanese car makers because they a much larger share of their cars in Japan than Honda and Nissan (Toyota Says No Full Production Until Year’s End, Apr 23). Cue the spiffy graphic:

The most interesting details from the press briefing is just what is causing them problems (Toyota Signals a Bleak Year, Apr 23, Wall Street Journal)

Yet Toyota said it still faces critical shortages for about 150 parts, many involving relatively low-tech basic materials such as specialty chemicals, resins and rubber. Most were supplied to meet exacting specifications that have made it difficult to source from other providers, according to company officials. Still, the number is down from roughly 500 parts in mid-March.

Executive Vice President Shinichi Sasaki said Toyota will conduct a review of its system of centralized parts sourcing, including a look into whether it can use more commonly available parts and materials in the future, and a reassessment of its dependence on single-source suppliers in Japan.

“Even in cases where we thought we had more than one supplier, it turned out in many cases that they procured subcomponents from just one firm,” said Mr. Sasaki. “We’re also looking to increase local procurement overseas as we discovered a high reliance on Japanese-made subcomponents.”

Or to re-phrase that quote, Toyota grossly underestimated the risk they were facing.

Toyota, of course, has long been lauded for working with suppliers. That ability has generally paid big dividends — most famously when a fire shut down a key supplier back in 1997. So what has gone wrong here?

I see a couple of factors. A possibility is to blame this on Toyota’s rapid growth over the last decade. That is effectively the default answer for all that has gone wrong with Toyota in the last few years. I think that is a little simplistic.

A more reasonable statement is that this is an inevitable consequence of trends in the auto industry. The last twenty year or so has seen the growth of over-sized Tier 1 suppliers who developed ever increasing capabilities. Where a supplier would once delivered parts, Tier 1 firms now can deliver complete systems. That allowed the likes of Toyota to work with a limited number of large suppliers while leaving the task of managing lower tier suppliers to their big partners. Arguably, this was the most efficient way of managing the flow of material as the cars became increasingly more complex. But it also leaves assemblers blind to linkages between suppliers when, as Toyota has found out, one’s dual sources of supply share a common second or third tier supplier.

It should also be noted that this is not just a Toyota problem. They may have been harder than other firms but it has really been an eye opener for all automakers (see Automakers rethink supply strategy after quake, Apr 22, Marketplace). The real question is what can be done about it. My guess is not as much as assemblers would like — at least for the near term. Presumably, the components that are holding them up are not commodities. They are thus tied to the fate of their suppliers until they can re-design the component or qualify another supplier. What I suspect will come out of this is that car makers will work with their Tier 1 suppliers to better understand their supply base and assure that suppliers are geographically dispersed. That is, one supplier may make a key component but would have the capability to produce it in multiple locations. That way, a natural disaster or a political disruption in one location does not take down everything. Suppliers may be willing to play the game since they too are hurt by not having diversified locations.

That said, there is an interesting coordination problem. This all goes for not if not everyone diversify. Some US-based suppliers are likely looking at a bad quarter even though they have all of their production thousands of miles from Japan. Why? Because Toyota or Honda plants in the US cannot run at full speed without complementary parts from Japan.