How the volcano eruption exposed the vulnerability of the global supply chain.

Commentary about business and finance.
April 23 2010 2:00 PM

The Ash Economy

How the volcano eruption exposed the vulnerability of the global supply chain.

Volcano in Iceland. Click image to expand.
Iceland

On Monday, April 19, the closing of Cisco Systems' $3.3 billion acquisition of Tandberg, a Norwegian teleconferencing company, served as a product demonstration. Marthin De Beer, Cisco's senior vice president of emerging technologies, whose flight from San Jose, Ca., to Oslo had been canceled, and Tandberg CEO Frederik Halvorsen held a virtual press conference using the merged firms' equipment. As the ash cloud emanating from Iceland wreaked havoc on global business travel, Cisco's Telepresence service (think a very high-end Skype) boomed. Competitor Hewlett-Packard said that one client, a pharmaceutical firm, doubled the use of its videoconferencing service last week.

Thanks to cheap and pervasive information technology, Cisco's Telepresence and its competitors have emerged as a sort of redundant network for business meetings. When face-to-face meetings are impossible, executives can go to a specially equipped conference room, flip a switch, and share bad jokes and boring PowerPoint presentations.

For business, investing in redundancy is a form of insurance. And for those in the business of trading information, this insurance comes relatively cheap. They won't divulge the locations, but most major Wall Street firms have backup trading floors in the Northeast—desks, chairs, and computer equipment that lie fallow. If a manmade or natural crisis shuts down their Manhattan headquarters, workers can show up, flip a few switches, and start trading derivatives. Google says that "every action you take in Gmail [and other programs] is simultaneously replicated in two data centers at once." If one fails, the user won't experience a disruption. A company spokesman says Google has put a lot of thought into the "geographic diversification" of data center site selections, so that if one area of the globe is affected by a disaster, traffic can be routed to another. And with the rise of cloud computing, everyone can have a redundant computer network. Backing up data used to mean keeping an external hard drive on the desk next to the PC—a move that doesn't provide much insurance if the house is flooded. Now, a host of services offer companies and individuals the ability to store data off-site. If a house burns down in New Jersey, a homeowner would still be able to gain access to the contents of her hard drive, which may be stored in a data center in Iceland.

But as the global economy learned last week, it's much harder—and in some instances, simply impossible—to build redundancy into the vital networks that move people, goods, and services around the globe. In fact, the same technology-abetted forces that have spurred globalization, heightened connectedness, and reduced inefficiency have left the global economy particularly susceptible to disruptions.

The International Air Travel Association reported that airlines lost $1.7 billion because of the volcanic shutdowns in Europe. But disrupted business travel and tourism (my own family vacation to Paris was buried in volcanic ash) are only the tip of the iceberg.

A century ago, even 30 years ago, an eruption from Iceland wouldn't have affected menus in Florence or auto assembly in Tennessee. But things have changed. The just-in-time mentality dictates that factories and retailers build superefficient, lengthy supply chains and keep as little capital and warehouse space as possible tied up in inventory. Globalization has meant that companies now source components and products from all over the world. The upshot: When there's a small disruption anywhere, the machinery of global capitalism slows down. And when there's a disruption in Europe, look out. The slow-growing region is a highly globalized economic powerhouse. "Europe is the biggest exporter in the world and the second biggest importer," said Eric Chaney, chief economist at AXA Group. And while container ships are the workhorses of global trade, plenty of really valuable stuff crosses the Atlantic in airliner cargo bays. By Tuesday, with flights from Europe having been canceled for a few days, the automaker Nissan was suspending some production at its factories in Tennessee and Mississippi. The culprit: a lack of pneumatic sensors made in Ireland.

Natural phenomena have laid bare the fact that the networks that power our economy are both fragile and really expensive to make redundant. Consider electricity. The recent windstorm in the northeastern United States sent homes and offices back to the 19th century for several days. But installing a home generator that can seamlessly pick up the electric load when the utility fails would cost several thousand dollars. Manufacturers can't keep empty, fully equipped factories on standby, with workers on call, in case an epidemic in China halts exports. It would cost too much.

When it comes to transport networks, it's simply impossible to build an adequate level of redundancy. Europe's extensive system of trains and ferries wasn't nearly extensive enough to handle the flood of traffic that materialized when aircraft were grounded. If the Panama Canal were temporarily shut down, goods could be shipped around South America or humped overland across the isthmus—but only at great cost and delay. In theory, flights from the United States to India via London could have been rerouted through airports in Africa. But Dakar Airport in Senegal doesn't have the spare capacity—the runways, the air controllers, the ground crews—that can be maintained and called into action the next time Heathrow shuts down. Airplanes, ships, ports, landing slots at airports, and airports themselves are too valuable and expensive not to be used.

There's hope, though. As Cisco and Tandberg showed, virtual meetings can substitute for face-to-face meetings. And even as atmospheric disturbances disrupt some trading networks, they may open new ones. Thanks to the melting of North Pole ice, European ships are tentatively beginning to forge a new, quicker shipping route from Asia to Europe and North America.

Newsweek's Nick Summers contributed to this story.

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