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.