sascom ® INDUSTRY ISSUES by Rob Handfield Reducing the impact of disruptions to the supply chain A managerial framework based on observations from multiple executives Reprinted from sascom magazine ® International manufacturing supplement
INDUSTRY ISSUES by Rob Handfield COLUMNS Reducing the impact of disruptions to the supply chain A managerial framework based on observations from multiple executives L ow-cost sourcing has now become a staple of competitive strategy in many retail and manufacturing and customs delays brought supply chain operations to a standstill. Other events that have an impact on customer sectors. As organizations source a service include natural disasters, fire greater proportion of manufactured and theft, poor communication of products from low-cost countries, customer requirements, parts shortages, they often do not consider the hidden and quality problems. These disruptions perils of these approaches, especially can be costly and have in many cases within the context of enterprise risk brought distribution and production to a screeching halt. Supply chain disruptions can reduce shareholder value by as much as eight to Supply chain disruptions can reduce 10 percent, or even worse in “time- sensitive” environments where earlyshareholder value by as much as eight to 10 market introduction is critical to success. percent, or even worse in “time-sensitive” The topic of ERM is at the top of most corporate agendas, but the risk of environments where early market extensive supply chain disruption as the consequence of an undesirable event is introduction is critical to success. often overlooked. When organizations discuss ERM, the discussion often revolves around financial and strategic management (ERM). Global sourcing risk (see Figure 1). In reality, however, affords many benefits in the form the total set of risks to an organization of lower price and expanded market is much broader. It includes hazard access, but there are risks associated. risk and operational risk. Hazard risks Only recently have senior executives refer to weather disasters, equipment begun to recognize the increased risk shutdown, or product liability, while attributed to the higher probability of operational risks include major product and service flow disruptions disruptions such as theft, late supplier in global sourcing networks. A major deliveries, IT systems shutdowns and so disruption in the offshore supply chain on. As shown in Figure 1, a significant can “shut down” a company, and have number of risk exposures have their dire consequences on profitability. This root cause in entities located within was felt most drastically in the past their supply chain, which include all few years, when such events as 9/11, organizations and activities associated the war in Iraq, the West Coast port with the flow and transformation of workers strike, and increased regulatory goods from the raw materials stage manufacturing | sascom 35
chains to assure uninterrupted material availability? Is it possible to respond in an agile manner to customer requirements in a global sourcing environment? Based on a set of interviews with executives in multiple industries, we discovered several key themes associated with supply chain disruptions. First, companies should develop supply chain strategies that explicitly consider two parameters that “amplify” the negative impact of disruptions on customer and brand performance: globalization and product/process complexity. Second, companies should design strategies with countermeasures that mitigate the impact of these effects, namely: • Improved visibility to key supplyFigure 1: Enterprise Portfolio of Risks. chain nodes that can quickly detect disruptions.through to the end user, as well as the is disrupted. Stock market reaction to • Well-positioned resources that enable 1associated information flows. supply chain disruptions have also been quick short-term recovery plans. Supply chain management (SCM) shown to be significant. Firms that haveis the integration and management of announced major supply chain problems • Long-term collaborative approachessupply chain organizations and activities have seen their shareholder value drop to eliminate disruptions in the future.through cooperative relationships, by 10.28 percent on average, with an Our research also suggests that 3effective business processes, and average recovery time of 50 trading days. companies with a high exposure tohigh levels of information sharing to In high-tech markets, companies global supply chain risk invest morecreate high-performing value systems such as Sony have even pulled their in improved inventory and capacitythat provide member organizations a manufacturing out of China and moved visibility systems. Companies with 4sustainable competitive advantage. it to Japan. Why? Sony executives found complex products and processes As many organizations continue that the relatively unresponsive Chinese are more likely to add incrementalto outsource manufacturing to low- production lines could not adapt fast inventory and labor to buffer the impactcost countries in Asia, the Caribbean, enough to cope with the unpredictability of