Automakers and their direct parts suppliers are fast discovering that in the
tightly choreographed dance of so-called just-in-time manufacturing, the supply
chain is only as strong as its weakest link. More than a month after the
devastating earthquake and tsunami that hit northeastern Japan and crippled four
nuclear reactors, vehicle manufacturers and their suppliers are just beginning
to get a handle on the disaster's true impact on their operations. Toyota
(NYSE: TM ), Honda (NYSE: HMC ) and Nissan (Nasdaq: NSANY ) already have had to
close plants in Japan and many are operating at half capacity. Toyota has
warned its dealers of vehicle shortages this summer. Ford (NYSE: F ) and
General Motors (NYSE: GM ) have slowed production and taken some plants
temporarily off line to save parts. Ford has warned that its earnings will take
a hit over the supply chain disruptions. GM has formed a crisis team to identify
at-risk parts and try to locate replacements. That will be tricky. Today's
vehicles contain 20,000-to-30, 000 parts, most of them tightly customized to
specific vehicles. Since automakers' cut the number of suppliers in half to
reduce cost and complexity during the recession, there's no quick fix when
things go awry. Direct (or Tier 1) suppliers like Autoliv (NYSE: ALV ), TRW
Automotive (NYSE: TRW ), Johnson Controls (NYSE: JCI ), Magna (NYSE: MGA ) and
BorgWarner (NYSE: BWA ) deliver engines, transmissions or other large components
directly to vehicle manufacturers. Shares of these companies have fallen an
average of 8% since March 11. Tier 1 suppliers are as vulnerable to the problems
in Japan as are vehicle manufacturers because they rely on their own lower-tier
suppliers for parts to build those components. And if any of those suppliers
has a problem delivering parts, the direct supplier can't build the component
– and the automaker can't produce the car. One example is Japan-based
Renesas Electronics, which produces more than 40% of the semiconductors that the
global auto industry uses to control engines and other systems. When the
company's main factory was damaged in the initial earthquake, production went
offline. Although Renesas had almost two months worth of inventory on hand, any
prolonged shutdown would disrupt the entire automotive food chain, forcing their
Tier 1 suppliers to shut down, too. And exposure to Japan is significant for
North American parts suppliers. In a survey of its members late last month,
the Original Equipment Suppliers Association found that 78% of respondents had
some form of part or material that originates in Japan; 63% said their Japanese
suppliers had not yet confirmed that they could meet delivery schedules. As a
result, nearly half of the companies surveyed had already reduced production and
more than 65% of the remaining companies expect to cut production in the next
month. Still, direct suppliers are responding quickly to the crisis. Autoliv
is extending its airbag and seatbelt plant in southern China and Johnson
Controls is raising the price of its lead-acid batteries. Automakers aren't
sitting on the sidelines either: GM is investing $100 million in a New York
parts plant. Bottom Line: There likely will be enough disruption in the supply
chain in the first half of 2011 to hit the earnings of auto manufacturers and
their direct suppliers. The Japan disaster has revealed a yawning gulf in the
JIT manufacturing strategy part of which gained fame in the auto industry as
"The Toyota Way". The concept of lean inventories and tight coordination
with suppliers is great until there is significant disruption in the supply
chain. One thing is certain: the industry will be forced to rethink and revise
how it does business. Manufacturers will develop contingency plans, add back
more suppliers and expand inventories. But to auto manufacturers and their
direct suppliers, it may feel more like closing the barn door after the horse
has not only bolted, but is heading into the stretch at Pimlico.
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