Disruption of the Supply Web

As floodwaters continue to course through Thailand, claims costs due to business interruption are increasing, as are the complications associated with finding a safe haven for outsourcing in a globalized economy.

Property and casualty insurers around the world have learned in 2011 that there is no such thing as a “safe bet” when it comes to mitigating supply chain risk.

One interesting question presents itself based on the natural disasters occurring in Asia’s manufacturing and technology segments. How many degrees of separation are required before a risk manager can truly be comfortable that his or her enterprise’s business interruption exposures are truly mitigated?

The risk management business often talks about supply “chains,” but a web is probably a more appropriate metaphor for describing how business operations are interconnected in the world today. A disruption in just one nodal point of a web can fracture any number of interconnected threads, which in turn puts pressure on other nodal points of the web. Tears in a web, if serious enough, can undermine the integrity of the entire web.

Why talk about webs? It’s a way to represent interconnectedness. Facebook claims that we are all even more closely connected now than the traditional six degrees of separation. That ‘six degrees’ theory says any two people on this earth are on average separated by no more than six intermediate connections. Facebook says we’re now down to 4.74 degrees of separation, which admittedly doesn’t quite have the same cache. But the point is, we are all more closely interconnected than ever; events in one part of the world are more likely than ever to affect the integrity of business operations elsewhere.

In business terms, this means an extra layer (or two) of caution may be required when assessing the impact of natural catastrophes on local business operations. Gone are the days when a risk analysis of one country suggests building manufacturing redundancies in another country, and thus the matter is closed – problem solved. Risks must be analyzed in a relational fashion now, not in isolation from one another. Risks in Thailand cannot be viewed in isolation of risks in Japan.

For example, after an earthquake and tsunami rocked Tohoku, Japan in March 2011, damaging the facilities of a number of key manufacturers in the auto and electronic industries, Japanese manufacturers shifted gears and moved some of their operations to Thailand to mitigate business interruption. In any other year, that probably would have been a sound business strategy. But in 2011, global insurers have seen a non-stop parade of catastrophic events. And so wouldn’t you know that after Japan’s largest recorded earthquake, Thailand has been hit with its biggest flood in decades. To date, more than $4 billion in insurance claims have already been filed as a result of the Thailand floods, A.M. Best reports, “mostly by businesses located in the submerged industrial complexes.” Thailand’s Industry Minister estimates flood damage to almost 10,000 affected factories at $25.6 billion.

Of course there isn’t a 100% foolproof place in the world to send your business operations when Fortune deals a bad hand. But this illustrates how the operative instinct should be to make sure a company’s ‘Plan B’ for mitigating risk also incorporates a ‘Plan C’ alternative (which may, in turn, require a ‘Plan D’ option, just in case). 

In other words, when planning for a disaster, one should be casting one’s net a little wider, so to speak, factoring what happens when the nearest safe havens are not as safe as you might have thought. In other words, add in another layer or two of separation.

Like it or not, we are connected to one another in this world much more closely than we think. An analysis of business interruption risk should reflect these multi-layered connections.