Supply Chain Risk

The current flooding in Thailand, the worst for fifty years, is showing the importance of supply chain risk management. The country has been devastated by monsoon rains and this is now starting to affect Bangkok. A number of major manufacturers, such as Toyota have plants in Thailand (Samrong, Gateway and Ban Pho) and these manufacturers have experienced difficulties. The Toyota plants have not been directly affected by the flooding, however they have been indirectly affected as a result of part supply delays which have resulted in production in all three plants being stopped. Due to the global nature of supply chains the flooding has not just stopped operations in Thailand it has effected operations in Japan with Toyota being unable to get raw materials from Thailand.

Such global supply chains are a source of competitive advantage allowing firms to gain the advantage of cheap labour, cheap raw material, local expertise and government incentives but such global supply chains can increase supply chain risk. Risk has many definitions:-

• it is the combination of the probability of events and its consequences
• it is the effect of uncertainty on objectives
• it is often characterised as what can happen, the likelihood of it happening and the consequences of it happening (similar to a FMEA)

So what can be done to reduce this risk, and how are supply chain trends affecting supply chain risks?

Supply Chain trends

A number of supply chain trends can be identified which have influenced the level of risk in our supply chains, these trends are well reported in the media but the negative side of such trends are often ignored. The key trends are:-

• Lean supply chains and JIT. This focus on efficiency rather than effectiveness has led to increased supply chain vulnerability as capacity and inventory is removed
• Reducing costs through globalised supply chains. This has led to longer supply chains which are more complex and more vulnerable to disruptions
• Reduced costs through economies of scale (centralisation). This has reduced cost and flexibility in the supply chain
• Reduced costs through outsourcing. This has led to a loss of management control of the supply chain
• Reduced costs through consolidation of suppliers. This has increased the chance of supply chain disruption.

How can risk be categorised?

There are four areas of supply chain risk:-

• Supply
• Demand
• Operational
• Security

These areas can be further divided based upon the likelihood of the event and the consequences of the event e.g. low likelihood, high consequences.  Studies have shown that companies work hard to reduce recurrent risks in their supply chain (such as currency risks) but do little to reduce the impact of high impact low likelihood events such as natural disasters. However, such environmental disasters seem to be occurring more often this means that such attitudes need to change and companies need to start to develop plans to reduce the effect of unpredictable events.

A number of risk management strategies have been developed which depend on the probability of an incident and the effect on the business, these are shown on the diagram below

Supply Chain risk management strategies

Low Business Impact

Avoid = Proactive action which removes the event

Reduce =Action reduces the effect of an event if it occurs

High Business Impact

Transfer = Proactive action which switches risk to 3^rd party

Retain = Reduces the impact if event occurs

What tactics can be used?

A variety of tactics may be applicable:-

Reactive

• Change product configuration to cope with disruption
• Change supply plan to cope with disruption
• Change pricing to satisfy customers and use promotions to switch demand to products that you do have

Proactive

• Postponement – modular designs allow switching to other components
• Use more than one supplier as it adds flexibility (often means guaranteeing orders to keep business running)
• Resilient supply chain design
• Flexible transportation routes

So how should you manage your risk?

• Understand the end to end supply chain
• Reduce complexity in the supply chain
• Identify bottlenecks & key nodes and develop plans to cope with disruption
• Establish continuity plan & team
• Share information and work with customers / suppliers

Product Design and Supply Chain

Earlier in the week I attended a fascinating forum led by Dr Omera Khan and Professor Martin Christopher dedicated to studying product design and how it relates to the supply chain. This little studied topic (only 36 articles have appeared in leading supply chain journals on the topic in the last 10 years) is a major potential source of business improvement as between 70% and 80% of a products whole life cost is decided at the design stage by decisions such as the:-

• The Number of Components
• Commonality of parts across product portfolio
• Lead time of materials
• Physical Characteristics
• Country of Supply

Such decisions effect not only the sale cost of a product but also the life cycle costs of the product which can be up to 75% of the cost of ownership

As design is increasingly  seen as a source of differentiation it is getting increasingly complex and having a major effect on supply chain cost and risk  due to factors such as global sourcing, offshoring, product complexity, process complexity and outsourced design.  The classic example of the effect of design on supply chain costs and supply chain complexity is the Boeing 787 which is 3 years late and massively over budget. The failure to deliver the 787 on time and on budget is partly due to its design which involved sourcing the best materials from the best manufacturers around the world – unfortunately this also meant an incredibly complex, high risk and costly supply chain to manage (see below).

