Wall Street Journal
October 24, 2001

Companies Are Seeing Efficiencies Erode
As Security Worries Drag on Productivity
By GREG IP
 

Shortly after the Sept. 11 terrorist attacks, Toyota Motor Corp. came within 15 hours of halting production of its Sequoia sport-utility vehicle in Princeton, Ind. One of its suppliers was waiting for steering sensors normally imported by plane from Germany, but the planes weren't flying.

Toyota, so committed to holding down inventory costs that it has no parts warehouses at its Indiana plant, has since asked suppliers to make doubly sure that they receive their own components on time. In response, Toyota supplier Continental Teves Inc. now plans to get the German-made sensor shipped by ocean instead of air and to store enough in the U.S. to last two weeks, rather than one.

That will raise inventory costs for the Continental AG unit, and it isn't clear yet whether the supplier will be able to pass along some of the burden to Toyota. But James Gill, a spokesman for Continental Teves, says: "Cost is not the question. It's keeping the customer happy and making them feel comfortable."

While the short-term economic damage of Sept. 11 is clear -- layoffs, grounded airplanes, half-empty hotels -- some more-subtle effects could last longer. In recent years, businesses have used information technology to trim costly redundancies and buffers ranging from extra inventory to backup staff. Computers made many businesses more predictable, productive and profitable.

The terrorist attacks threaten to undo some of that progress. "What the events of Sept. 11 did was to introduce a whole new set of uncertainties, which information technology is not going to improve our insight into," Federal Reserve Chairman Alan Greenspan told Congress last week. "And so it is a reversal of some of the forces which engendered the productivity acceleration of the last five years."

"Just-in-time" production -- which involves delivery of parts to the assembly line at the moment they are needed -- was one of those forces. It allowed efficiency pioneer Toyota, of Japan, and manufacturers that imitated it, to carry fewer spare parts and to correct part defects before piles of bad components ended up on warehouse shelves. Between 1990 and 2000, U.S. manufacturers' inventories dropped from those needed for 50 days of production to 40 days. Now, in light of post-Sept. 11 experiences with interrupted supplies, "I hear people wondering whether they have gone too far," says John Taylor, who teaches business logistics at Wayne State University in Detroit.

Keeping bigger inventories requires companies to lay out money sooner to pay for the ingredients of their products. In addition, the longer inventories are kept on hand, the more likely they are to suffer damage, become obsolete or spoil. Maintaining warehouses costs money, as does moving parts around within them.

'Need to Get Smarter'

That is why Toyota has no plans to build its own warehouses in the U.S. Just-in-time is "at the heart of our whole production philosophy," says company spokeswoman Barbara McDaniel. But she adds that "we as a company probably need to get smarter" about making sure suppliers don't run into problems like the one that almost halted SUV production in Indiana.

In ways that are only beginning to surface, Sept. 11 could add friction to an economy that had been discovering new ways to eliminate it. Many businesses are now spending more heavily on security and insurance. Others are investing more in expensive backup sites and contingency plans.

Morgan Stanley, realizing the vulnerabilities of what once seemed like a sound disaster plan, now intends to disperse its workers more widely, says Steve Van Wyk, chief information officer for the financial company's individual-investor group. "No one realized a disaster of such magnitude would happen, so everyone felt a few blocks might have been enough for people to spread out and have backups," he adds. "I don't think a few blocks are going to cut it any more."
 
During the Gulf War in 1991, Mr. Van Wyk's group, then Dean Witter Reynolds Inc. -- which merged with Morgan Stanley in 1997 -- began building a backup location for 300 employees several blocks north of its World Trade Center headquarters, which was home to roughly 2,600 of its workers. After the Trade Center bombing in 1993, the backup facility was expanded to accommodate 900.

On Sept. 11, employees began regrouping there after the attacks, exactly as planned. But then the workers were forced out, as authorities evacuated much of downtown Manhattan. Morgan Stanley, which has its headquarters in midtown, now plans to spread its employees permanently among more locations in the New York City area.