disruptions. Finally, organizationsEastern Europe, and Latin America, of market requirements for digital cameras. exposed to both types of risk also investthe increased frequency and severity However, avoiding risk is made in longer term solutions such as trainingof supply chain disruptions increases more difficult by the increasing and collaborative tools to establishsignificantly. Research has shown that pressure to source globally, to exploit resilient supply chains that are agile andmost organizations are not adequately lower manufacturing costs and import able to respond to disruptions. While noprepared to manage supply chain risks. products. The complexity of products company can eliminate the probabilityRecent studies suggest that only between and processes is also adding to the of a major supply chain disruption, ®five and 25 percent of FORTUNE 500 probability of disruptions. In this those that act appropriately ahead ofcompanies are prepared to handle crises environment, what steps can an time will be better positioned to manage 2or disruptions and that a US$50 million organization take to design its supply these potentially devastating incidentsto US$100 million cost impact can be when they occur. 3incurred for each day a company’s supply Hendricks, K. and Singhal, V (2003). The Effect . of Supply Chain Glitches on Shareholder Wealth.chain network Journal of Operations Management, 21, pp 501- How do supply chain risks occur? 522. Knight, R. and Pretty, D., (1996). The Impact1 Handfield, R. and Nichols, E. (2002). Supply Chain of Catastrophes on Shareholder Value. The Oxford Supply chain risk management systems Redesign, Upper Saddle River, NJ: Prentice Hall, Executive Research Briefings, Templeton College, comprise the set of systems and 2002. University of Oxford, Oxford, England. 4 processes used to manage supply chain2 Mitroff, I. and Alpasan, M. (2003), Preparing for Jiang, B., What Pulled Sony out of China? Supply Evil, Harvard Business Review, April 2003, 109-115. Chain Management Review, Jan/Feb 2003, pp. 23-27. disruptions. Disruptions are defined as
stage of production, destroying chips for millions of cell phones in those 1. Disruption Discovery few minutes. What type of intelligence does a firm need to detect disruptions? Disruption discovery 2. Disruption Recovery As shown in Figures 2 and 3, after a Once the disruption is discovered, how does a firm effectively recover disruption occurs, the speed at which from a disruption? the problem is discovered becomes 3. Supply Chain Redesign critical. Executives must therefore How can a company strategically understand the types of disruptions re-design its supply chain over time present in global supply chain systems to become more resilient and avoid or easily mitigate disruptions? and develop methods for discovering disruptions in a timely, responsive fashion. They must also develop an understanding of risk exposure andFigure 2: Risk Management Framework. detect when risk events are about toThree key elements of supply chain disruption management. occur, or have occurred. At Nokia, the company’s computermajor breakdowns in the production Albuquerque, New Mexico. On March screens indicated that shipments ofor distribution nodes that comprise a 17, 2000, a line of thunderstorms rolled some Philips chips had been delayed.supply chain. These may include events through the city, and the furnace in the On March 20, 2000, Philips calledsuch as a fire, a machine breakdown, plant was hit by lightning and caught Nokia’s Chief Component Purchasingan unexpected surge in capacity that fire. The fire was extinguished in less Manager, Tapio Markki, to explain thecreates a bottleneck, quality problems, than 10 minutes by the sprinkler system, delay, which it said would be a week.natural disasters, customs delays, or but it had effectively destroyed the The fire affected the production ofany number of different problems. We plant’s clean room. (In a clean room, a some four million handsets. Nokia wasfirst developed a common framework small spec of soot can ruin the delicate about to roll out a new generation offor discussing global supply chain microscopic circuits that are central cell phones that depended on the chipsdisruptions, as shown in Figures 2 and 3. to modern electronics.) Smoke had from the infirm Philips lab. More than Figure 2 illustrates the three critical spread throughout the facility and had five percent of the company’s annualcomponents to a risk management contaminated wafers in almost every production might be disrupted duringprogram:• The ability to discover that a disruption has occurred.• The ability to recover from the disruption.• Supply chain design strategies for resilience.Figure 3 illustrates the impact ofdisruption to a firm over time. Fromthe moment it occurs, a major supplychain disruption triggers a series ofevents that defines the relative maturityof a company’s supply chain risk-management system. Let us consideran example from a recent disruptionincident that illustrates the frameworkshown in Figure 3. A major supplier to Nokia is PhilipsNV which produces semiconductors ,for Nokia cell phones at its plant in Figure 3: Disruption Discovery and Recovery.
