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Risk management and paradoxical situations in modern supply chains

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Several new trends in the international trade, started in 90s and still part of the main paradigm in managing business, together with higher level of competition in the markets, generate two …

Several new trends in the international trade, started in 90s and still part of the main paradigm in managing business, together with higher level of competition in the markets, generate two inherently paradoxical situations in managing today’s supply chains. Firstly, two main factors, higher number of risk sources in a supply chain and faster propagation of risk impact in the network, put companies in a more risky position; however and paradoxically, the access to the resources needed to manage those risks has become much more limited. The outcome of this paradoxical situation is growing vulnerability in supply chains and higher impact on the companies’ performance; having a smooth operation in supply chains and providing reliable service to the customers seem more challenging now. Coupling this fact to the highly competitive nature of business and growing expectation of customers, we may find 21st_century companies in a second-level paradoxical situation.

A description of these paradoxes and role of supply chain risk management is discussed in this document.

Published in: Business, Economy & Finance

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  • 1. Risk Management and Paradoxical Situations in Modern Supply Chains by Behzad Behdani Delft University of Technology, Faculty of Technology, Policy and ManagementSeveral trends in the international trade, started in 90s and still part of the main paradigm inmanaging business, together with higher level of competition in the markets, generate twoinherently paradoxical situations in managing today’s supply chains. Firstly, two main factors, highernumber of risk sources in a supply chain and faster propagation of risk impact in the network, putcompanies in a more risky position; however and paradoxically, the access to the resources neededto manage those risks has become much more limited. The outcome of this paradoxical situation isgrowing vulnerability in supply chains and higher impact on the companies’ performance; having asmooth operation in supply chains and providing reliable service to the customers seem morechallenging now. Coupling this fact to the highly competitive nature of business and growingexpectation of customers, we may find 21st_century companies in a second-level paradoxicalsituation (figure 1). More Risk Sources in SC’s Higher Risky Situation Faster Risk Propagation in SC’s Higher Impact on SC st 1 Paradox Performance Less (Control on) Resources to Handle nd 2 Paradox Risky Situations Higher Customer Expectations Figure1- Two Paradoxical situations in managing supply chainsMore Risk Sources in Supply ChainsComparing with the traditional business, managers in firms must face more risk factors in theirsupply chains these days. Many of these new risk factors have originated from two influentialfeatures of business management in the 1990s, globalization and outsourcing.As economy around the world has become increasingly global, the extended supply networks had toface many new types of risk including natural disasters, political/social instability,cultural/communication inconsistency, exchange rate fluctuation, and local legislations. Traditionally,those risks were considered as "country/region-specific" but with significant change in attitudetoward global trade and investment, they are not national or regional anymore; they can easily
  • 2. influence many companies working miles far from those regions and countries. Just to giveexamples, cultural differences and norms are blamed for increasing rate of product recalls in recentyears1, China’s initial unresponsive and surreptitious approach is discussed as a key factor for theinfluence of SARS crisis on global supply chains2 and more recently, the terrifying pain of Tōhokuearthquake and the destructive tsunami afterwards, has been felt by many local Japanese plants andacross many supply chains far from the center of the earthquake3.More globalization in international business, moreover, offers another significant challenge forcompanies around the world; they have to deal with longer lead-time (and consequently, higheruncertainty) in their global supply chains which itself explains the critical role of transportation inglobal business. As an explicit consequence, another important class of risk might be highlighted inthe risk profile of global companies: “Transportation Risk”4, 5.Besides globalization, outsourcing has brought in several new risks for a supply chain. Dependencyon the quality of material and services from insourcer and the possibility of opportunistic behaviorfor participants with different and even conflicting goals are examples of these new risk factors.The other risk factor that has become important by growing tendency towards outsourcing is the"intellectual property risk"; with outsourcing and integration in the world economy, the intellectualproperties of companies are increasingly at risk. Accordingly, protecting intellectual properties is akey concern in the modern business environment shifting towards knowledge-based economics. Theinsufficient laws in the judiciary systems of some of host countries might even intensify the issue6.Adding to these new risks introduced by outsourcing to focal companies, a recent study shows thatmany businesses are ill-prepared for the time when the cooperation between the outsourcing andinsourcing company will terminate. This transition to build new cooperation schemes with newpartners may involve many challenges and risk