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Creating the Optimal Supply Chain – Review (Flexibility in the Face of Disaster: Managing the Risk of Supply Chain Disruption)

In the continuing review of the report titled – Creating the Optimal Supply Chain published by experts from Wharton and BCG, I took a look at the section titled – Flexibility in the Face of Disaster: Managing the Risk of Supply Chain Disruption in this post. In earlier posts, I had reviewed the first two sections namely, You Can’t Manage What You Can’t Measure’: Maximizing Supply Chain Value and Avoiding the Cost of Inefficiency: Coordination and Collaboration in Supply Chain Management. The report – Creating the Optimal Supply Chain is available online as well.
Supply Chain disruption is making headlines in recent times because of events that occurred in recent months past such as terrorist strikes, hurricane Katrina and the longshoremen strike at the US West coast ports. I must reiterate again, that the macro picture against which such supply chain disruptions might occur is the globalized, outsourcing/offshoring manufacturing/procurement business world. That implies that while the world’s resources and manpower is at a firm’s disposal, more or less, so also are the world’s problems – in a global supply chain, the disruptions even though occurring locally might have multiplied effects far beyond the locally known or observed effects. Also, those effects might not even be noticed by those decision makers who sit far removed from the means of procurement or production and the first intimation of the crisis might be at the supply level by which time it might be far too late.
The authors state,

Today’s leaner, just-in-time globalized supply chains are more vulnerable than ever before to natural and man-made disasters — a reality that creates greater demands on companies to keep supply chains flexible and integrate disruption risk management into every facet of supply chain operations.

That’s just way off-base. Today’s globalized supply chains, whether or not they are just in time, cannot be in any sense leaner than before. Given the fact that lead times have increased in a globalized world through outsourcing/offshoring, inventories have gone up in every stage of the supply chain – so how have globalized supply chains become leaner? But it is also true that exposing one’s lines of supply (just as in the case of war strategy) globally, the risks of disruptions have also increased. Now, the question has to be asked, was it worthwhile to have gone the route of globalization in procurement/manufacturing on the basis of per unit cost without taking into account the total costs of procurement that are involved for the supply chain?

Paul Kleindorfer, one of the authors of the report, notes

“Disruption risk has received increasing attention in the last few years,” Kleindorfer, co-director of Wharton’s Risk Management & Decision Processes Center, wrote in a recently published paper, “Managing Disruption Risks in Supply Chains.” “The reason is undoubtedly that, with longer paths and shorter clock speeds, there are more opportunities for disruption and a smaller margin for error if a disruption takes place.”

And further,

Given the high stakes, experts from BCG and Wharton generally agree that managing supply chain disruptions revolves around two goals: first, to thoroughly understand the potential of identified risks; and second, to increase the capacity of the supply chain – within reasonable limits – to sustain and absorb disruption without serious impact.

Without reading any further, the words above imply more inventory to be maintained in addition to any other measures that address identified risks. So in a globalized world, one is faced with the real need not only for increased inventory in the supply chain because of larger lead times but also to mitigate the risks of disruption. Suddenly, the whole idea of globalization, of offshoring and of outsourcing doesn’t seem as compelling but one can only make such a judgement if one could actually come up with an estimate of the total costs of local operations vs. global operations.
So what are the main sources of risk for the supply chain?

Kleindorfer has identified three main categories as the primary sources of supply chain disruption risk: operational contingencies, which include equipment malfunctions and systemic failures, abrupt discontinuity of supply (when a main supplier goes out of business), bankruptcy, fraud, or labor strikes; natural hazards such as earthquakes, hurricanes, storms; and terrorism or political instability.

Now, in all fairness, when globalization was all the rage in the decade of the nineties (and anti-globalization as well, where have all the protesters gone? Have they become the supply chain managers of today?), everybody was enjoying the peace dividends that followed the end of the cold war, the heady days of the internet fueled boom etc. Today, to put it succintly, things are different – our pespectives have been realigned for us whether we wanted it or not.
So how should supply chain practitioners approach the notion of handling supply chain risks and uncertainties?

At the Wharton Risk Management & Decision Processes Center, supply chain experts and industry leaders have over the last decade developed a multistep approach to disruption risk management. It addresses ways to help companies identify vulnerabilities, and includes the following four initial steps:

  • “Obtain senior management understanding and approval, and set up organizational responsibilities for managing the disruption risk management process.
  • Identify key processes that are likely to be affected by disruptions and characterize the facilities, assets and human populations that may be affected. Key processes typically include new product development, supply chain operations, and manufacturing. Key assets include both tangible assets (property and inventory) as well as intangible assets (brand image, public perceptions).
  • Traditional risk management is then undertaken for each key process to identify vulnerabilities, triggers for these vulnerabilities, likelihood of occurrence, and mitigation and risk transfer activities. This is the heart of the traditional industrial risk management process for disruption risks.
  • Reporting, periodic auditing, management and legal reviews of implementation plans and ongoing results (e.g., of near-miss management and other disruption risks) complete the business process for disruption risk management. The audit process is essential to providing on going feedback to management and supply chain participants on the performance of their facilities and their compliance with agreed, supply-chain wide standards.”

By taking these four steps, Kleindorfer argued, a company defines its own “risk architecture – which is a way of looking at the world that allows you not to be generally worried all the time.”

I think all of the above steps are great ideas but as elaborated by the authors but the initial steps. What seems to be the main thread in the above steps is the outline of a true feedback system put in place to mitigate supply chain risks i.e. setting up processes that quantify and then address issues that might pose problems for the supply chain and then through reporting and periodic auditing to ensure ongoing compliance.