optimization models currently in use are optimized for a “snapshot” in timeThe foundation for a solid supply chain risk and provide the optimal solution for the current operating and economicmanagement program includes improved environment. What is needed is a set of tools that can track changesknowledge of where the disruptions may occur, in the supply chain and work under a variety of operating and economicand training to know when and how to respond. environments. Nokia put in a series of dynamic visibility systems to track major shipments of all of its major suppliers.a time of booming cell phone sales. other Philips plants. The Nokia team It also established a thorough riskAlthough he did not see this as a major dug into the capacity of all Philips management assessment for each of itsissue at first, Mr. Markki communicated factories and insisted on rerouting major suppliers and created contingencythe news to others inside Nokia, that capacity. Mr. Korhonen recalls fallback plans for disaster planning atincluding Pertti Korhonen, Nokia’s top that “The goal was simple: For a little each location. The company arrangedtroubleshooter. Mr. Korhonen decided period of time, Philips and Nokia would supplier training in all of these planningthat the situation needed closer scrutiny, operate as one company regarding those elements. Finally, Nokia re-evaluatedand initiated a process of collaborating components.” The Finn’s actions got its entire supply chain network to avoidwith Philips on recovery efforts. He results. A Philips factory in Eindhoven single-sourcing any major componentsuggested that two Nokia engineers fly would provide 10 million chips, while and integrated these plans into its globalto Albuquerque to help Philips. When another in Shanghai worked to free up sourcing strategies.they arrived, they realized it would take more capacity to meet Nokia’s needs. One of the major lessons to beweeks to restore the cleanrooms and Nokia engineers developed new ways learned from supply chain disruptionsrestart production. to boost production at the Albuquerque is that the speed of a company’s plant – creating an additional two response to a disaster is critical. AsDisruption recovery million chips when the plant came shown in Figure 3, the time betweenExecutives put in “stop gap” measures back on line. Through these actions, a disruption and its discovery is theto recover from the disruption quickly, Nokia was able to avoid disrupting any first element – it is therefore importantand prevent it from affecting their shipments to its customers. to put in systems to detect when aoperations, or worse yet, their major disruption occurs. The second elementcustomers. This element of management Supply chain redesign of response time is disruption recovery,involves developing methods for supply Once they recover from the disruption, and the lead-time from discovery tochain disruption recovery both in proac- executives learn from the event and recovery. Companies that have alreadytive (anticipatory) and reactive modes. take steps to redesign their supply established contingency plans and Mr. Korhonen from Nokia quickly chains to minimize the probability visibility solutions, as well as excessiverealized that the disrupted supplies that the problem will occur again, or buffers such as inventory safety stockwould prevent the production of some better yet, eliminate the possibility of or extra capacity, will be able to recoverfour million handsets, and could impact it ever occurring again. This involves more quickly and quickly mitigatefive percent of their annual production. the development of tools for dynamic the impact of these disruptions. InThe team quickly ascertained the management of supply chain systems our Nokia-Philips example, other cellavailability of alternative sources for and redesigning/re-optimization of the phone manufacturers that were sourcingthe parts. They could purchase three of supply chain. from Philips, but did not respondthe five parts elsewhere. Japanese and Supply chain optimization cannot be quickly, experienced enormous negativeAmerican suppliers could each provide a single static model. It requires tools impacts. For example, one of Nokia’sa million chips; their relationship with that adjust with the dynamic nature competitors treated the initial call fromthese suppliers led to agreements to of supply chain events. These tools Philips as “one technician talking toship with only five days’ lead-time. should have global enterprise scope for another,” and allowed the one-weekHowever, two of the parts came enterprise redesign considerations and delay to take its course.from Philips only. Nokia’s chairman need to provide solutions in real time When it became clear that the much-spoke directly with Philips’ CEO, Cor or near-real time. It should be noted needed chips were significantly delayed,Boonstra, and demanded details about that that for the most part, network lower-level employees at the company