factors for both insourcer and outsourcer7.Faster Risk Propagation in Supply ChainsBesides new types of risks introduced by cost-efficiency trends in managing supply chains, thecompanies must deal with another important, and alongside painful, fact: disruption in one specificpart of a global supply chain can ripple down the chain much faster nowadays. This fast propagationof disruption effects in supply chains is chiefly due to lack of excess resources and redundanciesacross the system.Traditionally, supply chains were designed with some redundancies in different segments. Thesebuffers – whether in the form of excess stock, time…- would help companies to better handlefluctuations in the daily business. Moreover, facing with breakage in their supply chains, they hadextra time to plan for managing abnormal events; because, the influences could be handled partly inthe meantime with some of redundancies in the chain. However, hoping to eliminate all forms ofwastes and buffers, many companies took some approaches like lean and JIT. The potential gains ofthose philosophies in the stable business environment were huge. By holding fewer buffers, e.g. lessstock, and working with less suppliers the operating costs of business were decreased considerably.Besides, companies could benefit from the value of money savings by less investment, e.g., in thestorage facilities. Nonetheless, these enormous benefits has come with some pitfalls; working leanand lack of buffer contribute to faster spread of risks in global supply chains. Facing a disruption,there are very limited buffer in different tiers of supply chains to bear the impacts. Accordingly, theadverse effects of initiating event spread quickly form one actor to the downstream of supply chain
  • 3. and practically, there is little time for the companies to find appropriate response solutions to handlethose abnormalities.Higher Risky SituationIncreasing the risk factors in supply chains on one hand and the rapid propagation of disruptionimpacts in supply network (because of high level of interdependencies and lack of buffer) on theother hand, put many companies in a challenging situation; they must work in a more risky andunsafe business environment.Many studies have approved this increase in riskiness of the daily business of companies. Almost twothird (65%) of about 3000 executives surveyed in 2006 McKinsey & Co. Global Survey of BusinessExecutives reported that their firms supply chain risk had increased over the past five years (duringthe 2001-2006 period)8. In 2008 report, the situation is even worse when 77 % of respondentsbelieve that the degree of risk their companies must face in the supply chain has increased in pastfive years9.Another study by Lloyd’s in association with the Economist Intelligence Unit shows that over a one-year period, one in five companies suffered significant damage from failure to manage risk and morethan half experienced at least one near miss10.The increasingly exposure of supply chains to risks and disruptions is also studied from manytheoretical perspectives. One of those theories is Normal Accident Theory (NAT) which argues that inthe conditions of high “Interactive Complexity” and “Tight Coupling”, the occurrence of accidents inthe socio-technical systems is more likely or, as Charles Perrow describes, “Normal”11. A system istightly coupled when there is no or little slack within the system and between different parts andfunctions and it is interactively complex when its sub-systems (actors or different functions) areconnected and interact in many different (and unanticipated) ways. To avoid accidents, NAT suggeststhat firms must make the choices to either reduce their complexity or loosen coupling.
  • 4. Linear Interactions Complex High High Disruption Potential Tight Coupling JIT & Single Sourcing Globalization & Outsourcing Low Figure 2- NAT framework and business trends in managing supply chainsSo, based on NAT, JIT production makes supply chains more vulnerable to disruptions because ofhigh level of ‘tight coupling’. Consequently, to avoid “Normal Accidents” in a lean supply chain, theinteractions must be necessarily less and the processes must be kept linear. Similarly, globalizationand outsourcing increase the risk exposure in supply chains due to higher level of ‘Interactiveness’ inthe system; supply chains are growing in size, more actors are involved and many different functionsin those companies must be aligned and coordinated. This will unavoidably increase the probabilityof failure in the supply chain operation (Figure 2).Less (Control on) Resources to Handle Risky SituationsThe 90’s trends in business such as outsourcing, JIT production and Single Sourcing not only putcompanies in a more risky position, but also limit their ability to manage growing disruptions in theirsupply chains.As firms begin to outsource parts of their operation process they, at the same time, experience twoother phenomena—loss of control on the resources and loss of visibility across their supply chain12.This loss of control and visibility (that is reflected in the uncertainty about the situation in supplychain), on one hand, affects the companies’ ability to detect disruption and have a full image of thesituation and on the other hand, limits the degrees of freedom they have to cope with abnormality.Moreover, aiming to identify and eliminate all forms of wastes and buffers in their supply chains,many firms have turned to lean philosophy and also reducing the number of suppliers in their supplybase. This has resulted in eliminating many, if not all, types of buffers –in different forms like finishedgoods, work-in-process and raw materials inventory13- in the supply chains. However, when thedisruptions occur, they have little resources and alternatives to handle shocks and abnormalities.