Maintaining multiple locations isn't just potentially costly. It can interfere with the day-to-day interaction among employees that promotes productivity. "In the past, we didn't have to worry about specifically where somebody sat," says Mr. Van Wyk. An employee who needed to talk to someone in another department could just walk over. That is harder to do if the employees are in different neighborhoods.

Morgan Stanley plans to conduct more video conferences, and, in some instances, formal meetings will replace the conversations that used to occur in hallways and cafeterias. As workers are shuffled to new locations, the company hopes that mixing elements of departments previously kept separate -- such as information technology and operations -- could actually improve cooperation and the quality of service, Mr. Van Wyk adds.

Already, heightened security and related delays are raising the cost of transporting goods. It used to take Smith Carriers Inc. of Fairfield, N.J., two hours to deliver a photocopier to an office building in Manhattan. With added security at bridges, tunnels and customers' buildings, that has stretched to four or five hours, says Gregory Smith, the company's president. Drivers spend extra time inspecting truck interiors and undersides for suspicious objects or tampering. The company is installing new high-intensity lights at its terminal. It is contemplating buying costly alarm systems for each truck and a surveillance camera for the terminal.

Consumer Will Pay More

"Unfortunately, the end user, the consumer, is going to get hit with some of the expense," from these changes, Mr. Smith says. He recently tacked an extra $50 to $100 onto the $250 to $375 he used to charge to deliver a photocopier.

Delays at the border with Canada -- the nation's largest trade partner -- have slowed many industries' supply chains. In the days immediately following Sept. 11, those delays extended to 18 hours, compared with an average wait of only 15 minutes before the attacks.

Although the border slowdown now has subsided to only a few hours, it has prompted Lear Corp., a big auto supplier based in Southfield, Mich., "to rethink how we do things," says Bob Denning, the company's director of global transportation. One Lear factory that makes seats for General Motors Corp. pickup trucks has arranged to get seat parts from some of its own Canadian suppliers several hours earlier to compensate for the border delays. Mr. Denning says the amount of additional inventory has been "minor." But he doesn't expect factories that depend on parts from Canada to be able to operate with as little inventory as they could before Sept. 11 anytime soon, if ever.

Some businesses for now are resisting adding any inventory, in spite of disruptions suffered after Sept. 11. Crompton Corp., a chemical company in Greenwich, Conn., saw shipments it receives of an explosive chemical temporarily suspended by railroads after the U.S. began bombing Afghanistan earlier this month. But Thomas Mignanelli, director of asset management, says the company isn't planning to store more of that chemical.

"The cost is not just inventory, but in storage, which can be expensive," Mr. Mignanelli says. "You have to build new tanks or rent rail cars and tankers and let them sit on your property. Plus some of these [chemicals] may have shelf lives." He adds, however, that "at some point in time, we might change if circumstances become far worse."

Other companies have done the rethinking and are adding redundancy that previously seemed too costly to them. Before Sept., 11, the contingency plan at Aronson+Partners, a Philadelphia money manager with 23 employees, consisted of sending backup tapes home every night with key staffers. In the event of a disaster, managing partner Theodore Aronson would run the firm, which manages $5 billion, from his library at home.

Expensive Options

This summer, Mr. Aronson says, he investigated the cost of building a full-scale backup site, with computers and work stations where his staff could move if a disaster shut down their offices. He received estimates from consultants of $500,000 in upfront costs, plus $300,000 a year in operating costs. Mr. Aronson didn't think the potential benefit was worth the price. "We never believed all these systems would work as well as advertised," he says.

But the Sept. 11 attacks proved "that the impossible, never-could-occur event, can occur," he says. "It just reminded you that you have to swallow the cynicism and have a backup plan." Another source of pressure: His customers now are asking more frequently about the firm's disaster planning, he says.

So, in coming months, Mr. Aronson says, he will choose a contingency site in a nearby suburb, although he hopes to spend less than what the consultants proposed.

