Supply Chain Risk Management
April 25th, 2007On Friday, March 17, 2000, in Albuquerque, New Mexico, a bolt of lightning struck a factory of Philips NV, the Dutch electronics conglomerate, causing the furnace in Fabricator No. 22 to catch fire. At that time, it did not seem to be a major event. The automatic sprinkler systems were activated, and Philips staff put out the fire in less than 10 minutes. By the time the firefighters responded, they had nothing to do but verify that the plant was safe. What nobody realized that night was that the fire had compromised two of the four clean rooms crucial for the manufacturing of special chips for cell phones.
Philips immediately notified the two largest customers —Ericsson LM and Nokia Corporation—both of whom were in the process of launching a new generation of cell phone based on chips produced in the Albuquerque plant. In the original message, Philips estimated a one-week delay in the supply of chips.
Nokia was not unduly perturbed by the news, but just to be safe, placed the affected chip on a “special watch” that called for daily discussions between Nokia and Philips engineers. Nokia discovered very quickly that it would take several months to bring the Albuquerque plant back to full production, causing the company to miss the launch of its new-generation cell phones. At that point, Nokia sprang into action pressing Philips to find an alternative supply from its other fabs around the world and looked for alternative suppliers and paid them extra for quick setup, testing, and expedited production.
In sharp contrast to Nokia, Ericsson did not place a lot of importance on the event, knowing that one-week delays in supply chains are routine and that the company had enough stock to cover the gap. By the time they realized the true impact of the fire and the magnitude of the shortage it was too late. When Ericsson finally asked Phillips for help, Phillips couldn’t provide it because Nokia had already commandeered all of their spare capacity. When the company turned to other suppliers, they realized they had not developed alternate suppliers for the specific chip design that came from the New Mexico plant. The end result was that Ericsson bore the brunt of the disruption, and came up millions of chips short of what it needed for a key new generation of cell phone product. At the end of the first disruption-impacted quarter, Ericsson reported losses of $340 million before taxes, and then a staggering $2.34 billion loss for the financial year. In January 2001, Ericsson announced that it would no longer manufacture handsets and outsourced all of its manufacturing to Flextronics Inc. Three months later, in April 2001 the company signed a deal with Sony to create a 50-50 ownership joint venture to design, manufacture, and market handsets.
Thus, the fire in New Mexico and the response to its impact managed to do what years of intense competition could not: one of Nokia’s major competitors was eliminated from the marketplace. Within six months of the fire, Nokia’s year-over-year share of the handset market increased from 27 to 30 percent.
Although both Ericsson and Nokia had been hit by the same disruption, one recovered while the other had to give up significant parts of its business. This example illustrates the importance of risk management planning and its implementation as a supply chain management issue rather than strictly a comapny wide problem. Every link in the supply chain depends on its suppliers, logistics providers, brokers, port operators, and many other facilitators to get parts to plants and distribute products to customers. A serious business interruption can happen, not only because one of the company’s own facilities, distribution channels, or workforce is disrupted, but also when an element in its supply chain, its business ecosystem, is disrupted. Repairing the damage to the Philips plant cost about $40 million, mostly covered by insurance. The damage to Ericsson—the loss of its handset manufacturing business—was orders of magnitude larger.
Adapted from “Building a Resilient Organization” by Yossi Sheffi published in the National Academy of Engineering publications, Volume 37, Number 1 - Spring 2007.
A methodology for developing a risk management plan will be presented in the next post.