Supply Chain Risk Management

Stephen DeAngelis

June 03, 2010

A Supply Chain Digest article earlier this year indicated that, when CEOs think about supply chains, “cost cutting and risk management are at top of the agenda” [“How CEOs are Thinking about Supply Chain,” 9 March 2010]. The article indicates that “managing these trade-offs will be key to supply chain success.” It explains:

“What’s on the mind of corporate CEOs when it comes to strategy, the business environment, and the supply chain? … CEOs, not unexpectedly, have many business concerns, a number of them supply chain related. … The following numbers … represent the number of CEOs saying they are extremely or somewhat concerned about a particular threat:

  • Energy Costs: 54% in 2010 versus 50% in 2009
  • Potential Protectionism as a Barrier to Trade: 49% in 2010 versus 39% in 2009
  • Climate Change Issues: 37% in 2010 versus 26% in 2009
  • Scarcity of Commodities: 35% in 2010 versus 30% in 2009
  • Supply Chain Security: 35% in 2010 versus 33% in 2009

With the number and level of CEO concerns rising (these were just the supply chain-related ones; there were many others) supply chain risk mitigation will be very high on the CEO agenda.”

According to the article, CEOs also believed a “new normal” would emerge following the current recession and that the “new normal” could impact how companies think about supply chains. For some of the ways that supply chains might be changing, read yesterday’s post entitled Customer-centric Supply Chains. The article continues:

“To no one’s surprise, reducing operating costs remains the number 1 initiative on the CEO’s plate. 69% of respondents said they had major cost reduction plans for 2010 – but that’s down from 88% in the 2009 survey. Another 34% plan on major outsourcing initiatives, about flat with the previous year. Importantly, risk management and mitigation is also high on the CEO agenda. To the question ‘In the wake of the economic crisis, to what extent do you anticipate changes to any of the following areas of your company’s strategy, organization or operating model?’, the top response was ‘Approach to managing risk,’ with an amazing 41% saying that planned major changes in that area.”

Many of the cost-cutting efficiencies that CEOs hope to achieve will come from investments in the supply chain. The article asserts that many CEOs “will challenge supply chain leaders to move rapidly to fit their new world view.” Ironically, the article states, those involved with the “supply chain will be asked to reduce risks; but at the same time, some risk avoidance mechanisms will actually add to supply chain costs.” That’s why the article concludes that “how supply chain managers juggle these two trade-offs will be a consistent theme as we move forward over the next 2-3 years.” Catherine Bolgar believes that supply chain managers can successfully juggle these trade-offs [“Protection,” Zurich Financial Services, 10 May 2010]. She writes:

“While the latest technology, sharpest design and lowest cost are important, there’s another secret weapon that many companies overlook: the supply chain. A disruption in the supply chain can delay production or delivery of products, which can derail sales and deflate profit. The company that expertly manages risks in the supply chain will avoid some disruptions altogether and will bounce back quickly from others that are inevitable. ‘For a supply chain strategy to provide competitive advantage, companies need to understand and manage the disruption risk,’ says David Martin, head of customer and distribution management for Zurich Financial Services’s global corporate division, based in Zurich. ‘If they don’t, a strategy designed to ensure sustainable profits may actually make them less resilient.’ Consider that most of your competitors use at least some of the same materials and same suppliers. That means disruptions in the supply chain often affect not just one company but an entire sector. Amid adversity comes opportunity. ‘Competitors who are more agile and more flexible can gain market share at the expense of those who can’t,’ says Yossi Sheffi, director of the engineering systems division and the center for transportation and logistics at the Massachusetts Institute of Technology (MIT), in Cambridge, Mass., and author of ‘The Resilient Enterprise: Overcoming Vulnerability for Competitive Advantage.'”

