Impacts of Foreign Terrorism on East Coast Supply Chains and its Effects on Global Competitiveness

1. Impacts of Foreign Terrorism on East Coast Supply Chains and its Effects on Global Competitiveness Dr. Richard Lancioni Dr. Hope Jensen Schau Dr. Michael F. Smith Alexander Stein The 6th Annual International Business Research Forum Temple University Saturday, April 2, 2005

2. STUDY OVERVIEW • Background: The events of September 11, 2001 profoundly altered Americans’ sense • of security. The threat of terrorism has become a fact of everyday life, affecting • individual citizens, government organizations and private and public firms. In order to • better understand how U.S. firms are responding to this challenge, Temple University, in • conjunction with the CLM Delaware Valley Roundtable, is conducting a research survey of firms to determine how they are responding to the homeland security challenge in • protecting their supply chain systems. • Study Objectives: • Evaluate the overall effect of the events of 9/11/01 and related subsequent events on • the supply chain functions and activities of U.S. owned public and private firms: • -- security policies and programs • -- cost and profit impact • -- procurement programs and contractor relations • Assess the general perception of supply chain participants concerning regulation: • -- the incidence of responsibility and cost • -- future risks and opportunities

3. PRESENTATION OUTLINE I. Terrorism Impact, Cost and Continuing Risks II. Theoretical Perspectives: -- organizational response to change -- inter-organizational cooperation III. Immediate Effects of 9/11 IV. Shipper Security-Related Issues V. Carrier Security-Related issues VI. Effect of Governmental Policies VII. Summary of Research Findings VIII. Summary of Findings re: Theoretical Framework

4. Business Press IMPACT of SUPPLY CHAIN DISRUPTION • “A bit over a year ago, all the ports on the West Coast were shut for 11 days in a contract dispute with the International Longshore and Warehouse Union. That cut the flow of more than 60% of U.S. imports. Cost to the U.S. economy: by one estimate, $15.6 billion.” • “Two years ago about 98% of containers were offloaded from ships and moved from ports with no more than an examination of documents. Today the percentage is down to around 94%.” • “Disrupt the San Pedro harbor, and you could block the ports of Los Angeles and Long Beach, which handle more than 40% of U.S. container imports.” (Siekman, Industrial Management and Technology, 2004)

5. Business Press INCREASING COSTS of SECURITY • “The Transportation Security Administration has doled out $282 million in grants covering 536 port security-improvement projects over the past two years. But that's not much more than the $256 million it's given to just one airport, Los Angeles International, to improve security.” • “Admiral Thomas Collins, commandant of the Coast Guard, estimates that the U.S. maritime industry will have to spend $1.5 billion in the next year and some $7 billion more over the next decade to comply with the new rules.” • “This year the Coast Guard issued new maritime security rules. One effect is that 10,000 U.S.-flag vessels, some 5,000 maritime facilities, 40 offshore platforms, and all 361 U.S. ports must have new security plans. The rules roughly match international requirements for ports and vessels adopted by 120 nations last year.” (Siekman, Industrial Management and Technology, 2004) • “The U.S. Visitor and Immigrant Status Indicator Technology program, better known as US-VISIT, the border initiative on which the government is spending the most money. Unfortunately, though US-VISIT was launched in 115 airports at the beginning of this year (at a cost of more than $300 million), it won't be in place at all border crossings until the end of 2005.” (Stein, Fortune 2004)

6. Business Press POTENTIAL for TERRORISM • “Monitoring the flow of goods across the border is even more complicated and difficult than monitoring people. Everyone who enters the U.S. is interviewed and his baggage X-rayed. But only 2% of containers get the same level of inspection.” • “Because of the shortage of personnel, more than 2,000 companies that have applied for C-TPAT certification are still waiting for a green light. Of those that have been certified, the government has validated less than 10% of the security claims.” • “So far, 25 of the world's largest seaports have signed on, representing more than 70% of all goods shipped to the U.S.” • “Critics say CSI hasn't yet received the funding and manpower it needs to operate effectively. Of the Department of Homeland Security's $40 billion budget for fiscal year 2005, which begins in September, only $25 million has been allocated to CSI. In comparison, the government plans to spend $9 billion next year on missile defense, despite warnings from the Central Intelligence Agency that an attack on American soil is far more likely to come through a cargo container than a missile.” • “And only about 100 officers are monitoring overseas ports at any given time. That means little inspection actually takes place. In Hong Kong, for example, one of the busiest harbors in the world, eight U.S. customs officers were able to inspect just a fraction of the 19 million containers that left port last year. More troubling, cargo containers typically make numerous stops at ports around the world before arriving in the U.S.; the average one from China makes 17 stops before it gets to its final destination. U.S. officers are not policing all those ports—allowing for many points of vulnerability along the way.” (Stein, Fortune 2004)

