Reducing the Risk of Supply Chain Disruptions

Most managers know that they should protect their supply chains from serious and costly disruptions — but comparatively few take action. The dilemma: Solutions to reduce risk mean little unless they are evaluated against their impact on cost efficiency.

For supply chain executives, the early years of the 21st century have been notable for major supply chain disruptions that have highlighted vulnerabilities for individual companies and for entire industries globally. In addition to taking many lives, the Japanese tsunami in 2011 left the world auto industry reeling for several months. Thailand’s 2011 floods affected the supply chains of computer manufacturers dependent on hard disks and of Japanese auto companies with plants in Thailand. The 2010 eruption of a volcano in Iceland disrupted millions of air travelers and affected time-sensitive air shipments. Today’s managers know that they need to protect their supply chains from serious and costly disruptions, but the most obvious solutions — increasing inventory, adding capacity at different locations and having multiple suppliers — undermine efforts to improve supply chain cost efficiency. Surveys have shown that while managers appreciate the impact of supply chain disruptions, they have done very little to prevent such incidents or mitigate their impacts.1 This is because solutions to reduce risk mean little unless they are weighed against supply chain cost efficiency. After all, financial performance is what pays the bills.

Supply Chain Efficiency vs. Risk Reduction

Supply chain efficiency, which is directed at improving a company’s financial performance, is different from supply chain resilience, whose goal is risk reduction. Although both require dealing with risks, recurrent risks (such as demand fluctuations that managers must deal with in supply chains) require companies to focus on efficiency in improving the way they match supply and demand, while disruptive risks require companies to build resilience despite additional cost. Disruptive risks tend to have a domino effect on the supply chain: An impact in one area — for example, a fire in a supply plant — ripples into other areas. Such a risk can’t be addressed by holding additional parts inventory without a substantial loss in cost efficiency. By contrast, recurrent risks such as demand fluctuations or supply delays tend to be independent. They can normally be covered by good supply chain management practices, such as having the right inventory in the right place.

Read the Full Article:

Sign in, buy as a PDF or create an account.

References

1. C.S. Tang, “Robust Strategies for Mitigating Supply Chain Disruptions,” International Journal of Logistics Research and Applications 9, no. 1 (2006): 33-45.

2. S. Chopra and M.S. Sodhi, “Managing Risk to Avoid Supply-Chain Breakdown,” MIT Sloan Management Review 46, no. 1(fall 2004): 53-61.

3. M. Lim, A. Bassamboo, S. Chopra and M.S. Daskin. “Flexibility and Fragility: Use of Chaining Strategies in the Presence of Disruption Risks,” Northwestern University research report, 2010.

4. See K. Capell, “Fashion Conquistador,” BusinessWeek, Sept. 4, 2006.

5. R.H. Hayes and S.C. Wheelwright, “Link Manufacturing Process and Product Life Cycles,” Harvard Business Review 57, no. 1 (January-February 1979): 133-40.

6. J. Birchall and E. Rigby, “Oil Costs Force P&G to Rethink Supply Network,” Financial Times, June 26, 2008.

7. L. Lucas, “Diageo Overhauls Its Supply Chain,” Financial Times, March 11, 2013. In the past, Diageo largely sold a few premium brands globally (such as premium Scotch whiskey). These were sourced from a central location and distributed globally. As Diageo has grown in emerging markets, it has started selling many other products locally. While the sourcing for Scotch whiskey cannot be decentralized for obvious reasons, Diageo has worked hard to locally source as many products as possible, creating a more regional supply chain.

8. M.S. Sodhi and C.S.Tang, “Managing Supply Chain Risk” (New York: Springer, 2012), chap. 5.

9. See, for instance, L.N. Van Wassenhove, “Humanitarian Aid Logistics: Supply Chain Management in High Gear,” Journal of the Operational Research Society 57, no. 5 (May 2006): 475-489.

10. Chopra and Sodhi, “Managing Risk to Avoid Supply-Chain Breakdown.”

11. Actual costs go up with the square root of the number of pools of resources, while expected costs of disruption go down as the inverse of the number of pools.

12. Chopra and Sodhi, “Managing Risk to Avoid Supply-Chain Breakdown.”

13. M. Sodhi and S. Lee, “An Analysis of Sources of Risk in the Consumer Electronics Industry,” Journal of the Operational Research Society 58, no. 11 (November 2007): 1430-1439.