Bolgar goes on to recount an example Sheffi used in his book. The incident involved a chip supplier for Nokia and Ericsson. Sheffi describes how the companies reacted to news that a fire in the manufacturing plant could disrupt supplies of cell phone chips. “Ericsson waited. Nokia, however, quickly worked with the supplier to get chips from other plants, lined up other suppliers and adapted its phones to use other makers’ chips. Nokia secured its place as market leader while Ericsson suffered the ultimate blow to shareholder value: it got out of the mobile-phone manufacturing business.” Bolgar continues:

“The need for managing supply-chain risk has grown along with the dual trends toward globalization and outsourcing. The first makes supply chains longer, requiring more time for shipping and affecting the time needed to end a disruption. The second makes companies more dependent on outsiders — external strategic suppliers who deliver ever-more-complex and more critical products that once were done in-house. ‘The trend of recent years has been to reduce supply costs by buying from fewer and often more remote sources. But this can substantially increase risk, and in outsourcing supply you might be insourcing a problem when a strategic supplier encounters a disruption,’ warns Mr. Martin of Zurich Financial Services. ‘Clearly many organizations have thousands of suppliers, or even hundreds of thousands of suppliers,’ says Jon Hughes, executive chairman of Future Purchasing Consulting Ltd., based in Guilford, U.K. ‘I ask clients, “Tell me exactly how much resource and full-time equivalents you’ve got focused on supply-chain risk.” That will stop 99% of chief procurement officers in their tracks. Many organizations are still in a crisis management mode. Resources are deployed when there’s a problem, rather than saying that managing risk is a business activity like any other.'”

I am a big proponent of “what if” analysis. When companies routinely take the time to think through alternative scenarios, they are much better prepared to react when a crisis strikes — even if it’s a crisis that they had not considered. Bolgar continues:

“Companies have many options for protecting the supply chain, allowing them to tailor responses to various suppliers. Simple strategies, which might not be appropriate for all parts of a company’s supply chain, can include adding multiple suppliers or postponing customization — for example, putting on labels in different languages as close as possible to the store shelf so that in case of a disruption, such as a closed port, unlabeled products can be rerouted to other markets to fill the gap. That flexibility also can protect a company from getting stuck with unsold goods customers in one market don’t want, while allowing a company to jump on spikes in demand elsewhere. Another simple strategy for certain supplies can be increasing inventory. Just-in-time processes, with their extra-lean inventories, make sense when conditions are right — such as when a process is highly predictable, says George Zsidisin, associate professor of management at Bowling Green State University, Bowling Green, Ohio, and co-author of ‘Supply Chain Risk: A Handbook of Assessment, Management and Performance.’ ‘Not every product or process should have a just-in-time system set up,’ he says. More complex strategies include building in redundancy and flexibility. The resulting ability to quickly match supply and demand not only helps a company pick itself up after a disruption but also to quickly jump on fickle customer tastes. ‘If we build in flexibility, it means by and large we not only are able to respond to disruption, we also are able to respond to market changes. This is where competitive advantage lies,’ Dr. Sheffi of MIT says.”

Risk management is not a science. Even the best-made contingency plans and most thoughtful predictions can’t account for every eventuality. The eruption of the Icelandic volcano is one such event that rippled through both good supply chains and bad (see my post A Kick in the Ash for Supply Chains). Nevertheless, I’m willing to bet that companies with robust supply chain risk management processes fared better over this period. The better informed a company is the better equipped it is to respond. Drawing from informal channels of communication can be as important as data gathered from formal chains. Bolgar explains:

“Companies that really take risk management seriously consider the supply chain right from the design stage of the product or process. Early supplier involvement can reduce the overall product development cycle time,’ Dr. Zsidisin says. Companies have been on a cost-cutting spree, but many mistook low price for low cost. Not all costs — including those associated with risk — were captured. ‘We are starting to see a shift away from lowest price toward looking at suppliers that supply the best value to your firm,’ he says. This collaboration with suppliers also allows companies to know early when a supplier is having trouble. There might be labor unrest at one of their suppliers, or a shortage of materials farther down the chain. ‘Maybe their managers won’t tell you, but if your engineers are talking with their engineers, it’s likely to come up. That gives you time to take action,’ Dr. Zsidisin says. ‘And if you have trouble, a collaborating supplier may go out of its way to help you.’ In protecting the supply chain from unexpected risks, successful companies also allow their people close to the disruption to take action. ‘The front line is where the disruptions happen,’ says Dr. Sheffi of MIT. ‘In a disruption, the usual rules don’t apply. First, you don’t have time. Second, there’s confusion from a lack of communications and information. You have to fall back on the general corporate culture and act quickly.’ A culture of empowerment allows managers and even line workers to take corrective action on the spot. To actually make this happen, employees have to be assured that ‘if they did it with the best information available at that time, they won’t be punished,’ Dr. Sheffi says.”