still did not communicate the news may be initiated and deployed by key • Develop a detailed reportto their bosses for fear of reprimand. companies in the supply chain with the documenting the factors that causeThe head of the consumer electronics resources to do so, but all of the key or amplify disruptions. Conductdivision did not learn of the problem nodes in the supply chain need to be “post mortems” of major pastuntil several weeks after the fire. By involved at some level. disruptions to identify contributingthe time the company realized the factors. This can help to surfacemagnitude of the problem, it was too 3. Supply chain visibility weaknesses in current supply chainlate. Nokia had already commandeered Supply chain visibility is defined design, or product sourcing decisionsall of Philips’ spare capacity. Moreover, as knowing how much inventory is that exacerbate supply chainthe cell phone company did not have available, where it is located in the risk exposure.any alternative sources of supply. chain, and the level of demand in the The foundation for a solid supply chain The consequence was a shortage of supply chain. This is probably the risk management program includesmillions of chips, meaning a shortage of most important aspect of a successful improved knowledge of where themillions of high-end handsets and the system for dealing with disruptions. As disruptions may occur and training towrong product mix for the fast-moving one executive stated, “Visibility is the know when and how to respond. Thecell phone market. This supply chain battleground relative to supply chain level of awareness of the potentialdisruption contributed to massive losses competitiveness.” Unfortunately, there for disruptions, and the capability tofor the company. is no “silver bullet” that can handle respond, is the single greatest preventive all aspects of visibility. Visibility can action that organizations can take toSupply chain disruption issues: only be enabled via a combination prevent the effects of a major disruptionCommon themes of technology and continuous from disrupting global operations.Our research surfaced three important communication. Improved visibility of events is an on-and interrelated attributes that companies Firms in the early stages of risk going challenge, and there is a pressingshould consider in managing supply management should consider the need for companies to identify solutionchain disruptions: following approach to assess and providers that can assist in supporting develop systems for managing supply and developing these capabilities. ■1. Supply chain knowledge chain risk:An effective system for disruption dis-covery and recovery requires a thoroughunderstanding of the “as is” condition of • Develop a detailed and integrated value stream map on a pilot basis for a critical branch of global sourcing >>> This article is based on a study first published at http://scm.ncsu.edu/public/ risk/risk7.htmlthe supply chain being examined, as well operations, highlighting not onlyas the general status of external global, material flow, but also informationmarket, and environmental influences(e.g. political, cultural, etc.). This alsoincludes knowledge of the organization’sdisruption plans and capabilities. flow, inventory levels, decision points, mechanisms and triggers. • Evaluate contingency plans on this BIO Rob Handfield pilot product for risk reduction2. System-wide disruption awareness effectiveness, and identify key Rob Handfield, PhD, is a Bank of America University Distinguished Professor andand capabilities thresholds for executing mitigation Director, Supply Chain Resource Consortium,This includes real-time supply chain decisions. NC State University.intelligence gathering, information • Establish a greater understandingsharing, and coordinated response. of the external factors affecting theRisk and disruption handling cannot supply chain, through developmentand should not be handled by a single of a node-by-node risk enumerationdepartment and/or one company. All and identification plan, utilizingplayers in the supply chain need to be predictive risk analysis techniques.involved in disruption planning andpreparation. While disruption mitigation • Establish additional insights intomay be executed by a key logistics where and how much inventory isprovider, all supply chain stakeholders located throughout the supply chain,need to be involved and regularly and how it can be accessed andinformed about disruption management repositioned rapidly during aactivities. Certainly, disruption planning supply chain disruption.