Managing Supply Chain Risk in Lean Times
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Managing Supply Chain Risk in Lean Times

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Managing Supply Chain Risk in Lean Times Managing Supply Chain Risk in Lean Times Presentation Transcript

  • Managing Supply Chain Risk in Lean Times Track 1 Session 8
  • Mark Cotteleer Assistant Professor Marquette University mark.cotteleer@marquette.edu 414-288-5493 2006 MATERIAL HANDLING & LOGISTICS CONFERENCE SPONSORED BY HK SYSTEMS
  • Abstract The business benefits of operating lean are well established. However, as lean principles continue to take hold through our supply chains, it is also important to consider the risks they introduce. This session takes a look at balancing the risks and rewards of lean as it applies to sourcing. Attendees will take away an understanding of how to define and maintain "optimal leanness" in their firms. 2006 MATERIAL HANDLING & LOGISTICS CONFERENCE SPONSORED BY HK SYSTEMS
  • Agenda Tradeoffs in Lean Procurement – Financial Example How Much Risk? – How Realistic is the Threat? Risk Mitigation Strategies – Proactive – Reactive 2006 MATERIAL HANDLING & LOGISTICS CONFERENCE SPONSORED BY HK SYSTEMS
  • The Risk in Lean Procurement Mark J. Cotteleer Marquette University
  • Lean Practice in Sourcing Fewer suppliers Long term relationships – Selection based on past relationships and performance Single-sourcing of components “Tiering” of the supply base – Assignment of whole components to supplier – Design and production become responsibility of supplier “Just in Time” Delivery 2006 MATERIAL HANDLING & LOGISTICS CONFERENCE SPONSORED BY HK SYSTEMS
  • Tradeoffs in Lean Procurement Benefits Benefits of “Leanness” increase as policies are implemented – Supplier reduction – Supplier integration – Vendor-managed inventories Leanness Benefit Leanness is expected to improve operations, profitability, and firm value. Leanness 2006 MATERIAL HANDLING & LOGISTICS CONFERENCE SPONSORED BY HK SYSTEMS
  • A (hopefully) clarifying example from Finance Consider a simple business that purchases a single commodity from two suppliers. An analysis of the business yields the following forecast: N CFn NPV = ∑ Net Profit (est. cash flow) = $1,000 n =1 (1 + r ) Total Years of Life = 20 n Cost of Capital = 8% Then the value of the firm is estimated to be: NPV = $9818.15 2006 MATERIAL HANDLING & LOGISTICS CONFERENCE SPONSORED BY HK SYSTEMS
  • A (hopefully) clarifying example from Finance Assume the owner decides to increase supply chain “Leanness” by partnering with a single supplier: Net Profit (est. cash flow) = $1000 $1,100 XXX N CFn Total Years of Life = 20 NPV = ∑ n =1 (1 + r ) n Cost of Capital = 8% As a result of the increased cash flow estimate, the revised estimate of firm value is: NPV = $10,799.96 (vs. $9,818.15) And it looks like “going lean” was a good decision. 2006 MATERIAL HANDLING & LOGISTICS CONFERENCE SPONSORED BY HK SYSTEMS
  • Tradeoffs in Lean Procurement Benefits However, as the firm increases its “Leanness”, new kinds of risk arise from dependence on fewer, more critical suppliers – In short, becoming more “Lean” in procurement can lead to reduced supply chain stability Stability Benefit Leanness Benefit Stability Losses Due To Governance Mismanagement Life Cycle “Natural” Disruption Hold Up Leanness 2006 MATERIAL HANDLING & LOGISTICS CONFERENCE SPONSORED BY HK SYSTEMS
  • A (hopefully) clarifying example from Finance Neither supplier is well run. Therefore, although costs were reduced (improving expected profitability), uncertainty also increased, (thus increasing cost of capital). The new forecast changes as follows: Net Profit (est. cash flow) = $1,100 Total Years of Life = 20 Cost of Capital = XX 10% 8% As a result of the increased cash flow estimate, the revised estimate of firm value is: NPV = $9,364.92 2006 MATERIAL HANDLING & LOGISTICS CONFERENCE SPONSORED BY HK SYSTEMS