There aren't reliable historic benchmarks for how much added security will cost private enterprises and subtract from economic growth. Some expenditures will fuel economic activity. The security-guard business should boom. But this type of spending won't add to overall productivity, economists say.

Expenditures to improve Americans' safety are "socially productive but economically unproductive," says Gail Fosler, chief economist of the Conference Board, a business-research group in New York. She compares outlays for security to spending on government-mandated pollution controls in the 1970s. "In the end, we were all the better for [the antipollution spending]," she says. "But it is not productivity-enhancing."

Before Sept. 11, no more than 20% of the multitenant commercial buildings across the country managed by Cushman & Wakefield Inc. had access restrictions, says Laurence Conlon, who is in charge of beefing up security for the company. He expects that proportion to climb to 50% as property owners take steps to protect against terrorism threats.

It won't be cheap. The owner of a one-million-square-foot building in midtown Manhattan that Cushman manages recently has closed some entrances and restricted deliveries to tenant offices. The owner also added a security desk with guards who check visitors' bags in what was once an open lobby. The price tag: $200,000 a year, says Mr. Conlon, who declines to identify the building.

Safer Buildings

To boost security further, the same property owner plans to install a computerized access-control system, which matches employees' identities to digitally stored photos; intrusion alarms at strategic places in the building; a cutting-edge video-surveillance system and bomb-detection and X-ray equipment for its messenger center, Mr. Conlon says. The cost of the additional upgrades, including consulting fees, is expected to run as high as $370,000, with another $50,000 a year in maintenance.

This type of spending will add substantially to what the private sector already spends on crime prevention. Figures compiled by David Anderson, an economist at Centre College in Danville, Ky., put the pre-Sept. 11 nationwide amount at about $54 billion a year or 0.5% of the gross domestic product. That includes $20 billion for security guards, $5 billion for access-pass systems and $500 million for airport security.

It is harder to demonstrate the benefits of spending to prevent terrorism, than, say, shoplifting. The latter can be measured from month to month. "But when you have these very small probabilities of very bad things happening, like the one-in-a-million chance you open an envelope and it has anthrax in it, your attitude toward risk makes a big difference," Mr. Anderson says. "Because we are particularly averse to activities [such as terrorism] that are well publicized, people will spend a lot more than would otherwise be rational. With this new type of hysteria, we might easily start doubling our expenditures."

Some businesses will sit on their checkbooks for now and take their chances. Jeffrey Vertucci, a manager for DPR Construction, Inc., a global commercial contractor, says constructing a building so that its front wouldn't shear off in a bomb blast, as happened to the Murrah Federal Building in Oklahoma City in 1995, would boost the cost 6% to 7%. While government tenants might be willing to pay that cost, Mr. Vertucci says he hasn't heard from private developers who are. "With the market slowing and space increasing, the last thing they want to do is add 6% or 7% to the cost of a job," he says. If developers tried to pass along such additional costs to tenants, they would "never get it leased," he says.

In some cases, information technology will help defray the costs of preventing terrorism. E-mail and the Internet have reduced the economy's dependence on conventional mail and packages and made it far easier to stay in touch with backup office sites.

And significant security advances could even spur private-sector productivity. The Internet, after all, is an outgrowth of the Cold War defense effort.

Drew Roberston, president of ASI-Transmatch Inc., a transportation consulting firm, says most railroads rely on electronic tags on their cars to track cargo, including hazardous materials. Such systems can keep track of cars as they pass through rail yards, but for the hours in between, railroads typically don't know in real time precisely where their cars are, he says.

Mr. Robertson advocates the creation of a government-sponsored global-positioning system which tracks all rail cars and trucks carrying hazardous materials and shares real-time information among transportation companies, roughly akin to the way the Federal Aviation Administration operates. The cost would be less than $1 billion for rail cars about and $5 billion for trucks, he estimates. But once in place, such a system could be an economic plus.

"It would greatly increase the reliability of the transportation system," he says. "That can mean lower cost, lower production expenses, and less capital expenditure on tank cars and trucks."

-- Jeffrey Ball in Detroit contributed to this article.