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September 28, 2011

Managing Supply Chain Risk

Supply chain risk management expert Daniel Stengl writes, "After a major disruption there are many firms [that] severely suffer and take a long time to fully recover. On the other side of the spectrum there are a few companies that continue to satisfy their customers demand, and thus use these capabilities to retain and acquire new customers in the process." ["Robust Strategies for Mitigating Disruptions," Supply Chain Risk Management, 25 May 2011] The focus of Stengl's post is a paper written by Professor Christopher Tang, the Edward W. Carter Chair in Business Administration at UCLA's Anderson School of Management, entitled "Robust strategies for mitigating supply chain disruptions" [International Journal of Logistics: Research and Applications, March 2006]. Stengl writes:

"Tang defines 'robust' strategies as those which fulfill two objectives at once:

  • Help reducing costs or improve customer satisfaction during times without a disruption,
  • Support the firm during and after a disruption in continuing operations.

"The goal therefore is to create a win-win situation where the investment into the strategy can pay off no matter if a disruption occurs or not."

Tang obviously believes that such win-win strategies are possible; but, he is baffled by the fact that so many "firms perceive serious supply chain risk, yet do not take commensurable actions." Tang points to several studies that conclude that a large percentage of corporations with supply chain vulnerabilities fail to adequately address those vulnerabilities. He continues:

"While the exact reasons are not known, [James B. Rice, Jr., and Federico Caniato] and [George A. Zsidisin, Alex Panelli and Rebecca Upton] made the following conjectures:

"• Firms underestimate the risk in the absence of accurate supply chain risk assessment.

"• Firms are not familiar with ways to manage supply chain risks.

"• With inaccurate estimates of the probability that a major disruption would occur, many firms find it difficult to perform cost/benefit or return on investment analysis to justify certain risk reduction programmes or contingency plans.

"All of the three reasons are plausible, but I speculate that the last reason is most probable."

Tang offers three cases of companies with resilient supply chains that implemented his win-win strategy. He writes:

"Essentially, an established robust supply chain strategy would enable a firm to deploy the associated contingency plans efficiently and effectively when facing a disruption. Therefore, having a robust supply chain strategy could make a firm become more resilient. Three case studies reported in the literature are the following.

"(1) Nokia changed product configurations in the nick of time to meet customer demand during a supply disruption. Both Ericsson and Nokia were facing a shortage of a critical cellular phone component (radio frequency chips) after a key supplier in New Mexico (Philips's semiconductor plant) caught fire during March 2000. Ericsson was slow in reacting to this crisis and lost 400 million euros in sales. In contrast, Nokia had the foresight to design their mobile phones based on the modular product design concept and to source their chips from multiple suppliers. After learning about Philips's supply disruption, Nokia responded immediately by reconfiguring the design of their basic phones so that the modified phones could accept slightly different chips from Philips's other plants and other suppliers. Consequently, Nokia satisfied customer demand smoothly and obtained a stronger market position. ...

"(2) Li and Fung changed its supply plan in a flash to meet customer demand during a currency crisis. When the Indonesian Rupiah devalued by more than 50% in 1997, many Indonesian suppliers were unable to pay for the imported components or materials and, hence, were unable to produce the finished items for their US customers. This event sent a shock wave to many US customers who had outsourced their manufacturing operations to Indonesia. In contrast, The Limited and Warner Bros. continued to receive their shipments of clothes and toys from their Indonesian suppliers without noticing any problem during the currency crisis in Indonesia. They were unaffected because they had outsourced their sourcing and production operations to Li and Fung (www.lifung.com), the largest trading company in Hong Kong for durable goods such as textiles and toys. Instead of passing the problems back to their US customers, Li and Fung shifted some production to other suppliers in Asia and provided financial assistance such as line of credit, loans, etc. to those affected suppliers in Indonesia to ensure that their US customers would receive their orders as planned. With a supply network of 4,000 suppliers throughout Asia, Li and Fung were able to serve their customers in a cost-effective and time-efficient manner. Despite the economic crisis in Asia, this special capability enabled Li and Fung to earn its reputation in Asia and enjoy continuous growth in sales from 5 billion to 17 billion Hong Kong dollars from 1993 to 1999. ...