The U.S. intelligence community has discovered (repeatedly) that gathering information isn’t sufficient if that information is not shared so that the right person, with the right decision-making responsibilities can act upon it. Companies are no different. A process needs to be implemented in which the right information gets to the right decision-maker at the right time. Perhaps the most difficult part implementing such a system is winnowing out the important information from the mountains of data received. Bolgar concludes:

“How well a company protects its supply chain from risk is a measure of its overall performance, says Mr. Hughes of Future Purchasing. ‘If you’re not doing sourcing properly, then you don’t have operational excellence embedded in your day-to-day management. Either you have risk under control and are giving it the attention it needs, or you’re ignoring it and hoping for the best. It goes right to the DNA of the organization.'”

Hoping for the best is not a risk management strategy. To demonstrate how complicated supply chain risk management assessment can be, Bolgar, in a companion article, relates how pharmaceutical companies found themselves on the short end of a supply chain that was affected by the Olympics, a hurricane, and the Great Recession [“Assessment,” Zurich Financial Services, 26 April 2010]. It’s a fascinating tale.

“Acetonitrile is a byproduct created from the production of acrylonitrile, which is used to make plastics for things like car parts and acrylic fibers for things like carpets. In this scenario, acrylonitrile is the star and acetonitrile is a bit player. The perfect storm for acetonitrile started gathering when China shut a chemical plant to reduce air pollution for the Beijing Olympic Games in August 2008. In September, Hurricane Ike knocked out another chemical plant in Texas. Also that month, the financial crisis broke out in earnest, with the sale of Merrill Lynch and the failure of Lehman Brothers. The economic slowdown quickly battered car production, and, in turn, the demand for the main material, acrylonitrile, plunged. It didn’t help that the housing slump withered demand for carpets. Since acetonitrile was just a byproduct, its production also dropped. And pharmaceutical companies found themselves out of stock, and unable to continue clinical trials because of a lack of the solvent. Prices of acetonitrile shot up as companies scrambled to get a few gallons.”

Because of the attention one pharmaceutical company paid to supply chain data, it managed to mitigate the effects of the “perfect storm for acetonitrile.” Bolgar explains:

“At least one pharmaceutical company escaped the fallout. It had mapped its supply chain and had noticed the drop-off in acrylonitrile — the star of the show — and had bought extra stocks of the bit player, acetonitrile, in advance. It also arranged preferential agreements with suppliers before everyone got into crisis mode.”

That is a great example of how having a robust risk management process in place pays huge dividends. Bolgar continues:

“Having a single strategic material or using a single strategic supplier doesn’t have to be a problem, even in the face of disruptions. What matters is having a plan for responding quickly to disruptions, says Paul Kleindorfer, professor of sustainable development at the Insead business school in Fontainebleau, France, and professor emeritus of management science at the Wharton School of the University of Pennsylvania in Philadelphia. … Security is but one aspect of risk assessment. Companies typically also focus on exposures such as natural catastrophes like earthquakes or storms common in certain geographic areas, accidents, and strikes. … In setting up a supply chain risk management process, a company will see the weaknesses of certain suppliers. That presents a choice: work with the supplier to correct the problem, keep the supplier but get a secondary supplier on board as well, or get rid of the troubled supplier altogether, Dr. Kleindorfer says.”

Choice is what a good risk management process can provide. The last scenario in which a company wants to find itself is one in which it has no choices. Be that as it may, finding the right strategy remains difficult. Bolgar explains:

“Supply chains are one of the biggest risk areas facing organizations today, partly due to the all-consuming drive to cut costs, which creates an adversarial relationship with suppliers. … Companies that have decided to buy a failing supplier may find themselves dependent on a single source. At the same time, sourcing to multiple suppliers also can have drawbacks. Handing out smaller pieces of the pie to more suppliers means your company isn’t as important to any one supplier and in case of a disruption or shortage you might have to wait in line behind competitors. … [As a result,] companies are starting to address risk management all the way down the supply chain. They have to. As companies continue to tighten their focus on core competencies, they are relying on suppliers more and more, says Mr. Dhingaravel of Beroe. ‘They are pushing more and more responsibility to suppliers. It’s a train that cannot be stopped. Nobody is going to go back and do all these things themselves.'”

If the train can’t be stopped, my advice is to hop aboard and help decide where the ride will take you. Developing a supply chain that balances efficiency and resilience is critical as companies and suppliers move together in decades ahead.