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Global supply chain vulnerability

February 20, 2012 1 comment

Since globalization has boosted markets competitiveness, industrial companies have  relied on offshoring and outsourcing initiatives. Such initiatives have led to high network complexity and high inter-dependency among supply chain organizations, thus fostering supply chain vulnerability.

CNN  recently reports that global supply chains seem to be very fragile.  Natural events have shown how multinational networks are greatly exposed to different disturbances that can lead to material flows obstructions and to the breakdown of supply chain operations. Natural hazard (i.e. the unpredictable occurrence of an adverse events such as earthquake, tsunami, blazes) is one of the most relevant supply chain risk whose consequences result in the inability to continuously satisfy final markets. Scientific literature (Hendricks and Singhal, 2005) demonstrates that when such kinds of risks occur, supply chain partners will experience production and/or shipment delays, an increased in their equity risk, an increased in their asset risk and an increased in their financial leverage, thus reducing supply chain overall performance.

Natural hazard risks do not exclusively affect supply chain companies, the entire country economical system can be seriously impacted by the breakdown of supply chain operations. Bloomberg reports that the U.S.A President Barack Obama is directing the Departments of State and Homeland Security to come up with a plan to protect the $14.6 trillion U.S. economy from interruptions in the supply chain.

The article reports meaningful examples of how the occurrence of natural hazard risks can disrupt supply chain operations and negatively affects countries’ economy:

“Hurricane Katrina in 2005 threatened or disrupted the U.S. oil and refining industry. The 2010 eruption of the Eyjafjallajokull volcano in Iceland led to airline cancellations on almost a global scale. The Japan earthquake and tsunami last year 2011 interrupted imports and exports, hurt the U.S. auto and other industries and was blamed in part for worsening the U.S. unemployment rate.”

In this vein, recent posts by The Operations Room (i.e., Toyota gets ready for the next earthquakeHow the Japanese earthquake is shaking up an auto supplierProtecting customers from supply chain disruptions) discuss natural hazard negative effect on supply chain operations in the automotive industry.

Natural hazards risks have thus attracted business community attention, nevertheless one should highlight that these risks represent only one category of supply chain risks. As summarized by one of our works (Gualandris and Kalchschmidt, 2010), at the first level, supply chain vulnerabilities can be distinguished between two classes of risk considering their likelihood (i.e., the probability a risk have to occurs) and their impact (i.e., the negative effects on organization exerted by the risk occurrence): operational risks (high likelihood, low impact) and disruption risks (low likelihood, high-impact). According to what above, natural hazard risk can be classified as disruptional. Operational risk is related to the uncertainty that characterizes processes and material/information flows in the supply chain. This kind of risk arises more frequently and causes inefficiency, reductions in the network’s operative and economic performance, and (in the worst case scenario) the breakdown of supply chain operations. Within operational risk, it is possible to distinguish three classes of risk:

  1. Supply risk relates to the uncertainty that characterises suppliers’ delivery performance, vendors reliability as well as intellectual property losses and the extra costs of supply due to the fluctuations in exchange rates and raw material prices;
  2. Downstream risks  that arise from final demand unpredictability, from distorted information flows (i.e., from downstream partners), and problems related to the distribution network.
  3. Network risks that have to do with the increasing supply chain complexity, that reduces network visibility and generates a lack of coherence between strategies adopted by supply chain partners. Limited visibility reduces the confidence of each supply chain partner, the overall alignment among them and thus influece performance

According to survey analyses performed by McKinsey and by academicians (Thun and Hoenig, 2009) supply risk among the others represents the most relevant form of risk for supply chain companies.

As our researches have demonstrated (Gualandris and Kalchschmidt, 2011a), companies’ exposition to supply risk can be roughly evaluated according to three main risk conditions or antecedents of risks: product criticality, supply market difficulty, technological turbulence. The higher the presence of these antecedents, the higher the supply risk relevance. For instance, when purchases’ complexity and specificity are high, companies strongly depend on suppliers and the occurrence of a supplier’s failure to delivery results in the firms’ temporarily inability to continuously satisfy customers. Then, in case of high supply market concentration and capacity constraints supply risk became more relevant because suppliers’ opportunism is more likely to occur and firm’s room for maneuver is reduced. Third, literature relates the endogenous uncertainty coming from both technology and market changes to both supply risks’ probability and detrimental effects on companies’ costs and competitiveness: on one hand, by causing changes in the market and by requiring a greater companies’ agility, exogenous uncertainty increases the likelihood of a supply delay or failure; on the other, because of turbulence requires increased interaction between buyer and supplier, problems in supply cannot be easily managed (e.g., by turning to another vendor) thus increasing their negative impact on organizations.