  • 5. Higher Impact on Supply Chain PerformanceThe business for supply chains is more risky nowadays and the essential resources to handleabnormal events are rare and distributed among different actors; the explicit consequence of thisparadoxical situation in managing supply chains is higher impact on smooth operation of supplychains. So, mangers in the firms must be ready to face different type of disruptions that continuouslychallenge their constant efforts to improve the performance of their supply chains.The negative effects of a vulnerable Supply chain on the short-term and long term performance offocal companies are also confirmed by several empirical studies. Based on a large sample - 519glitches announcements made during 1989 to 2000- Hendricks and Singhal underscore the impact ofdisruptions in supply chains on the shareholder value. The message is alarming: on average “supplychain glitch announcements are associated with an abnormal decrease in shareholder value of10.28%”14. In another work, based on a sample of 885 supply chain events announced by publiclytraded firms, they show how abnormal events have a significant negative impact on the assetutilization, operational performance, and profitability of focal company as well15.Higher Customer ExpectationsToday we live in such a tough competitive time. Customers constantly demand for higher level ofservice (that includes higher reliability and near-instantaneous delivery of products); theirexpectations are growing every day; and of course, they have more options from global competitorsand have more avenues to compare, get opinions and negotiate pricing than ever before.For many companies, keeping and losing a customer literary depends on the previous customersexperience with them. Accordingly, customer satisfaction is the essential issue in managing supplychains in many companies willing to compete in the global market.Nonetheless, modern supply chains seems more vulnerable, complex and risk-prone; theirperformance in delivering the customers’ expectation is increasingly restrained by many new types ofdisruptions and uncertainties that must be managed in the daily business. Furthermore, while thecustomers’ expectations alter constantly over time, the change might be easily hindered by lack ofvisibility in a complex interconnected supply network16.Final words: Supply Chain Risk ManagementCustomers demand for higher level of service and their expectations are growing more and moreevery day while at the same time the trends in the business like globalization, single sourcing, JIT,outsourcing, etc. have made the business for most of international companies so rough andextremely risky. How can we handle this paradoxical situation?For most experts the answer lays in Supply Chain Risk Management; identifying, quantifying,mitigating and continuously monitoring risk sources across whole supply chain.However, for a business culture in which the risk criteria were increasingly being traded off againstother values such as cost or profitability, it is not easy to accept the concept and implement it in thereal life of their business. Most companies still tend to view risk management and contingencyplanning as being non-value adding. Why? For many reasons, two of them are:
  • 6. Firstly, linking supply chain risk management efforts to their results is not an easy task; because somepeople may ask themselves: if no accident occurs, is that due to proactive risk management work oris it pure luck?Secondly and related to the first point, the high level managers in most companies are not sure thatthey will receive any bonus for something might not happen during their management period.The first point seems a responsibility of scholars; they must present frameworks that supportcompanies to better evaluate the risk management practices. We are also in obvious need foroverall-accepted standards and also detailed best practices for managing risks in supply chains.The second point is more a practical issue; it calls for a shift in the cultural business and the mindsetof companies’ board regarding risk management and its contribution to overall strategy oforganizations- something that