  • A (hopefully) clarifying example from Finance An increase in “Leanness”: – Increases cash flow (Leanness Benefit) – Increases firm risk (Decrease in “Stability Benefit”) Pre-Lean Firm Value = $9,818.15 Lean Firm Value = $9,364.92 The shift to “Lean” actually cost the firm $453.23 (4.6%) of its value!!! 2006 MATERIAL HANDLING & LOGISTICS CONFERENCE SPONSORED BY HK SYSTEMS
  • How much risk can Lean Procurement add? A “Sole Sourcing” example… Three firms producing identical products – Each purchases 50 essential components from 50 different suppliers – Each supplier has 99% chance of avoiding disruption in the next year – If a component is dual sourced and disruption of one supplier occurs, the other supplier can meet demand Only difference between firms is percentage of components they have sole vs. dual sourced – Firm 1 = 0% (100% dual sourced) – Firm 2 = 50% – Firm 3 = 100% (100% sole sourced) What is the probability of supply (and therefore production) disruption for each of these firms? 2006 MATERIAL HANDLING & LOGISTICS CONFERENCE SPONSORED BY HK SYSTEMS
  • How much risk can Lean Procurement add? What is the probability of supply (and therefore production) disruption for each of these firms? Firm 1 (100% dual sourced) probability of supply disruption during year – 0.50% Firm 2 (50% sole sourced) probability of supply disruption during year – 22.41% Firm 3 (100% sole sourced) probability of supply disruption during year – 39.50% Probability of disruption is 79 times greater for the 100% sole source firm!! 2006 MATERIAL HANDLING & LOGISTICS CONFERENCE SPONSORED BY HK SYSTEMS
  • How much risk can Lean Procurement add? Probability of supply chain induced disruption is a function of: – Number of critical components – Percent sole sourcing – Individual supplier stability Stability Probabilities for 50% Sole Sourced Firm Overall Supply Chain Stability 100% 20 Components 40 Components 60 Components 75% 50% 25% 0% 100.00% 97.50% 95.00% 92.50% 90.00% Individual Supplier Stability (% chance o f no n-disruptio n) 2006 MATERIAL HANDLING & LOGISTICS CONFERENCE SPONSORED BY HK SYSTEMS
  • How realistic is this scenario? Supply chain disruptions are associated with diminished operating performance (Hendricks & Sighal, 2005a) – Operating Income – Return on Assets – Return on Investment Supply chain disruptions are associated with diminished market performance (Hendricks & Sighal, 2005b) – Stock Market Performance Supply chain disruptions are associated with increased stock market risk premium (Hendricks & Sighal, 2005b) – Beta 2006 MATERIAL HANDLING & LOGISTICS CONFERENCE SPONSORED BY HK SYSTEMS
  • The Lean/Stability tradeoff Benefits Supply Chain Management Benefit Stability Benefit Leanness Benefit Stability Losses Due To Governance Mismanagement Life Cycle “Natural” Disruption Hold Up Leanness L* 2006 MATERIAL HANDLING & LOGISTICS CONFERENCE SPONSORED BY HK SYSTEMS
  • Managerial Take Away Lean Procurement is subject to diminishing returns – Firms need to seek “optimal” leanness 2006 MATERIAL HANDLING & LOGISTICS CONFERENCE SPONSORED BY HK SYSTEMS
  • Influencing the Lean/Stability tradeoff Benefits Supply Chain Management Benefit Stability Benefit Leanness Benefit Stability Losses Due To Governance Mismanagement Life Cycle “Natural” Disruption Hold Up Leanness L* 2006 MATERIAL HANDLING & LOGISTICS CONFERENCE SPONSORED BY HK SYSTEMS
  • Influencing the Lean/Stability tradeoff Benefits Supply Chain Management Benefit** Stability Benefit** Leanness Benefit Stability Losses Due To Governance Mismanagement Life Cycle “Natural” Disruption Hold Up Leanness L* L** 2006 MATERIAL HANDLING & LOGISTICS CONFERENCE SPONSORED BY HK SYSTEMS