7. Theoretical Issues THEORETICAL PERSPECTIVES: PUNCTUATED DISEQUILIBRIUM and ORGANIZATIONAL RESPONSE to CHANGE • Actual short-term post 9/11 implications for supply chain management • Anticipated long-term consequences for supply chain management • Changes in organizational structure: internal value chain dimensions – • Intra-organizational adaptations • Inter-organizational responses • Centralization, communication, coordination

8. Theoretical Issues INTER-ORGANIZATIONAL COOPERATION: A RESPONSE to UNPRECEDENTED NATIONAL EVENTS • Crises create new risks, but also opportunities to create inter-dependencies that result in higher value and reduced long-term risks for all participants. (Benoit, Columbia Journal of World Business 1966) • Joint venturing in times of changing conditions is one way to rapidly improve competencies across multiple otherwise autonomous organizations. (Harrigan, Management Review 1987) • Stressful environmental conditions reduce the legal and proprietorial sanctity of organizational boundaries. One result is a more free information exchange surrounding issues of mutual concern. (Fiol, Administrative Science Quarterly, 1989)

9. Theoretical Issues The EVENTS of 9/11 and INTER-ORGANIZATIONAL TRUST: INCREASING DEPENDENCY on VALUE CHAIN PARTICIPANTS’ COMPETENCE and INTEGRITY • Competence and Integrity are more important trust components than Consistency, Loyalty and Openness. (Gabarro, Interpersonal Behavior: Communications and Understanding in Relationships 1978) • Situational trust in specific others is more critical than global trust in generalized others (Butler, Psychological Reports 1983, Journal of Social Psychology 1986) • “…only the specific components [of trust] predict organizational outcomes.” (Butler, Journal of Management, 1991)

10. Interview Results IMMEDIATE EFFECT of 9/11 Tendency Toward Security Centralization and Oversight: following the events of 9/11, the interviewed firms, including carriers, brokers/consolidators and shippers reviewed their policies and procedures: -- adequacy of security policies and programs -- consistent application of evolving policies -- central oversight of security programs and corporate standards Few Firms Made Drastic Changes: respondents report security program changes have been “evolutionary rather than complete makeovers”– State Government -- expanded training: “We expanded the role of safety managers to include security responsibilities”– Nationwide Shipper -- improved qualification of carriers by their shippers, with due diligence occasionally assigned to brokers/consolidators on a “best effort” basis -- increased preference of some firms to contract directly with closely qualified carriers, particularly in pharmaceuticals, food products and HAZMATS

11. Interview Results IMMEDIATE EFFECT of 9/11 -- Continued 9/11 Exacerbated an Impending Economic Slowdown: -- an estimated 11,000 trucking firms exited the freight industry in 2001-2002 -- higher insurance costs and reduced shipping volumes squeezed small operators -- HAZMAT contracting was particularly hard hit by slowdown Government Policies Not Seen as Onerous: respondents report that government regulation has not been intrusive: -- C-TPAT (pronounced C-T Pat). Its goal is to upgrade protection for an ext. 75% of the arriving cargo, so that inspectors can spend their time looking more closely at the remaining 25%. Participants must warrant that they have a tight security plan in place along the full length of their supply chains -- DOT HM-232 HAZMAT compliance is within normal operating requirements -- risk of government audit is seen as motive to upgrade security capabilities, generally as an extension of safety programs. Since early 2002 about 4,500 companies have indicated they plan to participate. About 2,000 have had security plans approved by U.S. Customs -- shippers and carriers are wary of additional and more drastic government regulation: “Future government programs could be painful. Shippers and carriers are cooperating with the government to avoid further regulation” -- Broker

