The latest ranking of the world’s top 25 supply chains highlighted a new factor that marked out the best performers from the rest.
“Speed, agility, efficiency, responsiveness and innovation all remain critical, but equally important is a resilient supply chain,” the research firm
Gartner said.
And, boy, have supply chains had to be resilient recently.
The financial crisis and natural catastrophes such as flooding in Australia at the beginning of the year, and the earthquake and tsunami that devastated Japan in March, have caused many headaches for procurement chiefs.
“Anybody who is a CPO has to wake up every day expecting something to go wrong,” says Tom Linton, formerly CPO at LG and now running his own consultancy,
Linton Advisors. “I used to call it crisis du jour because when you are running several hundred thousand parts and products in a supply chain round the world, something is going wrong.”
The impact of such events is increasingly significant. According to insurer
Swiss Re, natural and man-made disasters caused $218 billion in economic losses in 2010. This was triple the
figure of $68 billion recorded in 2009. In addition, there were 10 events that caused insured losses of more than $1 billion. These included February’s Chilean earthquake ($8 billion), September’s Christchurch earthquake in New Zealand ($4.4 billion) and winter storms across western Europe ($2.8 billion).
Data from the
World Economic Forum suggests there has been an increase in the number of natural disasters since 1900. While this rise is attributed to increased observation and coverage of these events, the report does comment that those such as floods and hurricanes appear more frequent.
From analysis of reported supply-chain interruption over the past decade, Brian Squire, reader at the school of management at the
University of Bath, cannot tell if the number of disruptions is going up, down or staying the same, as he relies on secondary sources of reporting. He says there is no identifiable trend that disruptions are getting more or less severe. “The duration and the financial impact of those disruptions do not seem to have changed in any noticeable way between 2000 and 2011,” he says. “The fluctuations in terms of duration and financial impact are random over time, and there are no discernible trends over that period.”
If it isn’t that such disasters are more frequent, supply chains are certainly more exposed. Their increasing length and complexity has made them more vulnerable. Tim Lawrence, managing consultant at
PA Consulting, agrees. “Everybody has moved to a leaner, single-sourcing, fewer-supplier approach. Hey presto, what’s going to happen? You are going to increase risk.”
For companies, the impact can be significant. Analysis by academics Vinod Singhal and Kevin Hendricks found that the average fall in a share price following an announcement to the market of a supply disruption was 10 per cent. And it takes the price at least 60 days to recover from the fall.
Massive economic impact
The economic impact – including damage, losses and lost productivity – of the earthquake and tsunami in Japan is expected to run to $235 billion, which would make it the most expensive
catastrophe ever. This is unsurprising, given the country’s position as the world’s third largest economy and major manufacturer.
Almost every large company, no matter which sector it is in, has been affected. Automotive manufacturers were all forced to halt production either owing to damage at their own or supplier facilities, or because of a scarcity of parts. The electronics sector was also badly affected. Analyst
iSuppli has warned of significant shortages of components and prices are also expected to climb, with some rising 10 per cent already.
“Soul-searching is definitely going on,” reports one procurement director whose suppliers in Japan have been heavily affected.
The impact is also felt in areas you might not initially expect. According to Manoj Malhotra, director at the Center for Global Supply Chain and Process Management at the
University of South Carolina, laboratories in the US that test blood samples are running short of necessary reagents because the chemicals used in them come from Japan.
The implications of such a devastating disaster should not be a surprise, says John Campi, managing partner at
Genesis Management Group and formerly CPO at Chrysler and Home Depot. But the level of dependence on a risky area of the world is another matter. “I am surprised at the foolishness of some people in the automotive industry to have such a dependence in an area that has such a history of violent earthquakes, and the resulting impacts that can have on the supply chain,” he says. “I think it signifies the lack of understanding of the kinds of risks effected by supply chain decisions that have far-reaching implications.”
Lawrence says many firms are now on the back foot as a result, scrambling around to shore up supply and assess the damage to supply chains. “A lot of companies have not understood that, two levels up the chain, this small sensor or pigment for a paint will cause the level of problems that it has.”
A lack of understanding of lower-tier suppliers is raised as a consistent issue. “A lot of companies threw the baby out with the bathwater [when outsourcing work], and a lot of them don’t know what’s on the bill of material one or two levels out,” says Linton.
For some, the events in Japan have exacerbated existing problems in an already tight supply chain. Having reduced capacity and inventory during the recession, suppliers are still rebuilding and restocking, says Justin Olejnik, head of offshore supply chain at electronics manufacturer
Surface Technology International (STI).
“We were suffering on long lead times and the Japanese disaster has just added to the problem. Components that were readily available are now just as difficult to source as those that have been traditionally problematic.”
Lawrence adds: “More than any other event, the Japanese earthquake has bought home how reliant we are on certain regions for our supply chains, and that they have a huge impact on the business.”
With Japan being a centre of lean manufacturing, could the massive disruption prompt a shift away from this strategy? Malhotra doesn’t believe so. “The principle behind lean doesn’t leave you with too much protection,” he says. “But the flip side is you will run for years and years with much more inefficiency built into your supply chain, which constantly adds cost to your product.” He adds that the philosophy of lean – the elimination of all types of waste – should survive, but businesses may add more inventory into the system as a buffer.
Wake-up call
Events such as those in Japan tend to focus the minds of even those who were not affected. A recent survey of 100 US technology firms by
BDO USA found 86 per cent thought supply chain issues were the biggest risk to their operations. In addition, the number citing natural disasters as a potential threat rose from 55 per cent in 2010 to 81 per cent this year.
