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Why the mad migration of parts for your iPhone matters

A Thai policeman stands guard helping to direct traffic through flooded Bangkok streets Wednesday, Oct. 26, 2011. Hundreds of factories are closed as the flood waters began to reach Bangkok. Paula Bronstein/Getty Images

Paula Bronstein/Getty Images

Much of Thailand is under water. In March, Japan's east coast was battered by the most devastating tsunami in 1,000 years. These are, above all, human tragedies. At least 366 people have already died in Thailand. In Japan, some 20,000 people are dead or missing. But as well as the fragility of human life, the disasters have revealed something rather more prosaic: the vulnerability and astonishing complexity of the global supply chain.

This week, Mazda, Toyota and Toshiba became the latest in a long list of international companies, mostly Japanese, to extend production shutdowns at flooded Thai factories. Honda's Thai assembly plant, where it churns out nearly 250,000 cars a year, or 5 per cent of its global output, has been shut since Oct. 4. Disruption goes well beyond simple assembly. Asia's extraordinarily complex supply chain means materials cross multiple borders on their way to the store.

There's a revealing story in Gordon Mathews' Ghetto at the Center of the World, a book about Chunking Mansions, the doss-house-cum-trading hub in Hong Kong. In one example of low-end globalization, Australian opals are shipped, via Chunking Mansions, to southern China where they are polished, sent back to Australia and sold as souvenirs to Chinese tourists.

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If something as straightforward as an opal can make such a circuitous journey, imagine what goes on with sophisticated electronics. Apple's gadgets, such as the iPad and iPhone, are produced in southern China in a factory owned by Taiwan's Hon Hai. But inside each shiny product are dozens of components made in Japan, Taiwan, South Korea, the U.S. and Europe. These wing their way around the world like deranged migratory birds.

At its best, this complexity serves to raise the quality and bring down the cost of each part, and hence that of the final product, by ensuring it is made in the best location. But such a tangled chain is prone to strain, particularly when it is paired with the just-in-time practices pioneered by Japan. Just as banks sought to become more profitable by reducing their capital to an absolute minimum, so companies seek to cut their inventory to a minimum.

It takes a crisis for the inner workings of the supply chain to come to light. Before the March tsunami, even most Japanese were unaware that the Tohoku region produced anything other than rice and fish. It turned out that several essential components were made there, including 40 per cent of the world's microcontrollers at a factory owned by Renesas. These days, few cars can run without at least 50 of these "little brains." When the Renesas plant was knocked out, car production was temporarily halted in several factories around the world.

Japanese companies did a remarkable job at getting Renesas and others back up and running. Yet the disruption has unsettled buyers. Daiki Takeyama, technology analyst at Goldman Sachs in Tokyo, says customers are pressing Japanese suppliers to move some production out of Japan. That would make the supply chain even more complex.

Thai floods are also having a disruptive effect. Honda Motor stopped production in Malaysia due to a lack of parts from Thailand. The computer industry is braced for a shortage of hard-disk drives after Thai factories were flooded.

The floods have washed up a third revelation. Almost nothing could be made these days without Asian parts. Greg Sutch of Intralink, a U.K. technology consultancy, says U.S. and European manufacturers would struggle to match Asian producers of some parts, even if they wanted to. He cites capacitors and connectors, without which much of the modern world would grind to a halt.

Ippei Takeda, chief executive officer of Nichicon, a Kyoto-based supplier of capacitors, recently told me that to produce an aluminum capacitor you need to make holes one micron deep in a sheet of aluminum 100 microns thick. One should imagine, he said, drilling 300,000 holes into a grain of Japanese rice, flipping it over and then doing the same on the other side. The point is that it's not easy to make sophisticated components. The barriers to entry are high. Specialization means that, once manufacturing has gone to Asia, it is very hard for U.S. or European manufacturers to claw back.

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That could have important long-term implications. Apple is rightly lauded for outsmarting Sony, the Japanese electronics pioneer that was unable to make the imaginative leap from analog Walkman to digital MP3 player. Yet Apple could not make its products without the Asian components nestled inside. South Korea's Samsung, for example, supplies the microchips that run the iPad and iPhone. Yet the two are also competitors – as well as legal sparring partners – following the launch of Samsung's Galaxy smart phone and Galaxy Tab. The Galaxy phone, in particular, has outperformed expectations, grabbing 10 per cent of the global smart phone market. Taiwan's HTC, too, has done well. Even Chinese manufacturers ZTE and Huawei are making inroads into the handset market using Google's Android software.

Many Asian manufacturers simply make components. But some that supply parts to their branded competitors aspire to inventing the next breakthrough device. It's certainly not easy. But so long as Asian companies are making many of the components inside everything we use, even Apple cannot relax.

Copyright The Financial Times Ltd. All rights reserved.

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