Shrink Risk in an Expanding Supply Chain

May 1, 2011
Uncertainty is an unavoidable part of risk management. However, there are tools to help minimize uncertainty by making best use of information you already have.

Uncertainty and risk are two of the biggest challenges to the supply chain. Risk can appear in a variety of guises: economic volatility, environmental crises, natural disasters, work stoppages, supply shortages, quality breakdowns, and dozens of other unpleasant surprises. When one of these unanticipated events strikes a supply chain, the consequences can range from the unpleasant to the catastrophic; i.e., from increased costs or moderate delays to a shutdown or a market collapse.

As globalization expands the geographic scope of business, it also increases the exposure to upheaval. Manufacturers know that identifying, managing and mitigating risk is vital. But not everyone knows how to identify the unknown, and prepare to effectively respond to risk.

Some actions are evident and self-explanatory. Manufacturers must work to identify and quantify potential risks. They must be as agile as possible, continuously improving their processes to expand visibility and allow quick execution of changed plans. They should consider whether adherence to common wisdom best practices is useful in a world of extended and fragile supply chains, driven by instant information, and subject to constant change.

Shrink Your Risk

Innovative companies need to work on minimizing risk, not just crafting a response to its manifestations. Their supply networks must be designed with resilience and agility in mind. Firms can:

  • Manufacture locally as well as globally;

  • Source contingent suppliers and logistics providers;

  • Better monitor and adjust inventories and safety stock; and

  • Establish more geographically distributed or near-shore supply bases.

The world's rapidly changing business conditions require supply networks that adapt and change more frequently. Firms can reduce risk by updating their supply chain strategies more often than the typical three to five years.

As a framework for establishing and implementing an effective risk management strategy, let us examine the following three basic guidelines.

Program Structure

Leading-edge technology must be combined with business processes that are both risk-aware and — to the maximum extent possible — self-remediating. Think of this as a lifecycle focused methodology for understanding, anticipating, accommodating and minimizing disruptive events. Most manufacturers do not have a formal capability for quantifying, anticipating and minimizing risk. Instead, their risk management strategies or plans for operations continuity focus on major disruptions and specific assets, such as back-up data centers or offsite data-storage facilities. In effect, this makes them asset-resilient but not mission-resilient.

In addition, few entities have evaluated the risks associated with new operating models, such as increased global interdependencies, expanded outsourcing relationships, and new mergers, acquisitions and partnerships. Technology, in combination with business processes and automation, can help companies mitigate risk through several key capabilities, including:

Global visibility and event management: Manufacturers need global visibility into events as they occur so they are able to immediately take corrective, remedial action. Technology can be an effective enabler by providing timely information to managers through alarm and supply chain event management capabilities. With such systems in place, organizations can anticipate or monitor planned and actual events, analyze and evaluate conditions, resolve problems by generating automatic responses and notify and collaborate on events.

Designing fault-tolerant supply chains with simulation and modeling: Simulation and modeling can help manufacturers build more fault-tolerant, resilient supply chains. By simulating key planned and unplanned scenarios and events such as supply chain failures, cost spikes, price volatility due to currency fluctuation and natural disasters, manufacturers can develop specific risk-management strategies to mitigate these risks.

Network Modeling

To further evaluate weak links across the supply network, strategic network modeling and optimization techniques can be applied. By assessing and analyzing potential failure points in the supply network and their impact on the business, manufacturers can redesign their supply network to build resilience.

Another solution that can help manufacturers manage risk is inventory optimization, which can help mitigate risk through inventory hedging strategies. This involves manufacturers determining what inventory to hold, in the right form, at the right location to minimize costs while maximizing customer service levels.

Furthermore, strategies such as inventory postponement (holding inventory in the form of sub-assemblies and then performing final assembly only after the customer order is received) and risk-pooling can be leveraged. Risk pooling can help by aggregating demand and inventory across locations, and as a result, it is more likely that high demand from one customer and location can be offset by low demand from another. This reduction in variability allows a decrease in safety stock and therefore reduces average inventory.

Centralized inventory can also save safety stock and average inventory in the system. Companies can also leverage common product “parts pooling” and components across different finished goods or products to help minimize risk.

Think Holistically

Historically, risk management approaches have mirrored the shortcomings of many organizational models: poorly connected functional silos, inconsistent access to information, limited management-reporting capabilities, minimal collaboration, and insufficient risk awareness across the enterprise.

Such risk provincialism can be dangerous. A pharmaceutical or food and beverage firm that optimized risk abatement by planning locally on supplier sources to minimize downtime, might risk the health of the entire firm by not focusing primarily on safety, which might involve far-flung but safer alternate suppliers.

A holistic view of supply chain risk recognizes that risks are interdependent. A firm whose risk planning identified an alternate manufacturing site, without investigating the potential impact on distribution and logistics, is risking an unpleasant surprise.

In recent years, leading firms have approached the problem by developing end-to-end risk management approaches to process-management and organizational structure covering all aspects of the supply chain including demand, supply, product, finance, service and technology. Such insights are reflected in the development of more integrated risk management models.

Manage Responses, Not Causes

The guiding force behind any company's risk management and mitigation program is preparation: understanding what potential disruptions exist; the likelihood, severity and duration of their occurrence; and the range of prioritized responses. However, optimal preparation is not contingent on micro-level identifications of every possible causal scenario. The complexities of today's environments make it nearly impossible to accurately identify all of the scenarios that might occur.

A better and more practical course is to focus on commonalities across scenarios, or in other words the shared effects. This means developing resilience frameworks not for work stoppages, hurricanes, terrorist attacks and so forth, but rather for labor shortages, destruction of property, supply disruptions and service outages. Building a risk program around symptoms (the effects) rather than scenarios (the causes) makes resilience development manageable because it acknowledges that many events share characteristics, impacts and, most importantly, responses.

There simply are too many potential disruptions for manufacturers to develop comprehensive resilience programs for every single one. For example, problems as varied as weather events and labor-driven port closures evince a similar need to maintain core services and suppliers. We often cannot know in advance when or where such upheavals will occur. But we can develop symptom-based programs that speak to the need for quick responses regardless of the specifics.

Many of the solutions needed to bring together data, tools and capabilities exist now. Manufacturers can acquire and use them to make risk more identifiable, manageable and avoidable, but it's vital to first develop a business case that defines the relationship between risk management and shareholder value. By doing so, manufacturers are in effect defining the advantages and consequences associated with managing (or failing to manage) risk.

To successfully mitigate risks, manufacturers not only need to know what the risks are, but more importantly have strategies in place before the event happens. That can be done by creating models and applying supply chain software that can simulate alternatives.

Supply chain management operations that contribute to high performance are those that maintain information at a level of detail that enables agile decision making, or even automated decision making, such as dynamic routing and sourcing.

Maha Muzumdar is vice president, supply chain marketing at Oracle.

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