The document discusses strategies for managing supply chain risk. It begins by noting that companies often underestimate the risks in their supply chains and where those risks may occur. It then advocates taking a comprehensive view of all potential risks across different cost categories. The document also recommends improving supply chain visibility through tools like barcodes and RFID tags. Finally, it suggests selectively shortening supply chains by bringing some production closer to key markets while still taking advantage of lower costs in other regions.

1. ARTICLE
PRTMInsightreprinted from | Second Quarter 2009
An Ounce of Prevention
Managing supply chain risk to eliminate threats proactively
CAUTION CAUTION CAUTION CAUTION CAUTION
CAUTION CAUTION CAUTION CAUTIO

2. ARTICLE An Ounce of Prevention
reprinted from PRTM Insight, Q2 2009
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F
ires, earthquakes, hurricanes. These are
some of the natural disasters that have long
disrupted the balance in extended global
supply chains. And then there are the risks “du
jour”—piracy, salmonella outbreaks, and oil
price swings. Yet sometimes the events that don’t
make the headlines can take just as great a toll:
the default of an important supplier, changes in
environmental regulations, or restrictions on port
capacity, to name a few (Figure 1).
Whatever the culprit, the
threat of a sudden disrup-
tion makes risk management
critical for any company that
has a supply chain span-
ning several continents.
However, companies often
underestimate what’s needed
to manage risk effectively or where their supply
chains are most at risk. This is especially true of
the firms that outsource to Asia to take advantage
of lower labor and material costs. According to a
recent survey, China is believed to be the region
that poses the greatest risk to supply chains
because of issues with product quality, intel-
lectual property, and data security (“Managing
the Biggest Supply Chain Risk of All: Constant
Change,” AMR Research, December 2008).
In these uncertain times, the best approach
companies can take is to develop a comprehen-
sive view of the various risks that threaten their
supply chains. They can then mitigate these risks
by improving visibility, selectively shortening the
supply chain, and strengthening relationships
with suppliers.
Taking a Comprehensive View
Top companies know that managing supply
chain risk depends first and foremost on devel-
oping a thorough understanding of the different
risks inherent in an extended supply chain. These
risks can incur costs across four major categories:
direct production, transportation, working capital,
and reputation (Figure 2).
Quantifiable and unquantifiable costs. Many
of the risks inherent in a longer supply chain
carry a quantifiable impact on cost. It’s not diffi-
cult to determine, for example, how an increase
in the price of raw materials will affect direct
production costs, or how an increase in theft
will affect working capital. Some risks can have
multiple cost implications. The sudden default of
a key supplier can expose a company to switching
costs and production delays, which can lead to
sizable contract penalties.
Some risks incur costs that are harder to
quantify, yet shouldn’t be ignored. Poor working
conditions or environmentally negligent manufac-
turing, for example, can greatly damage a compa-
ny’s reputation and necessitate expensive and
time-intensive crisis management efforts. Wal-
Mart, for one, is especially aware of these costs,
and has taken steps to prevent their recurrence. In
response to revelations concerning the conditions
of supplier factories in Bangladesh and China,
Wal-Mart established more stringent policies to
In today’s uncertain business environment, global companies need to make
managing supply chain risk a top priority. Although many companies focus
on their manufacturing operations, they need to take a holistic view of the
supply chain. This means not only developing the visibility to identify areas at
risk, but also having the strategies in place to eliminate those threats before
they wreak havoc.
Companies often
underestimate what’s
needed to manage risk
effectively or where
their supply chains
are most at risk.