So how do we prevent design having such negative effects on supply chain cost and risk? The answer is by involving the supply chain in the product design. The effect of design on the supply chain means that it is essential that logistics and supply chain staff are involved at the product design stage. So how can design reduce supply chain costs? Well one way is to design the product in such a way that it enables supply chain agility which is the ability to respond rapidly to unexpected changes in demand. Such agility is becoming increasingly important in many markets as:-

• It is becoming increasingly difficult to forecast demand
• Short Product Life Cycles mean that forecasting is especially difficult and firms do not want to hold obsolete inventory

So what can design do to increase supply chain agility:-

• Increase the amount of commonality between componants and materials e.g. Vauxhall & Audi sharing platforms and lego who have reduced brick types from 14000 to 6500. This helps to reduce inventory in the organisation and increases forecast accuracy as it is easier to forecast at an aggregated level
• Use suppliers with short lead times as this will allow the firm to quickly adapt to changing demand therefore allowing them to carry less inventory
• Use shorter planning horizons
• Increase modularity as it enables easier construction and assembly
• Design products for ease of delivery as this will reduce transport and storage cost whilst also reducing damage
• Use Postponement with product being held in its generic form. Because the inventory is generic it is more flexible allowing it to be used in many modules or products. This will increase forecast accuracy as forecasting is easier at the generic level additionally postponement allows late product customisation therefore allowing economies of scope in production and potentially reducing returns as the customer has been involved in the design.

It is therefore clear that supply chain expertise should be utilised within the design process, this may mean that some design decisions may be compromised, however the advantages are  worth this cost. Omera Khan offers advice to companies seeking to create an effective interface between the design and supply chain teams:-

• Appoint a person to champion the supply chain – design interface and to ensure that their is good visibility between the teams
• Encourage cooperation between all elements of the supply chain (internal and external) to minimise product design supply chain risk
• Utilise cross functional teams to contribute to the product design process
• Co-location of teams to enable information transfer on a daily basis
• Develop T shaped people with deep expertise in one area (design) but an understanding of other areas (supply chains) and vice versa. As this will allow the development of constrained design were design decisions are limited by supply chain constraints.

Rare earth elements and supply chain risk

Over recent months I have become increasingly concerned about the risk inherent in many supply chains. This unease has increased due to the recent spate of environmental disasters, the economic crisis and the threat of terrorism. The quest to reduce supply chain cost has led to manufacturing moving offshore to low cost countries, to the use of single suppliers for many items, to increased specialisation, and to reduced inventory. These trends mean that the small incidents can cause major supply chain disruption as shown by the recent experience of companies such as Apple.

This subject is finally beginning to make it to the main sections of the quality UK newspapers with both the Guardian and the Observer covering rare earth elements this weekend. Rare earths are essential components in most modern devices including low energy light bulbs, TVs, computers and handheld devices.

China dominates the mining and production of these elements controlling 97% of the market and they have recently clamped down on the illegal mining of these elements (35 mines have been shut in Inner Mongolia) leading to the price of Euripium Oxide increasing from $1260 per kg to $3400 per kg in a short period. This situation is likely to get worse as China is likely to introduce additional export curbs on rare earth elements (they reduced quotas by 72% in 2010 and a further 35% so far in 2011), additionally global demand is predicted to increase by 48% by 2015 leading analysts to suggest that there will be a shortfall of 50000 tonnes. The USA and many other countries have recognised this is a strategic issues with it being raised in congress on a number of occasions due to its effect on military equipment.

