Tuning out supply chain risk

Could a typhoon in Manila affect what teenagers in Minneapolis find in their Christmas stockings? I sure think so.

A lot of high-tech gadgets are made in the Philippine Islands, including parts of Apple Computer's iPod music player. Apple depends on that Philippine link in its supply chain: in the last quarter (July through September), Apple sold almost 9 million iPods, an average just under 100,000 per day.

Last month, I reviewed the contingency planning at a Philippines factory that assembles 1.8-inch disk drives that go into iPods. I'll call the factory "Pod Parts".

Pod Parts is located in Laguna Technopark ("LTI"), about 50 kilometers (30 miles) south of the capital city of Manila. LTI is a joint venture of Ayala Land Inc., Mitsubishi Corporation and Kawasaki Steel Corporation (now called JFE Steel). LTI is a duty-free export zone, operated by the Philippine Economic Zone Authority (PEZA) and occupied by 84 manufacturers, many of them large and Japanese-owned.

Pod Parts ships 20,000+ disk drives each day from this factory. It employs 6,000 people and runs 24 hours a day. To give you a sense of the human logistics involved, Pod Parts contracts a fleet of 80 buses to bring those employees to and from work. Most employees don't own cars.

In my review, I discovered that Pod Parts has only one factory making iPod disk drives--this one in the Philippines. If it were destroyed, it would take months, and several hundred million dollars, to build a new assembly line from scratch for 1.8-inch drives.

I estimate Apple needs at least 50,000 drives a day to make iPods, and probably more, assuming that flash memory iPods don't need disk drives. So I asked Pod Parts about the business impact (on Apple, and on Pod Parts' relationship with Apple) if Pod Parts couldn't deliver those drives.

'Well, they'd get drives from their other supplier', a Pod Parts supervisor told me. He knew that Apple split its disk drive orders between Pod Parts and a competing drive manufacturer. Good risk mitigation, I thought. Where is the competitor's factory located?

Just down the street in Laguna Technopark--about 1 kilometer away.

I later discovered that there are also four other manufacturers in Laguna Technopark that supply Pod Parts with components for disk drives. One of them, Nidec Corporation, supplies spindle motors to both Pod Parts and the competitor.

For manufacturing efficiency, the proximity of these factories to one another is an obvious advantage. Their proximity is, however, a potential risk to the continuity of the supply chain. It's hard to imagine a natural catastrophe that would affect just one manufacturer in LTI; it's likely they'd all be affected at the same time.

Is a calamity likely? Pod Parts has a documented, tested emergency-response system, an active emergency team and a visible, active security force. There is a municipal fire department in LTI. There are fire extinguishers all over the plant. Pod Parts is reasonably prepared ready for a fire or a plant-specific event.

But is a widespread, natural catastrophe likely?

1. The Taal volcano, 30 kilometers (18 miles) from Pod Parts, is one of 16 'Decade Volcanoes' identified as a serious potential hazards to population centers by the International Association of Volcanology and Chemistry of the Earth's Interior (IAVCEI). (Manila is the 6th largest city in the world with a population of 10 million people.) The Taal volcano recorded 29 volcanic earthquakes in one day in September 2006, according to the Philippine Institute of Volcanology and Seismology (PHIVOLCS). The Philippine Islands are in the Pacific Ring of Fire that includes 75 percent of the world's active volcanoes.

2. There were four earthquakes in the Philippines in one weekend this month (21 October 2006), one felt in Laguna that measured 4.7 on the the Richter scale. The Philippines experiences up to 10 earthquakes a day, according to PHILVOLCS.

3. Tropical storms and typhoons are a regular occurrence in the Philippines; this is a list of them in 2006. Just two weeks after my visit, Typhoon Xangsane (means "elephant") killed 80 people in Manila, left as many missing, and blew over so many gigantic billboards that the government is changing regulations to prohibit them.

Typhoon Xangsane also went directly over Laguna (middle of this map). I see that another serious typhoon is headed toward the Philippines, as I write this.

The area around Laguna Technopark is subject to regular flooding from storm water, blocking ingress of people and egress of goods. Pod Parts even sends people home early when a serious storm is forecast, because of the risk that the roads will be impassable.

Pod Parts told me they have about two days of finished product stored on site, waiting for shipment. The drives are just too valuable to keep around in inventory. Construction of an alternative production line is excruciatingly expensive, and would raise the cost of production, putting Pod Parts at a competitive disadvantage to its competitor.

A disruption at Pod Parts' could, in my opinion, have a direct and serious impact on Apple's ability to produce iPods, within about 48 hours of its occurrence.

If that interruption happened just about now (October), I think it could drastically reduce the supply of iPods available at retail for Christmas.

I asked myself during my review if I was just being an alarmist, seeing danger where there is none.

Two weeks later, LTI experienced the most-destructive typhoon in the last decade.