Companies that feel to be vulnerable to supply risk can leverage on four main supply chain risk management (SCRM) approaches:

  • Be proactive. Firms can increase the reliability of their upstream network by employing two suppliers, one of which may dominate the others in terms of business share, performance and price. By leveraging on dual sourcing, companies reduce vendors’ moral hazard risk and, in case of chain disruptions or operational problems, can effectively react supporting minor switching costs;
  • Be selective. By developing vendor rating programs, companies become able to identify reliable suppliers with superior capabilities and to preventively assess negative trends in their performance. Specifically, by leveraging on both operational and financial criteria companies can avoid adverse selection, anticipate undesirable events (e.g., suppliers’ failure or delays), and motivate suppliers to a parsimonious conduct;
  • Be collaborative. Companies should increase coordination with suppliers and build the basis for the implementation of robust and value-added relationships. Supplier development and other mechanism of alignment (i.e., revenue sharing contracts) can have profound positive impact on supply chain performance by creating a win-win situation and by accruing tangible benefits such as reduced costs, greater quality, and more reliable deliveries.
  • Be flexible. Flexible enterprises are those that can easily make significant shifts in their configuration and re-align their business to serve a particular purpose rapidly (i.e., substitute a failed supplier). For example, according to our empirical investigation (Gualandris and Kalchschmidt, 2011b), the implementation of manufacturing postponement (i.e., it refers to situations where assembly or manufacturing activities may be delayed to the end of the production process by adopting product modularity and process re-sequencing practices) allows firms to manage decoupling points along their productions lines, demonstrate high flexibility to external uncertainty and properly react when a supply chain risk occurs. Furthermore, we were able to evaluate that  such investments exert a positive mitigation effect on risk conditions: manufacturing postponement adoption allows companies to properly manage technological turbulence and proactively reduce negative effects coming from it (Gualandris and Kalchschmidt, 2011a).

Well…how about you? What’s the potential exposition of your company to such risks? Are your companies adopting such SCRM approaches to manage them? And… Should President Barack Obama sustain or support  SCRM investments to his purpose?

References

Hendricks, K. B. and V. R. Singhal (2005). “An Empirical Analysis of the Effect of Supply Chain Disruptions on Long Run Stock Price Performance and Equity Risk of the Firm.” Production and Operations Management 14(1): 35-52

Thun, J. H. and D. Hoenig (2009). “An empirical analysis of supply chain risk management in the German automotive industry.” International Journal of Production Economics.

Gualandris, J.,  Kalchschmidt, M., (2010). An assessment model to evaluate supply chain resiliency: application in the assembly industry. (Quaderni del Dipartimento di Ingegneria gestionale 3(2010)). Bergamo: Università degli studi di Bergamo. Retrieved from http://hdl.handle.net/10446/621

Gualandris, J. and Kalchschmidt, M., (2011a). The impact of risk conditions and postponement on upstream supply chain vulnerability. IPSERA proceedings ISBN 978-94-6178-001-0, 04/2011, Maastricht (NL). POMS Proceedings ISBN 978-0-615-46993-5, 05/2011, Reno (U.S.A).

Gualandris, J.,  Kalchschmidt, M., (2011b). Manufacturing Postponement: reducing upstream vulnerability by means of an improved flexibility (Quaderni del Dipartimento di Ingegneria gestionale 6) Dalmine: Università degli studi di Bergamo, Dipartimento di Ingegneria gestionale, retrieved from http://hdl.handle.net/10446/25238

Categories: Research in practice

Water footprints

An interesting article has been published on the Proceedings of the National Academy of Sciences. The study quantifies and maps the water footprint of humanity. Agricultural production accounts for 92% of world’s water footprint. Cereal products, in particular, give the largest contribution to the water consumption of the average consumer (27%), followed by meat (22%) and milk products (7%). The study shows that several countries rely significantly on foreign water resources and that many countries influence water consumption and pollution elsewhere. About one-fifth of the global water footprint is associated to products that are exported. Quite interestingly we tend to virtually import a huge amount of water consumption we are not aware of. An example? A coffee with milk cup needs 200 liters of water to be manufactured, from field to cup.

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