14. N.N. Taleb, “The Black Swan: The Impact of the Highly Improbable” (New York: Random House, 2007).

15. Sodhi and Tang, “Managing Supply Chain Risk,” chap. 3.

16. M.K. Lim, A. Bassamboo, S. Chopra and M.S. Daskin, “Facility Location Decisions With Random Disruptions and Imperfect Estimation,” Manufacturing & Service Operations Management 15, no. 2 (spring 2013): 239-249; and B. Tomlin, “On the Value of Mitigation and Contingency Strategies for Managing Supply Chain Disruption Risk,” Management Science 52, issue 5 (May 2006): 639-657. In a different setting, Tomlin (2006) observed results similar to Lim et al. (2013) from misestimating the duration of a disruption. He found that underestimating the duration of a disruption typically led to significantly larger increases in cost than overestimating the duration of a disruption.

17. Chopra and Sodhi, “Managing Risk to Avoid Supply-Chain Breakdown.”

4 Comments On: Reducing the Risk of Supply Chain Disruptions

  • Sameer Mehta | March 23, 2014

    Nice article which sheds light on the strategies to counter disruption. It seems important to consider fragility rather than focusing on building lean and cost effective supply chain systems.

    How does one quantify the benefits of segmentation and regionalization strategies to insure against the risk of disruption? More than often, a firm incurs significant fixed cost while augmenting from say 1 warehouse to 2. Also, we have weak prior distributions to effectively model the random event of disruption which further undermines the ability to take investment decisions.

    The strategies suggested in the article are effective and have other side benefits for large firms. Could you suggest some alternatives where medium size firms can battle the risk of disruption? I guess this would be challenging as medium size firms, when in their growing phase, have financial crunch and managers require quantifiable insights to take action.

  • M Sodhi | March 29, 2014

    Sameer, thank you for your two questions.

    First, benefits for segmentation and regionalisation should be quantified only in cost or other economic terms. The benefits as regards risk reduction are an added plus as we argued in the first half of our article so the basic economic case must stand on its own.

    Second, we had limited ourselves to large companies in the article but medium-sized companies are potentially more vulnerable owing to less diversification and fewer locations. Upon reflection, the same solutions still apply as long as fixed costs can be avoided by outsourcing storage and distribution, by renting facilities, or by working with distributors. The four approaches we laid out still apply:

    1. Segmenting the supply chain by separating the fast moving items from the slow moving ones also allows separate low-cost warehousing for the slower products that is farther away (or rented). (This would require an analysis of orders that the company gets from its customers to ensure entire orders can be met quickly.)

    2. Regionalizing is still possible if the company can outsource distribution in another region. Even large western companies sell their products to distributors in Asia or in other new markets.

    3. Concentration of resources on the demand side can be reduced through distributors. On the supply side, purchase-order sizes of strategic items may not be large enough for a medium-sized company to order from multiple suppliers, resulting in a sole supplier situation. Still, occasional orders (in full), can still be placed from other suppliers to create a backup supplier.

    4. Overestimating the likelihood of risk, say, that of loss of production capability, is a good idea regardless of the size of the company, and more so for a smaller company. The solutions may vary as we mention above. Both large and small companies need to plan for disruption, the latter even more so as there is less capacity to absorb losses.

  • Rabindranath Bhattacharya | March 31, 2014

    Rabindranath Bhattacharya, 31st March, 2014

    Disruption of supply chain could occur owing to the act of God or demand for abnormal increase in the price by the suppliers. Around ten years back when the steel price started moving up abnormally across the globe it was time to check whether your supply chain was resilient enough to face that impending disruptive risk. As the General Manager- Materials of a medium sized industry task was to check the type of sourcing of Castings, steel bars and tubes – multiple or single. Although we had multiples sources for all the items we had only one source-Indian Seamless for the supply of seamless tube used for manufacturer of water pump bearings in collaboration with NSK. The stoppage of supply of tube means stoppage of manufacture of bearings which would lead to stoppage of water pump production and ultimately stoppage of Suzuki car line where our share was around 60%.
    We anticipated this a year back and started discussion with major international players for the supply of seamless tube. We applied 80/20 rule and talked about those sizes where volume was steady and which constituted 80% of requirement. We settled the rate with Sumitomo steel of Japan and to our surprise we found rate 5% cheaper than Indian Seamless. Pilot lot was supplied and approved quickly.

    On the other side we were taking steadily higher quantity of tube every month to build up the stock and carried on dialogue with Indian seamless to reduce the demand for 25% increase to 10%. Indian seamless was adamant and as expected threatened us for stopping the supplies. We agreed only for the items where volume was low and erratic and requested them to maintain the supply for regular item for a couple of months more with an increase of 10%. Indian seamless agreed. We got the supplies from Japan and stopped taking regular items from them. Steel prices went through the roof in the mean time and when most of auto component manufacturers struggled we are able to bring the material cost down. How we shifted to China for other items is another story!
    I highlighted this story to show that mitigating risk does not always result in higher cost and principle could be applied in medium sized industries also. I always believed “if there is a will there is a way”

  • Sameer Mehta | April 6, 2014

    Thanks Prof. Sodhi and Rabindranath for your comments.

Add a comment