hopefully happens very soon. At least there are some good news! Oneof them is presented in a study done by IBM; they interviewed 400 senior executives from differentparts of globe from North America to Asia Pacific region who are responsible for their organizations’supply-chain strategies and operations17. One of the key findings of this study is very muchfascinating and inspirational:“Risk management emerged as supply chain executives’ second most common concern.”Footnotes:1- Aleda V. Roth, Andy A. Tsay, Madeleine E. Pullman, John V. Gray, "Unraveling the food supplychain: Strategic insights from China and the 2007 recalls" , Journal of Supply Chain Management, 44(2008), 22.2- Wei-Jiat Tan, Peter Enderwick , "Managing threats in the Global Era: The impact and response toSARS", Thunderbird International Business Review, 48 (2006), pp. 515-536.3- Behzad Behdani, " Japanese Catastrophe and the Dark Side of Global supply Chains" (2011), NextGeneration Infrastructures website, Accessed 15 June, 2011,http://www.nextgenerationinfrastructures.eu/index.php?pageID=5&itemID=564591.4- A 2008 survey by the consulting company PRTM found that companies consider on-time deliveryof critical products as well as overall product/supply availability as major risks when globalizing theirsupply chain [Global Supply Chain Trends 2008-2010, Sixth Annual Survey by PRTM, 2008,http://www.prtm.com/strategicviewpointarticle.aspx?id=2392&langtype=1033].5- Another recent report of the practitioners view on expected risk in their supply chains show that"Many companies are encountering issues with global sourcing, including unreliable delivery (65percent of respondents), longer lead times (61 percent) and poor quality (61 percent), with anadditional 15 percent anticipating such problems within the next three years. "[ Karen Butner, "Thesmarter supply chain of the future", Strategy and Leadership, 38 (2010), 22].6- the Economist, "Doing business in China: 850,000 lawsuits in the making" (2008), the Economistweb site, Accessed 15 June, 2011, http://www.economist.com/node/11023270.7- Klemen Kavcic, Mitja I. Tavcar, "Planning successful partnership in the process of outsourcing",Kybernetes, 37 (2008), 241.8- "Understanding supply chain risk: a McKinsey global Survey" (2006), The McKinsey Quarterly,Accessed 15 June, 2011,
  • 7. http://www.mckinseyquarterly.com/Understanding_supply_chain_risk_A_McKinsey_Global_Survey_1847.9- "Managing global supply chains: McKinsey Global Survey Results" (2008), The McKinsey Quarterly,Accessed 15 June, 2011,http://www.mckinseyquarterly.com/McKinsey_Global_Survey_Results_Managing_global_supply_chains_2179.10- "Taking Risk on Board" (2006), Lloyd’s and the Economist Intelligence Unit, Accessed 15 June,2011, http://www.lloyds.com/Lloyds/Press-Centre/Press-Releases/2005/10/~/media/Lloyds/News/Press_releases/News%20Centre%20Gallery/2005/11/Takingriskonboard_pdf.ashx.11- Charles Perrow , Normal Accidents: Living with High-Risk Technologies, Princeton UniversityPress, 1999.12- George A. Zsidisin, Gary L. Ragatz, and Steven A. Melnyk, "Effective Practice in BusinessContinuity Planning for Purchasing and Supply Management " (2003), Accessed 15 June, 2011,http://www.alliedacademies.org/Publications/Papers/JIACS%20Vol%2016%20No%208%202010%20p%201-17.pdf.13- Jeffrey K. Liker, the Toyota Way, McGraw-Hill, 2004.14- Kevin B. Hendricks, Vinod R. Singhal, "The effect of supply chain glitches on shareholder value",Journal of Operations Management, 21(2003), 501.15- Kevin B. Hendricks, Vinod R. Singhal, "Association between supply chain glitches and operatingperformances", Management Science, 51(2005), 695.16- In report published by Accenture in 2008, 63% of those surveyed experienced supply chaindisruptions in the past five years and 94% said the disruption influenced profitability and affectedtheir companys ability to meet customer expectations ["Keeping ahead of supply chain risk anduncertainty" (2008), Accenture and Oracle, Accessed 15 June, 2011, http://www.accenture.com/us-en/pages/insight-keeping-ahead-supply-chain-risk-uncertainty-summary.aspx].17- Karen Butner, "The smarter supply chain of the future", Strategy and Leadership, 38 (2010), 22.