End of the Line

Unfettered globalization is not creating the wealth and global stability its supporters claim. Rather, the new world economic system makes first-world economies more vulnerable to terrorism, war and natural disasters. CIOs have a role to play in protecting these fragile supply chains

A butterfly flapping its wings in the Amazon might have minimal effect on Western production systems, but a 60-second earthquake in Taiwan some years ago almost destroyed the US economy.

We populate a planet where an epidemic in China can imperil America's capacity to assemble automobiles and aeroplanes, and where closure of a single factory in England can deprive Americans of half their nation's supply of flu vaccine.

Corporations have created a global production system so complex, tightly geared and leveraged that a breakdown anywhere can mean a breakdown everywhere, warns Barry C Lynn, author of End of the Line, The Rise and Coming Fall of the Global Corporation.

A war on the Korean peninsula could slash global production of DRAM chips by 50 percent and NAND flash chips by 65 percent, massively disrupting the electronics and other industries. Widespread adoption of offshoring means an uprising in southern India could cost many global companies, including banks, their ability to process information. An avian flu pandemic in industrial Asia could destroy the system the US relies on for medical respiratory masks, among other calamities . . .

In a flat world, an "everyday disaster" far away can heavily disrupt the industrial systems on which nations depend, causing major job losses and stopping production of consumer goods. Worst-case outcomes can be bad - very bad. Lives can be lost and financial systems can collapse.

For these reasons and more, Lynn, a fellow at the New American Foundation in Washington DC and former executive editor of Global Business magazine, says we should be very, very worried. And, he says if CIOs want to vaccinate their own organizations against such disasters, they should be getting very, very busy.

"Our corporations have built the most efficient system of production the world has ever seen, perfectly calibrated to a world in which nothing bad ever happens," Lynn writes. "But that is not the world we live in. Not only is human civilization riven routinely by earthquakes and hurricanes, but so too is it shattered by wars and acts of terror and simple human error. Which means it is only a matter of time until we experience our next industrial crash, perhaps one much worse than any we have yet known."

Just look at his evidence. Lynn's "60-second earthquake" hit Taiwan (the world's number one source of made-to-order advanced semiconductors) in September 1999. The upheaval demolished infrastructure, cut off electricity and caused the deaths of more than 2500 souls on the island. Although the plants manufacturing the chips suffered relatively little damage, factories as far away as California and Texas soon felt the impact. As semiconductor chip supplies stalled, companies like Dell and Hewlett-Packard began shutting down production and sending workers home.

A disaster whose sole impact a decade earlier would have been local threatened to create a major global crisis, with world output of electronics falling 7 percent below predictions in October that year alone. And disruptions continued well into the new year, threatening an economic tsunami for the global economy, Lynn says.

Citing case studies from US multinationals such as Cisco, Dell, FedEx, General Electric, General Motors and Wal-Mart, Lynn shows how cost-cutting and outsourcing have left corporations dangerously exposed to even minor supply chain disruptions.

He also provides perhaps the most complete guide to how IT has remade global industrial systems. And he foresees similar disasters ahead as long as companies continue their "reckless" determination to outsource and move offshore every possible step in the supply chain.

Lynn bolsters his case with plenty of examples. For instance in 1993 a chemical plant explosion in Japan slashed half the world's supply of a resin used to produce computer chips. Within a month the price of memory chips had doubled, driving laptop prices up by $US100. In 2002 a 10-day US West Coast stevedores' strike cost the US economy $US20 billion in lost production, with American factories unable to import parts. And in 2001 the September 11 terrorist attacks shut down air traffic for days and slowed the movement of goods from Mexico and Canada.

Together they show just how closely connected the world now is and just how radically different are the dangers we now face. Lynn says CIOs are not only in the perfect position but also have a supreme responsibility to estimate and address those risks. That means helping their firms understand and keep track in real time of all their sourcing - from tier one suppliers down - and removing vulnerabilities. He does not just mean physical supply chains, either. Organizations must track their process supply chains too, he says. It means pushing executives, boards and even governments to grasp the extreme fragility of the global supply systems.

Lynn says organizations should be able to sit down together to discuss their sourcing strategies and to coordinate their contingency plans.

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Stretched to the Limit

Mention globalization and outsourcing and many people's thoughts turn to job losses or cheap clothing. Lynn argues the impact is more marked.

Our global corporations are stretched to the limit and vulnerable to the slightest disturbances in their global networks. What is worse, determined to cut costs, companies have gone beyond lean and become anorexic, he says.