"(3) Dell changed its pricing strategy just in time to satisfy customers during supply shortage. After an earthquake hit Taiwan in 1999, several Taiwanese factories informed Apple and Dell that they were unable to deliver computer components for a few weeks. When Apple faced component shortages for its iBook and G4 computers, Apple encountered major complaints from customers after trying to convince its customers to accept a slower version of G4 computers. In contrast, Dell's customers continued to receive Dell computers without even noticing any component shortage problem. Instead of alerting their customers regarding shortages of certain components, Dell offered special price incentives to entice their online customers to buy computers that utilised components from other countries. The capability to influence customer choice enabled Dell to improve its earnings in 1999 by 41% even during a supply crunch."

Obviously, having a resilient supply chain isn't the only key to success. Nokia, for example, in the years following its disruption coup, has struggled to maintain market share. Nevertheless the strategies used by each of the companies highlighted above demonstrate how resiliency is a plus during both good times and bad. Tang writes, "The common theme of these three companies is that they have established different robust supply chain strategies." He explains:

"Essentially, supply chain issues can be classified into two major groups: supply management and demand management. Supply management issues include supplier selection, supplier relationship, supply planning, transportation and logistics, etc. while demand management issues include new product introduction, product line management, demand planning, product pricing and promotion planning, etc."

Tang goes on to "describe nine different robust supply chain strategies that aim to improve a firm's capability to manage supply and/or demand better under normal circumstances and to enhance a firm's capability to sustain its operations when a major disruption hits." Tang summarizes "the key features of these nine robust supply chain strategies" in the following table (click to enlarge).

Strategies for mitigating supply chain disruptions

For a more complete description of these strategies, you can click on the provided link and read the paper in its entirety. Stengl writes that there are "challenges which have to be considered before implementing the strategies." Three of those challenges are:

  1. "Cost versus benefits -- These strategies probably make it easier to justify the investments due to their positive effects with or without disruptions; nonetheless, there is still a tradeoff which has to be analyzed. Tang suggest[s] [that companies] think of the remaining cost surplus as insurance premium.

  2. "Strategic fit -- Not every strategy may fit for every company. For example Dell's pricing strategy might be adaptable for airline tickets but not for heavy machinery with a new quote every day.

  3. "Proactive execution -- Proactive strategies (e.g., rerouting of shipments after a port strike) can be better than reactive strategies (e.g., increasing stocks)."

In his conclusion, Stengl writes, "I am missing some clearer description of the ways to generate these strategies. Also, there is no consideration of the completeness of this listing. So I have to assume that it is probably a good starting point."

John Westerveld notes that disasters are not the only risks facing supply chains. He agrees that disasters are "cause for concern" and "that supply chain professionals should have mitigation plans in place to address" them. He goes on to write, "But risks can take other forms, and these risks can be just as devastating to a company's bottom line." ["Natural disasters aren't the only risks in town," The 21st Century Supply Chain, 22 July 2011] He writes that he read about a company that "survived the chaos and upheaval of Hurricane Katrina, only to fall victim to other risks." He goes on to detail those other risks:

  • "Rapid growth – Rapid growth sounds like a great situation to be in, and it can be. But it can also cause significant problems. Companies have growing pains just like people do and processes that worked before can become problematic with higher volumes. Suppliers might not be able to grow at the same pace you are and qualified people might not be available to meet hiring demand.

  • "Expanded and new facilities – New facilities are really systems wrapped in a building and like any system there can be problems getting things working. As you bring new facilities on-line or as you renovate and expand existing facilities, you need to plan for potential start-up issues.

  • "Increased and changing product range – Things can be simple when we have one or two products but as the product offering grows, complexity grows with it. Care must be taken when adding new products not to kill demand for existing products, at least until supply has been whittled away. Apple is a master at this – when a new product is coming, even before it is announced, supply starts to dry up for existing products so that as Apple transitions to the new product, they reduce the risk that they will be left with large quantities of the outgoing product.

  • "New, large (and more demanding) customers – New customers are wonderful. Large customers, even better! But… there can be a downside. Maybe others have noticed this little truism – the larger the customer, the more demanding the customer. They want what they want, when they want it. And because this customer now makes up a healthy portion of a company’s revenues, the incentive is there to make sure these customers are satisfied. The risk is that if you have successfully ramped the company to meet this demand and the customer subsequently leaves, you are left with significant excess capacity and expense.

  • "Changes to the supplier base – Suppliers come and go. As the supplier base changes, so does the performance characteristics of your supply base. Quality, on-time delivery performance, lead times, costs, all impact profitability.