3. ARTICLE An Ounce of Prevention
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require suppliers—and suppliers’ suppliers—to
observe labor and environmental laws. And the
company is monitoring these suppliers more care-
fully to make the policies stick.
The efficient frontier. Generally speaking, the
greater the risk a company is willing to expose
its supply chain to, the greater the rewards it can
realize in the form of lower costs and higher profit
margins—until it reaches the point where risk
is so large that profit suffers. To understand the
risk-reward tradeoffs for a specific supply chain,
it’s useful to determine the points where the risk
is lowest for a given reward. Taken together, these
optimal points of risk and reward form a curve
that marks the efficient frontier of supply chain
tradeoffs, analogous to the risk-return model used
in financial portfolio management (Figure 3).
Once a company has established where its
efficient frontier is located, the goal is to find
a new set of points above the existing curve
where the supply chain can help generate larger
margins—without taking on more risk. The
ability to operate on this higher curve is critical to
managing supply chain risk more efficiently than
the competition.
This discussion, by necessity, is very
simplistic. In practice, it’s more complicated
because products often require different risk
management strategies at different stages of
their lifecycles. For example, a manufacturer
of industrial equipment would use a low-risk
domestic sourcing approach for newly introduced
products so that engineers could work closely
with manufacturing to get quality under control.
Then, once the product and market have matured,
the company would relocate sourcing in well-
established low-cost country sources. This move
would help shift the curve up so that the margins
for this product phase increase.
Employing Strategies That Work
Given all the different variables involved,
managing the supply chain risk of a portfolio
of products is a very complex task. There are,
however, some basic ways to manage these
tradeoffs and mitigate supply chain risk.
Improve visibility. All too often, firms find
themselves reacting to problems that have already
taken a toll on supply chain performance. Taking
a proactive approach, leading companies have
improved their ability to see what is going on
throughout the supply chain. They determine
what information they need to increase transpar-
ency in the nodes where risk is greatest and estab-
lish key performance indicators to measure these
risks on a regular basis.
For example, inventory levels and receipts at
key supply chain nodes can be analyzed to deter-
mine if a product is moving through the supply
chain according to schedule. Technologies such as
■ Exchange rate fluctuations
■ Supplier defaults
■ Regulatory actions
■ Extreme weather conditions
■ Changes in port and rail
capacity
■ Customs/border control issues
■ New environmental
regulations
Some Examples of Forgotten Risks
Figure 1: Risks Under the Radar

4. ARTICLE An Ounce of Prevention
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barcodes, global positioning systems, and radio-
frequency identification (RFID) tags help ensure
that data is as close to real time as possible. Six
years ago, UK-based retail giant Tesco began
using RFID tags on individual items to monitor
thefts of razor blades and other high-value items.
Today, the company uses these tags on crates to
track the delivery of perishables like milk.
Sometimes, however,
simple data collection will
suffice. For example, a $10
B specialty retailer with
thousands of stores in North
America was having problems
with delays its shipments were
encountering at various U.S.
ports. The company started
tracking these delays and discovered that most of
the containers destined for Long Beach, one of the
Los Angeles-area ports, were arriving later than
usual. Betting that the delays would only worsen
during the upcoming Christmas peak season, the
company proactively shifted deliveries of key ship-
ments to Tacoma, WA, a far less congested port.
This strategy added some minor costs to the equa-
tion. But the improvement in delivery times—and
the prevention of lost sales and customer regard—
more than made up the difference.
Selectively shorten the supply chain.
Increasing numbers of firms are engaged in near-
sourcing, moving production of critical products
or components from low-cost countries to places
that are closer to major markets. This practice
provides the best of both worlds. It helps improve
time to market and distribution flexibility while
containing labor, material, and total landed
costs. Manufacturers can use offshore produc-
tion for products where cost is paramount, and
reserve near-shore production for cases when the
risk mitigation and responsiveness to changing
customer demands take priority.
Some companies effectively deploy different
risk management strategies at various points
in a product’s lifecycle, with the strategy depen-
dent on the type of product. Joseph Abboud, a
US-based clothing company, has a long lead time
for producing its new apparel, and so it conducts
this production overseas in low-cost countries.
But since the lifecycle for such clothing is short,
Abboud also needs to able to react quickly if
demand for those items suddenly explodes. So it
uses a U.S. manufacturing facility to replenish
stores in this key market.
Contrast this company with a manufacturer in
the defense and aerospace industry that sells highly
engineered, long-lifecycle products. For this type of
product, it’s important to mitigate risk in the early
stage of development. The company has located its
engineering staff near its production facilities, so
that the teams can work closely together to finalize
product design and launch. Then, as the market for
the product grows and demand stabilizes, the firm
will move production to a low-cost country to cut
costs and improve margins.
Taking a proactive
approach, leading
companies have
improved their ability
to see what is going
on throughout the
supply chain.
Figure 2: Understanding the Costs of Risk
Raw material price volatility
Border control issues
Rise in damages and theft
Product-quality incidents
EXAMPLE
Direct production
Transportation
Working capital
Reputation
COST IMPACT