The authors refer to a real world example of how disruptions to a supply chain can be handled well through risk management techniques. The example centers around the responses of Nokia, Ericsson and Phillips during a fire at a Phillips manufacturing plant in Alburqueque, NM.

When the fire wiped out the plant, both companies instantly lost a key link in their supply chains. As reported in Business Week:
“Nokia’s response was two-fold. The company immediately created an executive-led ‘strike team’ that pressured Philips to dedicate other plants to making the RFCs that Nokia needed. Nokia engineers also quickly re-designed the RFCs so that the company’s other suppliers in Japan and the United States could produce them.” The plan worked: “Through quick action, Nokia was able to meet its production goals, and even boost its market share from 27% to 30% – a level more than two times that of its nearest rival.”
“Ericsson, however, reacted much more slowly. The company did not become aware of the supply problems for weeks, by which time its ability to meet customer demand had been seriously compromised. And because Ericsson relied exclusively on the Albuquerque plant for the RFCs, Ericsson – unlike Nokia – found itself with nowhere else to turn for these vital components. Ericsson posted a nearly $1.7 billion loss for the year, and ultimately had to outsource its cellular handset manufacturing business to another firm.”

The differences might be striking but overall it seems to be a function of information – whether it is available to decisions makers or not. Putting up risk management processes in place might facilitate the parsing of information quickly within the organization and the firm is able to assess the impact of disruptive events on their supply chain activities.
Hau L. Lee’s Harvard Business Review (HBR) article on “The Triple-A Supply Chain” argues that,

…supply chains can no longer afford to be merely fast and cost-effective, author Hau L. Lee argued that “great companies create supply chains that respond to sudden and unexpected changes” by building “Triple-A” supply chains that are agile, adaptable and aligned.

Dr. Lee’s prescription of agile, adaptable and aligned supply chains are elaborated below:
Agile supply chains:

Agile supply chains “respond quickly to sudden changes in supply or demand.” What methods can companies use to incorporate agility in supply chains? “Continuously provide supply chain partners with data on changes in supply and demand so they can respond promptly; collaborate with suppliers and customers to redesign processes, components, and products in ways that give you a head start over rivals; finish products only when you have accurate information on customer preferences; keep a small inventory of inexpensive, non-bulky product component to prevent manufacturing delays.”

Adaptable supply chains:

Adaptable supply chains “adjust supply chain design to accommodate market changes.” Methods to use? “Track economic changes, especially in developing countries; use intermediaries to find reliable vendors in unfamiliar parts of the world; create flexibility by ensuring that different products use the same components and production processes; create different supply chains for different product lines, to optimize capabilities for each.”

Aligned supply chains:

Aligned supply chains “establish incentives for supply chain partners to improve performance of the entire chain.” Methods to use? “Provide all partners with equal access to forecasts, sales data and plans; clarify partners’ roles and responsibilities to avoid conflict; redefine partnership terms to share risks, costs and rewards for improving supply chain performance; align incentives so that players maximize overall chain performance while also maximizing their returns from the partnership.”

I think Dr. Lee’s recommendations for Tripe-A supply chains are spot on but this agility, adaptability and aligned supply chains in a global context is a beast to manage and that realization is becoming abundantly clear. Going forward, I am sure that further research is going to delve into firm size and other similar characteristics that might have an impact on the ability of firms to become Triple-A supply chain certified.
But here is some anecdotal confirmation of what I have always thought is happening when it comes to global supply chains – specifically the total cost of the global supply chain.

But, Young cautions, “you can only have time and money to build in so much systems’ redundancy.” Because building in redundancy isn’t cheap. In a recently published newspaper article, BCG’s Stalk and Young wrote that offshore operations often expect and therefore plan for the unexpected by “building redundancy into the system, and probably back home. If such redundancy is included in the initial ‘cost advantage’ calculation, the company may find it will take 2 to 2 1/2 years to recoup all the start-up costs associated with offshore sourcing and manufacturing.”

While it is true that the longer term trend is towards globalization, the right way to approach the notion of globalization in my opinion is to globalize manufacturing or procurement with the idea of addressing foreign markets in the medium to longer term. If it can take as much as 2 – 2 1/2 years to recoup start up costs and the increased inventory across the supply chain as well as the attendant risks of obsolescense and not having the right products in the right place at the right time are part of ongoing costs or missed opportunity costs, then in a period of increased disruptions due to terrorism or natural events, the very idea of global manufacturing and procurement might be in jeopardy.
The real story about risk management according to BCG’s Matthesen is only that you’ve to be comparitively better than your competitors at adopting risk management into your operations,

Matthesen allows that the essence of risk management boils down to adequately appreciating the risks that a company is exposed to for different areas of business; identifying the ‘choke points’ along the supply chain that would completely harm a business if disruption occurred; and then taking the right set of preventative measures to allow for some protection, remembering to periodically review your supply chain plans and risk assessment priorities.

However, there is a crucial assumption there. Firms within an industry are likely to be affected alike by disruptions if they’re structured or designed alike. Perhaps, the larger that a business gets, a common structure is often observed because of a convergence of supply chain design choices and constraints that drive such decision making. As far as recommendations go, it is a reasonable one but is it a wise one? The answer to that question lies in the hindsight that one will have developed after the next disruption. As far as truly uncertain events go, they do have a role in shaping the competitive landscape in the kind and severity of constraints that such events impose on global supply chains. In my opinion, the question is not so much whether you’ve prepared for every and any uncertain event but whether you have set up within your organization the processes, experience, skillset and processes of handling such events if and when they do happen. And it is a question of when and not if.

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Category: Logistics, Reviews, Strategy, Supply Chain Management


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October 2006