  • "Changes to IT systems – This can be a killer. IT systems are often the brains of the operation. If the brains aren’t working, not a lot of stuff can get done. Companies are often lured into huge projects to overhaul and replace their systems. If done right, the change can be quite beneficial. If done incorrectly, the results can be disastrous, sometimes leading to litigation."

Westerveld directs his readers to an article by Mark Humphlett, director of enterprise resource planning product marketing at Infor. In that article, Humphlett writes that "savvy supply-chain chiefs who strengthen the agility and resilience of their supply channels [will] first answer several key questions." ["Manufacturers Must Brace for Global Supply Chain Uncertainty and Risk," IndustryWeek, 31 May 2011] I agree with Humphlett that good answers result from asking good questions. The questions that Humphlett believes need to be answered include:

  • "Have the key sources of risk been identified and their impact assessed?
  • "Have we built a supply chain that can absorb the disruptions?
  • "Is risk management viewed as a one-off exercise, initiated after an unexpected event occurs, or are employees actively building risk mitigation into their everyday activities?"
  • I have noted in a number of previous posts that identifying every possible source of disruption is impossible and, therefore, a waste of time. The best place to start is by identifying critical processes and assets and then assessing their vulnerabilities. Plans must then be made to address those vulnerabilities. Humphlett indicates that supply chain executives must "also develop a plan that can be turned into a competitive weapon allowing them to take an unplanned event and turn it into an opportunity." On that point, he agrees completely with Professor Tang. He offers his own "strategies for doing just that":

    • "Develop networks that endure potential upheavals.

    • "Software tools and other technologies are available to analyze the sources of risk for your company. In the process, they can help determine where and when to make, buy, store, and move products through your networks. These tools help to evaluate different sourcing, production, transportation and inventory strategies to match changes in the business environment, such as the impact of supply disruption, single sourcing versus dual sourcing and alternate parts, for example. Companies can then make use of their assets most effectively, trim costs, reduce inventory levels, and improve customer service.

    • "Employ advanced supply-chain tools to assess all risks."

    It's easy to recommend the development of networks that can survive upheavals, but it is much more challenging to actually put them in place. The more complex the supply chain is the more difficult that task becomes. Humphlett does offer a few recommendations for how that can be done. He writes:

    "Companies should construct various what-if situations and test them extensively. For instance, determine how the company would cope with, say, a three-month disruption in supply of a critical part or product. You can assess where you can obtain supplies from different vendors, and at what cost. You can figure out how much the changes could affect costs and profits and customer deliveries. These and other real-life scenarios can be tested in advance allowing you to make contingency plans."

    This is a recommendation I heartily endorse (see my post entitled Examining the "What Ifs" in Life). His next recommendation is to view risk holistically. He writes:

    "Establish a companywide business process that takes risk into account. Ensure the process assesses the risks and the impact to your supply chain. Involving your sales, operations and financial units in this strategic planning process will help identify and flesh out the issues. Using a comprehensive sales and operations planning process involves more than simply demand-supply balancing because it takes into consideration alternative demand-supply situations as well as their effect on profit margins and sales."

    As I've written in the past, "Segmenting risk management rather than addressing it holistically is like trying to keep water out of a boat filled with holes." Risk management cannot be a siloed business activity. Humphlett's next recommendation continues with that theme.

    "Include risk identification into your operations. Managers should recognize what potential sources of risk could impact their part of the business and identify new ones that emerge. Risk management should be as pervasive as your quality management or your sustainability strategy. Otherwise, the assessment of risk will fail to deal with those sources of risk where the impact may prove the highest."

    His final recommendation involves doing something more about risk mitigation than just thinking about it. He believes that companies should be pro-active.

    "Developing sound risk-mitigation strategies will help you build an agile supply chain. These strategies can deliver a huge competitive benefit and greatly diminish your supply chain risk. You should consider all the potential sources of risk to a supply chain and what to do should an unplanned event occur is no easy task. But, it's the only way to mitigate risk proactively rather than after the fact. And today's software tools and other technology make the evaluation and execution process much easier."

    Westerveld writes, "If you were to pick one [of these strategies] that you absolutely must implement, it would be to build risk management into all aspects of your business. Make risk assessment and mitigation a key part of your decision making process. A good place to start would be to add risk assessment and mitigation to your monthly S&OP process. What better place to ensure that all teams are thinking in terms of what risks exist and how best to manage them?" I couldn't agree more.

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