12. Interview Results SUPPLY CHAIN ROLES and EXPECTATIONS are CHANGING • largely unaffected by • regulation (HM232, etc.) • provide expanded • carrier/warehousing • qualification Brokers/ Consolidators Shippers Carriers • expanded safety • and security programs • employee screening • “hold harmless • provisions” in some • freight contracts • direct contracting • w/shippers • closer qualification • of warehousing • contractors and • carriers • requesting carrier • qualification by • brokers Warehousing • upgraded security • incoming inspections

13. Interview Results SHIPPER SECURITY-RELATED ISSUES Qualification of Carriers is Seen as Priority Issue: -- conduct carrier screening directly or through brokers: -- insurance coverage -- DOT safety record -- HM-232 compliance -- security seals -- incidence of liability negotiated on a case-by-case basis; larger shippers often self-insure -- trust and reliability are held at premium: “Our actions are intended to create confidence in our services.” – Regional Carrier HAZMAT Freight is a Growing Problem: -- fewer carriers will handle HAZMATS; rates are rising annually in double digits -- HAZMAT insurance rates is a major cost concern -- increased regulation is seen as a real possibility

14. Interview Results CARRIER SECURITY-RELATED ISSUES Increasing Difficulties in Meeting Qualification Standards: -- many carriers cannot afford to self-insure; increased withdrawals from HAZMAT -- carrier rates have risen, but margins are still squeezed -- long-term survival depends on safety record and shipper trust Safety and Security are Viewed as Closely Related: -- upgrading training of safety personnel -- safety and security are still largely de-centralized functions -- increased government regulation is a constant risk -- industry organizations provide limited guidance concerning security

15. Interview Results EXISTING GOVERNMENT POLICIES are NOT VIEWED as INTRUSIVE Benefits of Individual Self-Audits (ISA) is Well Recognized: -- limited government security resources are seen as a welcome opportunity to self-regulate: “We comply in part to avoid further regulation.” – Nationwide Shipper -- large shippers are anxious to comply with current regulations HAZMAT Economics are Not a Direct Result of Government Regulation: -- HM-232 regulations are acceptable to most shippers and carriers -- Relatively low rate and high insurance costs are key factors in many carriers’ withdrawal from HAZMATS

16. Interview Results TECHNOLOGY is a POTENTIALLY MAJOR SECURITY AID Growing Use of EDI Solutions Could Improve Security: -- direct exchange of shipment and inventory information for content verification -- reduced personnel involvement with HAZMATS and other sensitive shipments GPS and RFID Tracking of Shipments and Inventory Under- utilized: -- shipment tracking is largely by phone, radio and manual input -- inventory verification from manifest -- newer technology solutions may be beneficial for improving security

17. SUMMARY FINDINGS and CONCLUSIONS 9/11 Indirectly Brought Changes to U.S. Firm Supply Chains: -- accelerated economic slowdown led to carrier shake-out -- shippers gradually centralized some security functions, i.e., planning, policy- setting, and oversight; security operations remain predominantly local -- small carriers are feeling increasingly squeezed, particularly in HAZMATS Shipper-Carrier Relationship is Evolving: -- some shippers prefer to contract directly with carriers, rather than use brokers -- carrier scrutiny and qualification has been expanded, directly or via broker -- incidence of liability is increasingly negotiated between shippers and carriers -- in more risky environment, mutual trust is increasingly important

18. SUMMARY FINDINGS and CONCLUSIONS – Continued Likely Long-Term Economic Effect of 9/11 on Supply Chains is Relatively Small -- 2003-04 economic recovery has stabilized the freight industry -- shippers incurred limited increases in expenses due to heightened security; carrier impact largely due to higher insurance costs -- but supply chains continue to be vulnerable to terrorist “shocks” U.S. Firms Believe They are Effectively Dealing with Heightened Risks -- current programs and practices are seen as adequate -- limited number of industry-wide security practices -- the cost of current programs is not burdensome; limited pass-along to consumers -- few see the need for expanded government regulation

19. STUDY FINDINGS SUPPORT the THEORETICAL FRAMEWORK • Supply chain participants report improved cooperation between and within their ranks in response to the shared crisis of 9/11: • Enhanced information sharing • Risk-sharing, where appropriate • Cooperation with governmental entities • Crisis response: • Centralization within organization • Coordination between organizations • Improved qualification of partnerships • Growing importance of trust