Mitigating supply chain risk in uncertain times murphy's law--mworld volume 11 number 3 fall 2012


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The simple fact is that in today’s longer global supply chains, product moves over greater distances and across
more multinational borders than in the more localized
supply chains of the past. This distance-based supply chain, whose links are forged by many supplier tiers in various countries, carries a risk dependent on its length and
diversity. The longer and more diverse it becomes, the
more it is susceptible to unforeseen circumstances.

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Mitigating supply chain risk in uncertain times murphy's law--mworld volume 11 number 3 fall 2012

  1. 1. CHECKPOINT Mitigating Supply Chain Risk in Uncertain Times—Murphy’s Law BY THOMAS L. TANEL The simple fact is that in today’s longer global supply chains, product moves over greater distances and across more multinational borders than in the more localized supply chains of the past. This distance-based supply chain, whose links are forged by many supplier tiers in various countries, carries a risk dependent on its length and diversity. The longer and more diverse it becomes, the more it is susceptible to unforeseen circumstances. By consequence, the supply chain is rendered delicate, extended, and bloated in some way. Are you equipped to succeed in a supply chain world of increasing difficulty and insecurity and multiple interconnected supply chains? Do you have the correct response to a supply disruption in the supply chain and the attendant supply-related risk? Supply chain disruption can destroy shareholder value and corporate profitability. More importantly, taken together, total supply chain costs consume about 7 to 12% of corporate annual revenue across all industries, which makes the task even more daunting. IMPACT ON GROWTH In their 2005 study of the financial effect of supply chain disruptions, Kevin Hendricks, formerly of the University of Western Ontario, and Vinod Singhal, of the Georgia Institute of Technology, made some interesting findings. They discovered that the average effect of supply chain disruptions in the year leading to the disruption included a 107% drop in operating income, 7% lower sales growth and 11% growth in cost. Share price volatility in the year after the disruption was 13.5% higher than in the year before disruption. Don’t you think that BP can attest to this effect as a result of the Gulf Coast oil spill in the USA? Risk is an everyday occurrence in business, and companies either consciously or unconsciously include it in their decision-making process when managing their operations. (See sidebar: Most Common Supply Chain Risks.) Companies must invest in enhancing the integrity of their supply chains, in a manner that balances operational objectives with reputation risks (a type of risk related to the trustworthiness of business). Supply chain risk exists in many varied forms. For MOST COMMON SUPPLY CHAIN RISKS • Financial instability, bankruptcy, or financial failure of a supplier • Fire, chemical spill, etc. at the supplier firm • Problems in electronically sharing information with suppliers • Suppliers incorrectly interpreting our requirements • Natural disasters affecting suppliers’ operations • Political instability, terrorism, civil strife, or war affecting suppliers’ operations • Reduced accuracy of forecasts and plans • Long physical distances between buyer and suppliers • Inability to influence /manage suppliers • Lack of alternative sources of supply • Labor availability, slowdowns, strikes, and quality of workforce • Health issues, disease, quarantines, and pandemics Source: CATTAN Services Group, Inc. Research MWORLD FALL 2012 American Management Association 19
  2. 2. CHECKPOINT instance, damage to a firm's reputation can Figure 1: Levels of Likelihood Criteria Dimension Example result in lost revenue or destruction of shareholder value. Damage to revenue may be perDescriptor Probability Rank Value petrated by transportation disruptions, natural Highly Probable >75% High 5 disasters, strikes, and political unrest—all of which may interrupt supply of product to the Probable >50% — <75% Medium High 4 ultimate customer or components to the facOccasional >25% — <50% Medium 3 tory. By way of example, the European debt criRemote >10% — <25% Medium Low 2 sis, the Japanese earthquake and tsunami, and the Arab Spring uprisings all had a ripple effect Improbable <10% Low 1 in 2011. As PPB Newslink reported in March 2011, more than 40% of the world’s USB flash drive supply is produced in Japan. In fact, one major sup- organizations pay, on average, an additional 4% to plier, Toshiba, supplies 30% of the world’s resolve a supply incident stemming from supplier finanmemory chips alone. When the tragedy unfolded in cial distress. What specifically accounts for that 4% cost Japan due to the history-making earthquake and increase? According to the PSC research, the real cost of tsunami, memory prices jumped by 50 to 60% poor supplier risk management includes: supplier product line or facility closures; reduction in quality stanovernight–literally. dards, and supplier layoffs and bankruptcies. Recently, as a hedge against rising oil prices, Delta SUPPLY BASE A major concern for purchasing STABILITY and supply chain executives is Airlines bought the Phillips 66 refinery in Trainer, supplier financial stability as the sup- Pennsylvania, to maximize its jet fuel production ply base shakeout occurs from the last four years’ capacity. As reported by USA Today, “Fuel makes up worldwide financial reckoning. According to between 25% and 40% of an airline's costs, and soarPricewaterhouseCoopers