Everyone seems to be aware of supply chain risks since the aftermath of last year’s Japanese tsunami and the heavy flooding in Thailand just six months later.  The two natural disasters had a combined cost to global industries of nearly $230 billion.  Worldwide, natural disasters cost $310 billion according to the insurer, Munich Re.  Many companies have trouble coming to grips with supply chain risks, because the most significant and costly supply chain disruptions are caused by seldomseen natural events, and it is impossible to predict when and where they will occur. As a result, knowing how to justify the investments you make to guard against supply chain disruptions is no easy undertaking.

Understanding the Challenges

Companies face many risks. The known and controllable ones like forecast accuracy and market changes are easier to predict and to hedge against effectively. The unknown—unknown risks, including natural disasters, terrorist attacks and environmental risks defy prediction.  Onesupply chain risk approach to quantifying the risks has been to estimate the impact a supply chain disruption will have on the value of a company’s shares.  The average 7% decline in stock price associated with the average supply chain disruption is significant enough to grab the attention of executives, but this measure does not suggest what actions should be taken to avoid this difficult outcome.

Supply chains evolve all the time.  New suppliers are added, when price or other factors favor the new supplier.  In general, all the actions taken by individuals in engineering, sourcing, procurement or supply chain risk management are aimed at improving the value of the supply chain to the company.  While software tools are used extensively to evaluate different supply chain scenarios, differences in risk have not been part of the optimization calculations.

Furthermore, industryspecific competitive factors tend to cause competitors to make similar supplier decisions, often resulting in a few key suppliers being shared by all or most of the key competitors in the industry.  In this case, when a supply chain disruption affects a key supplier in the global supply chain, all the competitors are affected, and all the competitors start scrambling to resolve the problem at the same time.  The concentration of suppliers in supply chains increases the impact of supply chain disruptions, but this impact can be completely overlooked until the disruption actually occurs.

Finally, the extensive use of lean practices to increase the efficiency of supply chains with respect to cycletimes and inventory investments has also made supply chains less resilient.  With little slack inventory or slack time available across the supply chain overall performance of the supply chain depends on highly reliable performance being achieved from all the tiers of suppliers in the entire chain.  Essentially, the drive for efficiency will drive purchase decisions towards lowercost suppliers without consideration for the increased risks their lowcost operating model may bring to the overall supply chain.  Invest in supply chain value to avoid these pitfalls.

Click here to download a brief white paper that provides more insight into ways to mitigate supply chain risk in your company.

Written by Edith Simchi-Levi, VP of Operations at OPS Rules Management Consultants