Globalization really means that many nations share the same means of production. Outsourcing means many firms share the same source of supply. Having two competing suppliers in the same overseas country is really just another form of single sourcing. Put them all together and you get a "world-spanning" system of production that is highly efficient, and extremely fragile. A war, even a regional conflict, could bring the whole house of cards down.

"For individual firms there is a bet going on that there is not going to be conflict, but we have entered an entirely new global production system. We've never run the system at speed before, and we've certainly never run it through a crisis before, and if you look at it carefully you'll see that it won't survive a crisis," he says.

"Now the good thing for the CEO is that basically every single player is in the same boat. There's been such a radical reorganization of the system that every single firm faces pretty much the same risk. If China goes down, if there's a war in Korea for instance, if there is a humungous earthquake in Taiwan, a revolution in South India, every firm pretty much gets hit equally. So in a certain sense in terms of the way firms look at competitive risk, there is no risk. Now to the rest of the society, however, the risk has been hugely increased.

"With increasing frequency, deliveries of oil, computer chips and vital components suffer costly interruptions. A collaborative spirit probably will become the grease that keeps a creaky system from grinding to a halt," he says. "And we will be measuring the value of companies by the resiliency they show in the midst of breakdowns."

Factor in the way the outsourcing revolution has transformed both the hierarchy of power and the capacity of certain firms to keep track of production systems. Stir in the way just-in-time production has erased inventory, led to systematic single sourcing and further aggravated outsourcing. The result is a very different system from how it has operated in the past. The new way of working may be more efficient, but it is also extremely fragile. That fragility would be a problem even in a purely domestic proper context, but globalization, Lynn says, aggravates every fault in the system.

"Time and again, human beings have learned to build buffers into complex systems. We design compartments into our ships, circuit breakers into our electrical networks and minimum reserve requirements for our banks. Yet since the cold war era, we have done the exact opposite with our industrial system," Lynn wrote last year in the Financial Times. "Rather than conceive market-friendly methods to distribute risk and dampen shocks, we devoted ourselves to eliminating the bulkheads that have traditionally existed between nations and between ­companies. To evoke a more raw analogy, in our production system, we bulldozed all the levees flat."

Global corporations rely too much on single-source suppliers and run inventories too lean to be prepared for supplier interruptions. It is this interdependence, once heralded by the drafters of free trade deals as peace inspiring and stabilizing, that threatens the current economic system, Lynn says.

He fears too few organizations have any idea of the extent of their vulnerability. It shocked Dell to learn that key parts of its computers depended on a single supplier in Taiwan, Lynn says. Yet he argues the surprise of Dell executives was in itself hardly surprising. There are now so many layers between an organization and its original suppliers that no one understands the supply chain from the inside out any more.

CIOs to the Rescue

Now, Lynn says, CIOs - viewed as heroes a decade ago - have a chance to regain their former status. "[CIOs] are the ones that can figure out how to make the company really smart in terms of its supply chains," he says. "One thing the CIOs can do is help - in fact it is their duty to help - their firms understand and keep track of all their sourcing in real time. This is the value the CIOs can bring. If they have the ability to do this they should be pushing for it because it's something that no one else necessarily has the ability to bring about."

CIOs also understand networks. They understand how networks operate and the need for redundancies and multiple pathways for information. They routinely deal with systems that have failed because of a failure somewhere in the system. As long as they can get their heads around the real differences between physical and virtual networks, Lynn says, they can make an invaluable contribution. Physical systems are in some ways more fragile than information systems because there are fewer redundancies at the cost level, he says. That is particularly true with the new network models of production that have replaced the old assembly line model.

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"The CIO has some of the insight that can really help the corporation as an entity understand the risks to the system," Lynn says. "But he has to really deeply understand the fact that in the physical system you can't swap in a new plant the way you can a new router when a router goes down. And you can't just throw a switch that routes your information through a different place in the same way you can do with chips. So the CIOs have to make the leap to understanding the difference between the physical world of production and their world of moving information around. But once they understand the difference, their insight could be of great use to the firm as a whole and society as a whole."

In looking for supply chain vulnerabilities it is no good just identifying your tier one suppliers. The CIO should ensure the company can track as many suppliers at all levels as possible. And he or she should brace for some shocks in doing so. For instance, after the Taiwanese earthquake Dell Computer discovered it had been "whacked" in weird ways. Within two days of the quake, for some reason, tier one suppliers in Malaysia had cut off the flow of goods to the organization.

"Dell then went out to i2 Technologies in 2001 and asked for an off-the-shelf package that would allow it to track everything back - everything, down to the littlest screw," Lynn says. "And i2 said: 'No way, that is just not possible'. So Dell went and working off an IT platform developed internally their own system that allowed them to take it as far down as they could, which was at least tier four.

