Last year, Toyota Motor Corp. effectively turned a sterling reputation for producing high-quality automobiles and a loyal customer base into a brand  associated with defective cars and failure to inform owners of life-threatening flaws with accelerators and brakes.

Now Toyota has stumbled again.

This time, the Japanese automaker is running out of parts, forcing plant shutdowns around the world despite its famously reliable and efficient production processes. How is this possible?

Start with the obvious: the massive March 11 earthquake off the coast of Japan, that resulted in a huge tsunami striking the country and awful pictures filling television screens around the world. A large swath of the nation was devastated. Worst was the crippled Fukushima Daiichi nuclear power plant, but death, destruction, and disruption temporarily brought much of the country to a standstill.

With its renowned resourcefulness, Japan is returning to normality. Yet the havoc inflicted will continue to impede the public and private sectors' ability to function. Toyota, among the Japanese-based companies that have been severely affected, will continue to struggle for months to come. The company reports that although its 17 plants in Japan were relatively undamaged, its factories there have been operating only at half capacity; its overseas operations are running at a 40 percent capacity. The domestic production schedule is expected to remain as is for some months, while production in North America will soon be reduced by 75 percent. The situation is so bad that the company anticipates that it will not be able to get back to full production until the end of this year.

How could such a massive problem occur, especially when the company's manufacturing plants in Japan didn't have much damage and the overseas plants weren't involved in the disaster at all? One would think Toyota recognized the risks of earthquakes and related problems that they could cause. The scope of this natural disaster was extraordinary, yes, but earthquakes are well known in Japan. Even Toyota's executive vice president in charge of production has referred to Japan as a "quake-prone country."

Where Was the Risk Management?

Toyota has succeeded in many areas, among them its highly respected just-in-time inventory system. The system is designed to keep investment in inventories low, providing parts and assemblies to the production line as needed. It seems to have been working extremely well—until now. The company says it faces shortages of 150 parts, many of them specialty products that meet the company's exacting specifications. And with damage to its supplier base, the parts simply aren't available as needed.

If you ask anyone involved in manufacturing—from the CEO right down to plant managers and workers on the production line—they will readily say that the last thing they want to see, or expect, is a production shut-down due to lack of parts. For that reason companies have well-established plans for obtaining needed resources from a range of sources, both physically disbursed and spread among suppliers.

Why does it so often occur that actions are taken by companies after they suffer a major blow, rather than anticipating what could happen and taking relevant actions to mitigate the risk?

Even manufacturers that forge a long-term partnership with one specific supplier have a “Plan B” in case the primary supplier for some reason is unable to provide what's needed. That's not to say there will never be disruptions, especially where parts such as micro-controllers customized to particular automobile models are involved. But one would expect, depending on risks and costs, disruptions should be short-lived without causing long-term production shut downs. Toyota's competitors, by the way, seem to be doing better, with Honda's CEO reportedly saying in early April he hoped production will return to normal “within a few months” and Nissan's COO saying in late March that he expected full production within “weeks, not months.”

Another Toyota executive vice president reportedly said the company is now planning to review its centralized parts sourcing, including determining whether it can use more commonly available parts, and will reassess its dependence on single-source suppliers in Japan. Interestingly, he added: “Even in cases where we thought we had more than one supplier, it turned out in many cases that [those suppliers] procured sub-components from just one firm … We're also looking to increase local procurement overseas as we discovered a high reliance on Japanese-made sub-components.”

All of this makes eminent sense but begs the question: Why wasn't this done long before the devastating natural disaster hit? Why does it so often occur that actions are taken by companies after they suffer a major blow, rather than anticipating what could happen and taking relevant actions to mitigate the risk?

To be fair, one could ask whether this is one of the “black swan” events, like those assessed by financial companies in their value-at-risk models and now the subject of broader risk management discussions—a highly unlikely event that could have a severe effect on a company. The answer lies in the likelihood that an earthquake and tsunami could cause serious damage to the company's supply chain. Seismologists and other scientists are better equipped to provide that information, although it would appear that the chance of such disasters is higher than many took into account in whatever they were doing to identify and manage risks to supply chains. 

A Troubling Pattern in Dealing With Risk

As we look back over Toyota's problems—first with production quality and compliance failings, and then not having enough parts to maintain production schedules—one wonders whether any relationship exists between the two. One would need to be inside the company to know with certainty, and we're looking in from the outside based on media reports. With that said, it's difficult to believe there isn't a common problem here.

Looking at business objectives, among the most critical to an auto manufacturer are: maintaining a high level of quality, especially concerning the safety of the company's cars; acting in a way that provides consumers with confidence that the business complies with all regulatory standards; and ensuring supply chains provide needed parts on a timely basis to the production process.

With these objectives, an effective risk-management process would identify what events or circumstances could occur to obstruct the achievement of those objectives, then analyze those risks, and finally determine appropriate responses to mitigate them. Yes, a cost-benefit relationship must be weighed, and it can be challenging to determine where to draw the line in expenditures to manage low-likelihood risks. This gets down to the company's overall risk appetite, and its tolerances in specific risk areas.

It's hard to imagine that Toyota's shareholders, and presumably its board, would accept a risk appetite so high where the company could produce cars that seen as being unsafe, hide information from regulators, and have to slow production to a crawl due to lack of parts.

A Lesson That Must Be Learned

For regular readers of my columns, you'll see a consistent message on a critical underpinning of effective risk management. Unfortunately for some senior executives and directors, this message needs to be repeated, as too many somehow don't focus on it—or at least, not sufficiently. The message is this: Risk management is not about what has happened, but what could happen.

Certainly past history serves as a basis of what could happen, and should be considered. But beyond that, we must look at what else could be coming down the pike (or perhaps over the seawall) that can create havoc for an organization. A company's success, and in some cases its very survival, can be at stake.