  • Managerial Take Away Lean Procurement is subject to diminishing returns – Firms need to seek “optimal” leanness “Optimal Leanness” can be increased through supply chain risk management Lean discourages diversification as a supply chain risk management strategy – Managers must, therefore, focus on mitigation 2006 MATERIAL HANDLING & LOGISTICS CONFERENCE SPONSORED BY HK SYSTEMS
  • Lean-induced risk requires proactive and reactive management Proactive Reciprocal Trust IP Control Active Assessment Reactive Tit for Tat Response Capability 2006 MATERIAL HANDLING & LOGISTICS CONFERENCE SPONSORED BY HK SYSTEMS
  • Proactive Risk Mitigation: Reciprocal Trust The only way to have a friend is to be one (R.W. Emerson) Loss of “Trust” in the supplier relationship leads to costly behaviors (Rossetti & Choi, 2005) – Suppliers as competitors – Parts, repairs, accessories – Dispersion of Intellectual Property Key trust issue from a stability perspective is supplier willingness/opportunity for “Hold Up” – Monopoly sources – Increased switching costs – Loss of flexibility 2006 MATERIAL HANDLING & LOGISTICS CONFERENCE SPONSORED BY HK SYSTEMS
  • Proactive Risk Mitigation: IP Control Retained ownership of design and associated intellectual property Retained ownership of manufacturing process Retained ownership of tooling 2006 MATERIAL HANDLING & LOGISTICS CONFERENCE SPONSORED BY HK SYSTEMS
  • Proactive Risk Mitigation: Active Assessment Active, comprehensive assessment is critical – Financials may be a trailing indicator – Governance continuity – Capital Investment – Percentage of business (not too high OR too low) “Surprise” Supply Base Data Preliminary Deep Risk Action Develop Evaluation Selected? Dive Ranking Required? Action Plan Model Model No No Market Disseminate Data to Response Network Network Internal Private Equity Turnaround Consulting 2006 MATERIAL HANDLING & LOGISTICS CONFERENCE SPONSORED BY HK SYSTEMS
  • Reactive Risk Mitigation: Tit for Tat Theoretically “best” strategy for achieving cooperative behavior among self-interested parties – Partners engage in repeated, long-term relationship – Always cooperate unless provoked – Always retaliate if provoked – Forgive quickly Repeated punishment and forgiveness eventually generate a payoff higher than any initial loss from rebuffed cooperation Partner’s incentive to cheat rises as soon as they predict an end to the association – Must move quickly/decisively to end relationships 2006 MATERIAL HANDLING & LOGISTICS CONFERENCE SPONSORED BY HK SYSTEMS
  • Reactive Risk Mitigation: Response Capability When a friend is in trouble, don’t annoy him by asking if there is anything you can do. Think up something appropriate and do it. (E.W. Howe) Build reactive capacity – Process for intervening in troubled suppliers – Internal – Response network – Repeatable & Regularly Exercised Process 2006 MATERIAL HANDLING & LOGISTICS CONFERENCE SPONSORED BY HK SYSTEMS
  • If You Cannot Manage It, You Must Diversify It Sole source on components, not capabilities – Harley-Davidson locks in long-term commitments with suppliers but retains redundant capabilities in supply chain (i.e., only you make castings for the FatBoy but someone else makes castings for the Road King). 2006 MATERIAL HANDLING & LOGISTICS CONFERENCE SPONSORED BY HK SYSTEMS
  • Key Takeaways Lean Procurement is subject to diminishing returns – Firms need to seek “optimal” leanness “Optimal Leanness” can be increased through supply chain risk management Lean discourages diversification as a supply chain risk management strategy – Managers must, therefore, focus on mitigation Proactive and reactive risk mitigation represents a critical element of lean management 2006 MATERIAL HANDLING & LOGISTICS CONFERENCE SPONSORED BY HK SYSTEMS
  • Questions?