5. ARTICLE An Ounce of Prevention
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Strengthen supplier relationships. Extended
supply chains and broader geographic demands
make strong relationships with suppliers even
more critical to managing risk than in the past.
Leading companies today are taking preemptive
steps by working more closely with key suppliers.
This means not only sharing data, but also helping
suppliers understand the specific risk factors
facing the supply chain, and jointly developing a
plan to address these factors. At the same time,
it’s important to help suppliers improve their own
operations, since even a small glitch can rever-
berate through the supply chain.
In the food industry, quality issues—think
tomatoes, peanut butter, and pistachios, to name
a few—are occurring with increasing frequency
as salmonella outbreaks become more common.
Taking food off grocery store shelves doesn’t solve
the problem. Leading food retailer Sainsbury’s in
the UK has addressed this issue by not only care-
fully selecting its choice of suppliers, but also by
performing unannounced inspections of supplier
facilities to ensure they continually meet quality
and safety standards.
Strong supplier relationships also constitute
an important form of quality management for
Toyota. The company famous for introducing
Lean manufacturing to the world staunchly
believes that its suppliers need to embrace these
concepts—and has taken steps to make this
happen. When building an assembly plant in
Texas for its Tundra truck, Toyota created an
on-campus site for 21 suppliers so they would
be nearby. The company has also increased its
equity position in some suppliers like Japan-based
Denso, and has put Toyota employees in some
suppliers’ organizations.
Looking Ahead
Extending the supply chain is a decision that
can’t easily be reversed. Once companies move
production to a distant location, they can lose the
local skill sets and infrastructure that would make
it possible to replant domestic manufacturing later
on. So it’s critically important that any company
considering offshoring make the decision with full
knowledge of the risks being assumed.
That said, any company that already has a
global supply chain in place cannot be competi-
tive without a comprehensive risk mitigation
strategy. There is no one size fits all answer: Ulti-
mately, every firm must deploy an approach best
suited to its business and operational goals. But
there are some general principles all companies
Risk
MarginLowHigh
MaximumMinimum
Point of diminishing returns
Efficient
frontier
Figure 3: Shifting the Curve
Effectively managing supply chain risk requires
improving margins without increasing risk

6. ARTICLE An Ounce of Prevention
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should keep in mind.
Align the footprint to risk. As a rule of
thumb, companies should determine the points
on the value chain that create the greatest value
and the points that incur the greatest costs.
These are the areas where a company has the
most to gain or lose and,
as a result, where its risk is
greatest. Decisions to improve
margins on these activities
need to consider whether the
improvement is worth taking
on the additional risk. For
example, a high-end bicycle
producer found that it made
sense to locate the high-value,
high-risk activities—frame fabrication, painting,
and final assembly—close to the end consumer.
At the same time, the company moved the
sourcing of its lower-risk, lower-value compo-
nents to countries where labor was relatively
inexpensive.
Make it a team effort. Competing interests
often cause planning to stagnate, leaving the
company unprepared when new risks emerge. In
many cases, different functions of the organiza-
tion can be so focused on their own immediate
goals (whether delivery times, customer satis-
faction, or transportation rates) that it becomes
nearly impossible to reach a consensus about
the best strategy for the company as a whole. For
a balanced approach, all relevant functions—
product planning, design and development,
sourcing, logistics, regulatory compliance, and
finance—need to be involved in identifying key
risks and the means for measuring them. This is
critical to developing a flexible supply chain with
minimum risk.
Be vigilant. Both companies that are planning
a global supply chain and those that already have
one in place need to take a proactive approach to
risk. While the past can be instructive, it’s not the
sole indicator of what may happen in the future.
Some of the risks that have become realities
over the past couple of years—the credit crisis,
wide swings in oil prices, and the slide of entire
industries—have rarely occurred in combination
in the past. So it’s essential to keep reassessing
the risks on the horizon, as well as the strategies
for mitigating them.
In today’s business environment, what
seemed an impossibility a short time ago is a
possibility now. For that reason, companies that
will get ahead in the long run are focusing on
mitigating risk throughout their supply chains.
They know that when uncertainty is a constant,
the winners leave nothing to chance.
For more information, please contact:
Mark Crone, PRTM Principal
mcrone@prtm.com, +1 212.915.2600
Jeff Holmes, PRTM Director
jholmes@prtm.com, +1 202.756.1700
Kyle Hill, PRTM Manager
khill@prtm.com, +1 86 21.3860.7888
Near-sourcing
helps improve time
to market and
distribution flexibility
while containing labor,
material, and total
landed costs.

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