Supply chain management is a delicate balancing act in these unpredictable times – on the one hand, there is pressure to keep the supply chain as cost efficient as possible, while on the other, it needs to be flexible and resilient in the face of unforeseen events. How do leaders proactively manage the risk of disruption?
In a recent article in the Sloan Management Review ManMohan S. Sodhi, professor of operations and supply chain management at Cass Business School and Sunil Chopra, the professor of operations management at the Kellogg School of Management, discussed this dilemma.
Supply chain management has become increasingly sophisticated over recent decades with improved financial performance as a result. Just-in-time (JIT) manufacturing; sole-source suppliers; outsourcing to low-cost locations; common parts; and centralized inventories – these among other measures have helped leaders run supply chains more efficiently and guard against recurring risks such as changes in demand, supply or even quality.
But as supply chains have become more complex, the potential for serious disruption has magnified as a consequence. Natural disasters, suppliers going bust, war, terrorist attacks, they are all hard to predict, but they can seriously affect your business. For example, the Japanese tsunami of 2011 was not only a humanitarian tragedy, it also had a hugely detrimental impact on the car industry worldwide, as a number of manufacturing plants pivotal to the global auto market were located in the disaster region. Similarly, the ash cloud crisis of 2010 disrupted travel around the globe and affected numerous time-sensitive air shipments. Such disruptive risk has a domino effect on the supply chain, as the impact on one area ripples into others.
There is a ‘Catch-22’ nature to the objective of reducing the impact of disruptive risk while at the same time trying to achieve cost efficiency. Increasing inventory, maintaining multiple suppliers, or adding capacity in different locations – such techniques certainly help to avert risk, but at a cost. This research suggests that instead leaders need to design supply chains in such a way as to ‘contain’ risk, controlling the amount of complexity in the system and trying to avoid the domino effect of interdependencies between products.
Developing a containment strategy through either segmenting the supply chain or regionalizing it will not only reduce its fragility but also improve financial performance. Take fashion retailer Zara – well-known for its innovative approach to fashion production and design, it develops items in weeks rather than the industry average of six months, and launches thousands of new designs each year. But although around half of its manufacturing remains in Spain, it outsources the production of basic items (such as white T-shirts) to low-cost multiple suppliers in Turkey and Asia. Segmenting its supply chain in this way reduces the impact of potential disruption from having a single production outlet/area. In the same way, a car manufacturer might segment its supply chain by restricting the number of common parts across car models or identifying multiple supply sources for those common parts.
Regionalizing the supply chain, another form of containment strategy, has the same aim of limiting the impact of a disruption. And in a world where fuel price rises push up transportation costs, a regionalized supply chain can also mean lower distribution costs. As mentioned, the devastating 2011 tsunami wreaked havoc on the Japanese car market as plants around the world became affected by a shortage of parts made only in the tsunami-affected regions of Japan.
The lesson for business leaders is that they must view their global supply chains from the wider perspective, understanding the importance of a strategic plan that allows for business continuity in the event of a disruption but that also builds resilience into the business. Whatever you need to invest in, whether it is a back-up supplier, increasing inventory, or developing another distribution centre, the benefits may not be felt for years, but you are creating resilience, and that is the key.
Segment your supply chain to reduce risk – for example, consider sourcing from multiple low-cost suppliers if you have high-volume products with low demand uncertainty. Conversely, if you have low-volume products with high demand uncertainty, segmentation might be on a smaller scale with a centralized but flexible supply chain, able to cope with changes in demand. Or if you produce both, guard against the impact of disruptions and create supply back-ups by housing them in distribution centres (for fast-moving items) or centrally (for slow-moving goods).
Go global but think local – consider the benefits of local sourcing and distribution, particularly when competing in emerging markets. Having multiple plants, even within the same country, not only reduces the impact of disruption but can also be more cost-effective, especially with regard to distribution.
Don’t take pooling to extremes – building some degree of commonality in your supply chain and reducing the amount of suppliers or plants or distribution centres can make sense when you are looking for cost savings and efficiency, but keep control of the pooling of resources. Too much and you end up with a fragile supply chain, especially if disaster strikes.
Finally, regionalizing or segmenting your supply chain means that if or when disruption occurs, any back-up supply can be deployed more easily and quickly.
Read the full article in the Sloan Management Review: Reducing the Risk of Supply Chain Disruptions