LLP, many companies are ing prices in the past several months have dug into beginning to learn that relationships with critical industry profits and led to higher fares for the flying suppliers shouldn’t be taken for granted. public. The Pennsylvania refinery and products it Relationships must be acknowledged, protected, and produces will fulfill 80% of Delta's fuel needs in the nurtured to positively impact a company’s bottom U.S,” the publication said. Clearly, understanding and mitigating supply line. chain risk needs to be recognized by the C-level of As a case in point, the effects from the March 2011 earthquake and tsunami, and the ongoing nuclear management. For example, what does this do to our crisis in Japan: Automotive News reported that supply supply risk and the increased supplier risk dependchain management at Honda was being stress tested, ency? How do we assure ourselves of supplier viabilgiven that at least 113 of its suppliers are located in the affected areas. Closely monitoring the financial health of suppliers has become an important part of the job for anyone involved in a company’s purchasing or procurement sourcing efforts. A solvent supplier yesterday may become an insolvent supplier today. While supplier insolvency is a known risk, the recent economic downturn has brought it to the forefront. To weather this and future storms, organizations must focus on a proactive approach to better anticipate changes in supplier viability and financial health. According to a recent research project by the Procurement Strategy Council (PSC), procurement 20 Figure 2: Severity of Impact Criteria Dimension Example Descriptor Rank Value Catastrophic High 5 Critical Medium High 4 Serious Medium 3 Marginal Medium Low 2 Negligible Low 1 American Management Association MWORLD FALL 2012
  3. 3. CHECKPOINT ity and financial health in light of these trends? Having assessed the risks and LIKELIHOOD identified those Highly that require action, plans need to be Probable drawn up and responsibilities Probable assigned to control and mitigate these risks. This means risk identifiOccasional cation, risk assessment, and risk mitigation. The intent of risk mitiRemote gation planning is to answer the question, “What is our approach for addressing this potential unfavorImprobable able consequence?” ᔢ Avoiding risk by eliminating the root cause and/or consequence ᔢ Controlling the cause or consequence ᔢ Transferring the risk, and/or ᔢ Assuming the level of risk and continuing on the Supply Chain Continuity Plan The allocation of risk should be dependent on the assessment of the likelihood and consequence of the risk and then the identification of who is best able to control or manage the risk. Normally a risk template has two critical elements: 1. Likelihood of occurrence (probability)—A risk is an event that "may" occur. The probability of it occurring can range anywhere from just above 0% to just below 100%. 2. Severity of impact or consequence (magnitude)—A risk, by its very nature, always has a negative impact. However, the severity or size of the impact varies in terms of cost and impact on some critical factor. So let’s look at the Levels of Likelihood Criteria Dimension Example in Figure 1, which represents the probability that a risk will occur. It values that risk’s probability of occurrence on a scale of 1-5 with 5 being the highest-ranked probability and 1 being the lowest-ranked. The Severity of Impact Criteria Dimension Example in Figure 2 represents the magnitude of a risk’s impact. On a scale of 1-5, it values risk’s severity of impact with 5 being the highestranked impact and 1 being the lowest-ranked. You then use the two dimensions in Figures 1 and 2 to calculate and quantify the risk in Figure 3. This Risk Analysis Levels of Likelihood and Severity of PHOTOS: COURTESY OF THOMAS L. TANEL RISK MITIGATION PLANNING MWORLD FALL 2012 American Management Association Figure 3: Risk Analysis Levels of Likelihood and Severity of Impact Scorecard Example Severity of Impact NEGLIGIBLE MARGINAL 2x5= 1x5= 5 10 2x4= 1x4= 4 8 2x3= 1x3= 3 6 2x2= 1x2= 2 4 2x1= 1x1= 1 2 SERIOUS 3x5= 15 3x4= 12 3x3= 9 3x2= 6 3x1= 3 CRITICAL 4x5= CATASTROPHIC 5x5= 20 4x4= 25 5x4= 16 4x3= 20 5x3= 12 4x2= 15 5x2= 8 4x1= 4 10 5x1= 5 Impact Scorecard Example gives you a quick, clear risk quantification ranking of the priority that you need to give to each risk. Do you remember what BP’s CEO said about the Gulf of Mexico oil spill? He gave it a likelihood of occurrence of 1 but a severity of impact of 5. Well, the company was certainly wrong in their risk assessment! The Scorecard Example chart in Figure 3 allows you to rate potential risks on these two dimensions: (1) the probability that a risk will occur is represented on one axis of the chart and (2) the impact of the risk, if it occurs, on the other. The higher the score, the higher the risk. You can now decide how risk-averse-based you are. Does your organization have the wherewithal to implement a robust Supply Chain Risk Management (SCRM) strategy? If not, do you feel that your organization is flirting with disaster by not exploring and investing in SCRM measures? Since SCMR is becoming an increasingly visible, multifaceted phenomenon, what are you doing to mitigate it? As companies look to recover from the uncertainty and economic turbulence of the last four years, the experience of managing supply chain risk across oceans and continents is still daunting for many organizations. Why? They unknowingly have realized that they have taken on greater exposure to risks and uncertainty as the supply chain today has been rendered weak and vulnerable. MW Thomas L. Tanel, C.P.M., CISCM, CCA, CTL, is president and CEO of CATTAN Services Group, Inc. 21