Supply Chain Matters provides our February update commentary regarding the global supply chain impacts from the devastating monsoon floods that impacted Thailand in the fall of 2011. Our last early 2012 update in January reflected on the initial quantifiable impacts across industry supply chains. As the period of end of year earnings announcements concludes, we are getting a far more quantifiable picture of the cascading global supply chain impacts as a result of the floods.

We begin with the overall financial impactsAccording to a recent Insurance Journal posting, noted rating agency AM Best indicates that the insurance losses resulting from the floods in Thailand could be considered one of the five costliest insured loss events in the past 31 years.  Thai authorities now estimate that flood damage costs could be up to $15 billion, involving more than 400 manufacturers and households. A study from Aeon Benfield indicates that the amount of structural damage is actually “four times greater than what resulted from Japan’s earthquake and tsunami in March 2011, but only half of the total insured loss due to a low rate of insurance adoption.”  The implication is that many smaller suppliers or manufacturers may have self-insured.  The more sobering news for sourcing and procurement professionals to be concerned about is an indication by Best that the Thai commercial insurance industry “will likely face sharply contracted (coverage) capacity, higher pricing and tighter terms for coverage with the Sian and Japanese reinsurance renewals in April.” The takeaway, in our point-of-view, is that existing suppliers in these regions will probably face significant higher insurance or liability costs by virtue of their location in a disaster-prone region.

From an economic standpoint, the financial impact to the overall economy of Thailand was far larger than expected. That economy contracted at the annual rate of 9 percent in the final quarter of 2011 which is quite significant. According to the National Economic and Social Development Board of Thailand, the manufacturing sector alone declined 23 percent while net exports fell at an annual rate of 6.1 percent compared to a 17.3 growth rate in the previous quarter.  Beyond Thailand, the economy of Japan contracted a worse than expected 2.3 percent in the final quarter of 2011 and government authorities pointed to a strong yen, falling overseas demand and the impacts from the Thailand floods as hampering production and exports.

The financial impact among individual companies has also come to light.  Western Digital, initially the most impacted manufacturer with 60 percent of its global hard disk drive (HDD) manufacturing sourced in Thailand, indicated that in its fiscal second-quarter, earnings fell 36 percent while overall HDD shipments dropped a substantial 45 percent. That volume drop equates to a shipping shortfall of over 52 million hard drives from the year earlier quarter.  Overall revenues were down 20 percent from the previous quarter. The news from Western Digital was generally well received by Wall Street given the dour initial news immediately after the floods. Company officials noted that while manufacturing levels are on the increase, manufacturing capacity levels will not reach pre-flood levels until at least the September quarter, and that supply chain pipeline inventories are not expected to reach normal levels until the first-half of calendar year 2013.  Meanwhile, rival Seagate Technologies Inc. who had far more limited production presence in Thailand reported better than expected earnings, margins and shipments for the quarter ending in December.  Seagate shipped almost twice the volume of Western Digital, 47 million HDD’s in comparison to the 28.5 million for Western. Seagate’s gross margins increased nearly 12 percentage points from a year earlier as limited overall supply chain supply led to higher prices. According to IHS iSuppli, the average selling price for HDD’s increased on average 28 percent in Q4 of 2011 and will only decline slightly in the current quarter. In our January update, we noted reports of pricing spiking as much as 50 to 100 percent at the retail level in Asia.

Moving up the supply chain, computer providers Dell and Hewlett Packard has released each of their latest quarterly earnings with noted admissions to the financial impact from interruption of HDD supply.  Dell’s fourth quarter 2011 results indicated that while revenues rose 2 percent, earnings fell 18 percent. Dell CFO Brian Glidden acknowledged that the flooding in Thailand financially hurt the company during the quarter.  Not only were available hard drives expensive, Dell could not fulfill its desired needs for higher capacity drives. HP announced that for the quarter ending in January, PC related profits were down 31 percent, and server related profits declined 32 percent.  Overall profits declined 31 percent, and HP’s CFO in-turn acknowledged that the HDD shortage hurt both PC and server sales, and that the impact would continue through the first half of this year.  Readers should recall that both of these companies previously downplayed any significant disruption in supply or pricing.  This again brings credence to the concept of whether in times of significant supply chain disruption, it may be better to bring forward the worst and best case impacts, setting appropriate expectations, rather than waiting for the actual results to occur.  In the case of Western Digital, prior announcements of significant impact, followed by better than expected performance, was well received by Wall Street, in spite of not so positive financial news. Apple on the other hand, most likely from its huge influence in volume buying agreements, has publically indicated little supply impact and had stellar financial results in its latest quarter.  Interesting enough, both Western Digital and Seagate are listed suppliers on Apple’s supplier responsibility report.

Moving down the supply chain, a Forbes hosted article penned by semiconductor industry analyst Jim Handy noted the effects of the HDD supply disruption on the other components of global PC and server supply chains.  Handy notes that  about 40 percent of the total semiconductor market is made up of data processing applications, and because limited supplies of HDD restricted PC build schedules, other components such as LCD screens and DRAMS went into oversupply.  He predicts that other PC components will enter oversupply this quarter which will have a negative impact on semiconductor component prices both in the current quarter and perhaps the remainder of the year.  Supply Chain Matters would add that this may also reflect a situation where longer-term volume buying contracts could not be adjusted or that supply chain planners were challenged with maintaining current build plans while hoping for the best in HDD supply.

As more quantitative and other data attributed to this one significant major supply chain disruption becomes ever more visible, the consequences for re-examined strategic sourcing, supply chain risk mitigation and other planning become more obvious in the months to come.

We can all collectively hope for a less disruptive remaining 2012, but that may be wishful thinking.

Bob Ferrari

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