"One of the things they found - they were very honest - they said: 'You know, we were just shocked to find out that we were sourcing hundreds of millions of dollars of product from one company with which we did not even have a relationship'. The company was TSMC - Taiwan Semiconductor Manufacturing Corporation."

That insight led to genuine practical gains. The next year Dell cut a deal with TSMC to supply the same product cheaper.

"They were able to see there was a supplier over whom they had the ability to apply pressure. So that's a practical outcome. It's not a good outcome from TSMC's point of view but it was a good outcome for Dell, which was a good reason for them to spend quite a bit of money on having their CIO help their manufacturing people figure out the whole system.

"In some cases your suppliers won't be honest, they won't tell you the truth, they will try to hide facts, but if you have the power to force the suppliers to do it, you will at least be able to see where your problems are, at a minimum. You may even pay for the process by finding certain places where you can apply pressure to certain suppliers to get some deals."

You should dump suppliers that will not share information with your company, Lynn says.

Bullish Behaviour

Lynn also wants CIOs to get more "bullish" in their behaviour. They should, he says, be pushing their CEOs and boards to understand their supply chains, physical and process.

The modern CEO is not the old CEO, he points out. Modern CEOs often come out of sales or finance, and have little if any understanding of the structure of their firms. When the board or CEO resolves to source business services to southern India, it is the CIO who must question whether there are contingency plans in place should southern India go offline.

But ideally, once boards and CEOs understand the extreme fragility of the system, they will start lobbying governments to play a role in shoring it up and reducing the risks.

Lynn says that although Dell Computer CEO Michael Dell understood the value of the information he gleaned from studying his supply chains, he made no effort to use that information to lessen his political risk. "A good corporate citizen might have gone to Washington and said: 'Gosh guys, you know what? If there actually were to be conflict I would be crushed'," Lynn says.

"CIOs need to lobby their boards to get the resources to understand the system so the boards and the CEOs in tandem with the CIOs can work with government and say there are risks here that never existed before, and that we cannot control - they're beyond our ability."

Many Heads Better Than One

Speaking of sharing, Lynn thinks it is time corporations lobbied for a rethink of competition rules that restrict oligopolies from talking to one another. Such entities do share information, he says, but quietly and unofficially. Yet these entities do not dare to sit down with one another to discuss sourcing strategies and contingency plans. In that sense, the competition between these firms is happening at the wrong levels, he says.

"If you're working on a contingency plan, you have to coordinate your contingency plans across industry levels."

The best model for such collaboration is the way CIOs got together and worked with government to draw up best practices and reasonable approaches to ensuring security of the Internet, he says. The outcome is fair to all players, is not excessively expensive and gives all organizations access to best practices.

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"The Japanese are very good about this - they compete in certain areas and in some they cooperate. In our country we use to have trade associations," Lynn says. "This is something that we have conveniently forgotten - that back in the 1920s, Herbert Hoover before he became president was the major mover and shaker within the trade association/chamber of commerce movement in this country, which would bring together all these firms so that they could talk to each other.

"They would coordinate what they needed government to do, so it's not something that's entirely unheard of. It's been done before; it's done in other countries. In these cases it makes sense for people, because one thing that firms have realized is, you know what, the contingency plans don't work. It's musical chairs."

Lynn points out that if a breakdown disrupts a supplier with 20 customers, it might end up with the capacity to service just three of those customers temporarily. The other 17 companies will be "screwed". Look at contingency plans that way and you realize that many of them actually count for very little. Such recognition can transform the way people imagine risk.

"If the boards realized that the contingency plans were not worth the paper that they were written on, then it would change how the boards deal with this. It would change the dynamic between the private sector and the public sector because ultimately there is a limit to what any firm can do about this. Ultimately the problem here is a failure of governance; that government here has not set simple, clear market rules that would enable the private sector to operate their machines, operate their systems in ways that are safe for the firm and safe for society."

Trade utopians love to argue that global interdependence forces nations to behave peacefully. Nonsense, Lynn says. Instead it can lead to conflict. That is just a fact of life. "Now we can all wish, and hope and pray, but it will happen at some point. There will be some kind of conflict; whether it's hot or cold it's just hard to tell," he says.

"To the extent that a firm has the power within the marketplace as now shaped to diversify its sourcing, it should do so. There may be a lot of cases in which firms don't have that power. In that case they should go complain to the government and say: 'Hey there is nothing I can do about this but I just put not only my company but the society that relies on me at risk'."

However, above all else, Lynn says, they should consider their sourcing vulnerabilities with cool, clear eyes, and take all steps to eliminate them.