Global Warming Is Real and Has Consequences – Part II

Climate-change naysayers claim that shifting from fossil fuels to alternative energies is unnecessary or too costly for economies. Yet, the cost of climate change is clearly evident. Manufacturers are considering moving from Thailand and other countries threatened by flooding and other forces related to climate change, according to Pavin Chachavalpongpun, associate professor at the Centre for Southeast Asian Studies, Kyoto University, in the second and final article of this two-part YaleGlobal series. The 2011 floods disrupted operations at 250 foreign factories in Thailand and led to price hikes of hard drives, auto parts and other electronics worldwide. Concern about climate change could spur new production and supply-chain strategies: increasing inventories, diversifying plant locations, placing locations close to market and avoiding locales prone to flooding or other climate conditions that could disrupt manufacturing. Before the massive floods, “Thailand was an attractive investment destination in the first place, with a well-developed infrastructure, a free-enterprise economy, generally pro-investment policies and strong export industries,” Pavin notes. Thai politicians compounded the disruptions by refusing to cooperate on policies to prevent flooding. So in selecting factory locations, investors and businesses could seek competitive advantage and avoid countries with climate woes and political infighting. – YaleGlobal

Global Warming Is Real and Has Consequences – Part II

Trying to dodge fallout of climate change, firms reorganize supply-chain networks in Thailand and beyond
Pavin Chachavalpongpun
Friday, April 6, 2012

Flood brings hardship and hard disk woes: Workers abandoned flooded Western Digital’s hard disk factory in Thailand (top); Thailand's Prime Minister Yingluck Shinawatra distributes food to stranded residents

SINGAPORE: As the monsoon season approaches Thailand, farmers are not alone in watching the rolling clouds, but also factory owners and workers. Unlike the farmers who hope for the rains to flood seedling plots, workers worry that devastating floods might follow and drown factories. The floods of 2011 inundated 250 factories, putting 200,000 people out of work and disrupting global supply chains of electronics and auto parts. As the Thai government readies plans to fight floods, foreign manufacturers aren’t taking chances, reorganizing supply-chain networks and looking for alternative sites for production.

In retrospect, 26 of the 90 provinces in Thailand were seriously affected by a sheer amount of floodwaters. Many automotive-assembly plants and parts-maker factories for Honda, Toyota, Isuzu, Nissan and Ford, situated in and around Ayutthaya and Pathum Thani provinces, suffered greatly from the destructive floods, with severe effects on the world’s automotive markets. Automotive production in Thailand has certainly been affected in the near term due to the shortage of auto parts as a result of the floods, with no apparent medium- or long-term effect on the country as an automotive production hub in the region.

Almost 10 percent of total auto parts for local production come from the country’s flood-affected regions. Toyota, Auto Alliance Thailand, Mitsubishi Motors, Nissan all depend on auto-part makers in this particular region. Frost & Sullivan, ID, reports that some of the factors likely to be considered by original equipment manufacturers in the future include increasing the stockpile in terms of auto parts and revisiting the process of just-in time production.

A new production model would entail exploring a multi-sourcing strategy that involves not only sourcing parts from different suppliers but from different regions as well – a climatic de-risking of the supply chain with original-equipment manufacturers investing in geographic locations least impacted due to natural disasters. For example, Toyota recently announced its plan to build its second production plants in Karawang, West Java, Indonesia, which has had a good record for being a climate-safe area. Meanwhile, as part of diversifying its production bases by not relying on Southeast Asian plants alone, Toyota will also expand its North American production facilities to make the cars it needs for export.

Manufacturers could be losing confidence in Thailand or any other locale struggling to cope with the challenges of climate change.

Meanwhile, flooding in Thailand also forced the increase of the cost of traditional computer hard drives, at least the in short term, because manufacturers struggled to work around shuttered plants and suppliers. Hard drives were in relatively short supply throughout the end of 2011 and into 2012. This has already impacted the availability and pricing of everything from notebook and desktop computers to media players, set-top units for cable television and stand-alone hard drives.  

As analysts have anticipated, reduced supply coupled with high capital expenditures, as a result of the floods, has meant that hard-drive prices have gone up, already engendering ripple effects across the industry. Computer makers were supply-constrained and could not make as many systems as they thought they could sell. Thus, they had no choice but to raise prices on the computers they could make to meet revenue goals. For example, if limits on hard-drive availability meant a computer maker could only make about 85 percent of the number of systems originally planned. Prices for those systems would have to be 11 to 25 percent higher for the manufacturers to maintain the same level of revenue and keep their investors happy. But that was before factoring in increases in hard-drive prices. Already, hard-drive costs have increased 10 percent, driving up prices for low-margin products as much as 20 percent. While not immediately noticeable, the price range of a notebook computer has increased since last year, due to costs and revenue pressure from supply constraints.

Although the floodwaters have receded, it does not mean that hard-drive makers and component manufacturers could just walk back into their fabrication plants, flip a switch and get back to work. Some facilities remained offline as companies repaired and replaced expensive manufacturing and process equipment. This meant that hard-drive shortages continued after the floodwaters receded, and manufacturers incurred significant costs to get back online.

As for the impact on foreign direct investment, according to the recent report of the World Bank, estimated damage to Thailand’s manufacturing base is about US$13 billion in terms of assets destroyed and US$22.75 billion in production loss. While short-term FDI in Thailand may be aided by the rebuilding effort at damaged plants, investor confidence will probably suffer in the medium to long term.

Investors are likely to revisit their manufacturing footprint and take into account the risk of floods and other natural disasters in Thailand. As a result, existing operations in Thailand may be scaled back or eliminated altogether and new investments curtailed, especially if there are other attractive destinations in the region such as Malaysia and Vietnam. But this must not overlook the fact that Thailand was an attractive investment destination in the first place, with a well-developed infrastructure, a free-enterprise economy, generally pro-investment policies and strong export industries.

To regain investor confidence, Thailand, under the leadership of Prime Minister Yingluck Shinawatra, has proposed spending US$4.2 billion on reconstruction and steps to prevent future floods. She has sought to reassure investors that Thailand would remain a safe place for business, as leading Japanese companies including Honda Motor and Toyota Motor have scrapped profit forecasts after the floods and shut factories in Thailand. In fact, Yingluck even paid a visit to Japan in early March with the key objective to boost investor confidence in Thailand and, in particular, show off concrete plans toward managing floodwaters should the problem reoccur.

It might be too little too late for the Yingluck government to control damages. Declaring her visit to Japan a success, Yingluck ignored reports that some big Japanese companies may want to spend more to build factories in Thailand’s neighbors, including Indonesia and Vietnam, after the Thai floods disrupted production. Honda Chief Financial Officer Fumihiko Ike said that his companies hoped the Thai government would improve infrastructure, including water-drainage systems. However, the company is planning on flexibility in managing factories in neighboring nations. Honda has acknowledged the need to reconsider diversifying investment not only inside Thailand to avoid flood-prone areas, but other locations, too.

Meanwhile, Takahiro Sekido, chief Japan economist at Credit Agricole CIB in Tokyo, said: “Executives recognise the concentration risk after the floods. The recent trend of accelerating investment into Thailand will cool despite the fact that Thailand was such an ideal destination.”

After all, the concerns among foreign investors are not only on nature’s damaging floods, but also the “political floods,” with various actors in Thai politics exploiting the disaster to undermine opponents, thus delaying necessary cooperation and the speediest solution to the problem.

 

Pavin Chachavalpongpun is an associate professor at the Centre for Southeast Asian Studies, Kyoto University.

Copyright © 2012 Yale Center for the Study of Globalization

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