Auto Supply Chain Broken By Japan Woes

tdp2664
InvestorPlace
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.