The effect of the shortage depends on a number of factors:-

1. how quickly companies can replace rare earth elements in their products – this will be very difficult  requiring huge levels of redesign
2. can an alternative supply be found – various countries have untapped reserves e.g. USA, and Greenland. China has only 37% of world estimated reserves but controls 97% of production.

If alternatives can’t be sourced then it is likely that China will continue to milk this cash cow and generate  large profits, whilst from the consumers point of view prices of gadgets will increase substantially meaning that they become the preserve of the wealthy.

A number of lessons from the rare element story can be taken – mostly these are concerned with supply chain risk at the company and the country level with the over reliance on one source for a key component leaving companies and countries in heavily compromised position. So what should companies do to prevent themselves falling into a similar situation?

1) Map your supply chain identifying the risk at each point (FMEA will be useful)

2) Develop contingency plans – scenario plan e.g. alternative sources of supply

3) Improve visibility across the supply chain  therefore allowing quick reaction when problems are discovered. Increased visibility will also reduce the temptation to increase inventory as a buffer to risk

4) Implement control techniques so that you notice problems asap e.g. control charts, FMEA etc

Future Supply Chains

Earlier in the week a colleague of mine  David Menachof presented on the future of supply chains and last year another colleague, Chandra Lalwani, completed a study on next generation supply chains. Predicting the future is fraught with difficulty, if  you are of a certain age you will remember predictions that by the year 2000 we would have unbreakable cars and robot housekeepers. Despite such difficulties it is still worth future gazing as it can help in scenario planning. So what are the global trends that we think are going to influence future supply chains well our best guess are:-

Population

• Increased population from 6.9 bill in 2000 to 8.9 bill in 2050
• 97% of people added to the worlds population in the coming decades will be born in a developing country
• Urbanisation – 50% of people will live in urban areas
• By 2030 93% of the middle class will be in the developing world
• But the people at the bottom of the pyramid represent a huge opportunity which cannot be ignored (CK Pramalad)

Economy Shifts 

• Rise in the importance of BRIC companies (IMF said that they are expected to drive 70% of future growth)

Commodities

• Increasing price of  commodities such as coal and oil, need to develop alternative sources of energy such as renewables or nuclear, and also alternatives to other commodities used in production which are running out

Climate Change

• Increased frequency of natural disasters
• Legislation to force reduced use of fossil fuel

So how do we react?

Recognise that supply chains must be designed differently in different types of country:-

• Emerging: the BRIC (Brazil, Russia, India and China) and, the Second Eleven (Mexico, Bangladesh, Vietnam, Indonesia …)
• Developing: those with a high degree of social and economic hardship; lacking the robustness to compete alone such as a host of African; South American or Asian economies. Huge potential profit in selling to these communities but need very low tech and cost supply chains
• Devastated: those wrecked by geological or meteorological phenomena and requiring Humanitarian Aid and International support like Haiti, Niger, Pakistan, Chile.
• Dislocated: those experiencing or recovering from warfare such as Iraq or Afghanistan.
• Transitional: those moving from Centrally Planned to open markets like Russia, Eastern Europe and, the Baltics in the 1990s

Increase the visibility of our supply chains so that  supply chain risk can be better managed

• Cloud based computing?
• Better trained staff?
• Technology but their is a need to recognise the differences between different country types
• Increased collaboration between supply chain partners

Reducing the risk inherent in our supply chains

• Near sourcing
• multiple sourcing
• simpler product design
• strategic sources from less environmental threatened areas
• improved security
• Map supply chains to identify risk points (FMEA etc)
• Developing contingency plans against uncertainty

Greening the supply chain 

• Mapping of supply chains and operations to identify green opportunities
• Design of facilities so that they use less energy
• Onsite energy generation ?
• Increased collaboration between supply chain partners and competitors

Developing methods of dealing with congestion 

• Better and more roads, however space is limited
• Port centric logistics
• Near Porting
• Near Sourcing
• Better utilisation (planning, product design

Only a few of these ideas are my own so I must thank David and Chandra for their ideas and Rob Bell for the ideas related to logistics in developing economies which has been termed transformational logistics (http://transformationallogistics.wordpress.com/)