The Risk-Price Trade-off

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On Saturday the NY Times ran a short piece by Thomas Fuller about the floods in Thailand and the impact they are having on global Hard Disk Drive (HDD) availability.(1) The article states that “Before Thailand’s great flood of 2011, companies like Panasonic, JVC and Hitachi produced electronics and computer components that were exported around the world. Now of the 227 factories operating in the zone, only 15 percent have restarted production.” Fuller goes on to note that “Before the floods last year, the concentration of hard-drive manufacturing in Thailand kept prices down because of economies of scale and the proximity of suppliers to one another. But the floods showed how risky this arrangement was.”

The piece makes an interesting point about what is known as “concentration risk,” in this case the concentration of HDD suppliers all operating in one zone, which, when disrupted, exposes the counter-parties to those suppliers to, in this case, significant supply risk. Of course, in SCM, concentration risk often arises for very good reasons.  There are advantages that may be specific to a given area, e.g., lower tax rates for manufacturing activities or preferential access to transport lanes. These advantages often result in lower prices for buyers but at a higher cost (of risk) that is often invisible until moments such as the current situation in Thailand. There is no free lunch, the saying, goes, and that’s the same here. Risk is a cost — sometimes a difficult cost to see or value — but it is a cost nonetheless. Just because one does not have to pay it every day does not mean it does not exist. This cost is visible to HDD consumers at this moment but invisible to many others. It is, therefore, good for SC risk managers to ask themselves what invisible costs they are bearing today and what would happen should those costs, long deferred, should suddenly have to be paid.

(1) http://www.nytimes.com/2012/01/21/business/global/floodwaters-are-gone-but-supply-chain-issues-linger.html?_r=1

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