This is not the first major supply chain disruption of the past few years – Hurricane Katrina, the financial crisis, and the Icelandic volcano eruption all provided a wake-up call. But with even large, sophisticated companies experiencing disruption, it suggests lessons have not been fully taken onboard.
“I’m not sure CPOs have stepped through the implications of where their suppliers are, what the underlying vulnerability is, what their contingency is in terms of the sort of event that can happen, and the extent to which they can switch on alternatives,” says Alan Braithwaite, executive chairman at
LCP Consulting.
Betty Kildow, author of the book
A Supply Chain Management Guide to Business Continuity, says risk management practice and awareness is the “best it has ever been, but it still has a long way to go”. Momentum from major events can be quick to fade, though. “I’m already seeing it. It is a testimony to the human spirit we can forget very negative things. I hope we don’t forget too much, too quickly, to prevent us dealing with the things we need to.”
She uses the analogy of a CEO who watches a building across the street burn down. Seeing it on fire will prompt thinking on how to avoid the same fate – a thought that will ultimately dissipate. The resulting rubble will provide a reminder – but the memory passes. The only thing that might get the message across is repeatedly seeing a sign reading “out of business” in place of the rubble.
“Perhaps some of the lengthy outages we are going to see as a result of Japan will not only get attention, but maintain attention,” she adds.
Alan Day, managing director of consultancy State of Flux, agrees the topic is higher on the agenda, but questions whether busy senior executives have the opportunity to focus on risk
management. “They spend so much time and energy sorting [one crisis] out, there is a sigh of relief and before they get a chance to do anything, they are on to the next thing. So lessons learnt are not captured.”
The true test, says Lawrence, will occur if a similar event happens in the future – will the same organisations be affected or will they have adapted their supply chains to cope?
Focus on pinch points
Day says CPOs have three options when it comes to mitigating risk – “live with it, improve it or insure against it”.
Experts agree that mapping your supply chain and identifying the pinch points – be they geographical, political or economic – where potential risks may arise is a vital prerequisite. In addition, building a business case for investment in risk management by analysing the potential cost to the organisations as a result of disruption is equally important. Putting an all important-figure on potential problems is difficult, but could include fixed costs, production downtime, reputational damage and lost revenue, business and customers.
Publisher
Wolters Kluwer has developed a five-point scale, from risks that will affect margins to those that have affected company revenue. The best time to perform this assessment is before you award a contract to suppliers. The prime gap in knowledge exposed post-Japan is the limited awareness that many firms have about their exposure to suppliers past tier one. “You have to convince the corporation you want to pay a lot of attention to tail risk, because this ‘black swan’ could come along and crush you,” says Steve Nied, vice president of strategic sourcing at Wolters Kluwer.
Campi says that in most industries, CPOs have been able to hold the principal supplier accountable for failures further down the line. “It doesn’t make the risk any less – that’s just how they have operated.”
Stopping diligence at tier-one suppliers is not good enough for key products, argues Nick Wildgoose, global supply chain proposition manager and previously CPO at insurer
Zurich. “You need to do as best you can in getting back to raw material level if you can. If something is generating 50 per cent of your profits, I don’t think it’s good enough to stop any due diligence at tier one.”
Just finding out who these suppliers are can be a tall order. A car, for example, is made of thousands of individual parts, which in turn are made up of thousands of materials and components. Resource-poor CPOs simply don’t have the time to examine every single provider.
Day suggests prioritising. “If you took your top three end products you are selling, what is the supply chain behind those? And where are the risk nodes behind that?”
But, says Linton, it’s not enough just to know their name. Working for
IBM in Japan at the time of the Kobe earthquake in 1995, the first thing to do was take a map of the country and place a pin to identify a supplier’s location, and determine if it was in or out of the destruction zone. “Understand your manufacturing base – know it down to the factory level, not just down the brand level.”
Kildow stresses the importance of partnering with suppliers to mitigate risks up front. “Let your suppliers know your needs and expectations around business continuity – sometimes they are not even aware,” she advises, mentioning that some firms send business continuity “ambassadors” to advise and support suppliers with risk management.
Better communication was a lesson for Olejnik. “One thing it has highlighted to us is that there is more we could have done in sharing information with our distribution partners. It would
not have solved the problem, but would have triggered the distribution chain to have some conversations with us.”
In the aftermath of an event, it could mean revisiting specifications to make sure they do not rely too heavily on particular brands or components that add extra vulnerability into the chain.
Following a disruption, you also need to make sure you are at the front of the queue with your own vendors. “How do you ensure you are a customer of choice at the end of the chain?” asks Day. “If you have an SRM programme, do you understand your supplier’s SRM programme or what they are doing with their key suppliers?”
A diverse supply base is also highlighted as an effective, but initially more expensive, strategy.
Kildow says this doesn’t necessarily mean going half and half with supply, but could mean separating a small chunk of business – with the awareness of your other suppliers that this is part of your risk management strategy. But she warns, make sure an alternative has the capacity to boost production if required. And don’t fall into an obvious trap. Day tells of one company that split its production, only to find the new supplier was also located in a potential earthquake zone.
If you diversify, keep an eye on the reality, advises Wildgoose. Logistics companies tell him it is common for firms not to meet the mix between air and sea freight they originally set out because of low-level supply chain disruption. “The mixes end up closer to 50/50 or 60/40. They are considerable sums, but they just get buried in variances. This is where you have to put some work in, understanding what is the cause of the need to change the mix.”
In the past, CPOs have been content to pass risk down the supply chain, relying on contract clauses such as Force Majeure to protect them in case of disruption. With such clauses notoriously difficult to establish and enforce, this is unwise, says Lawrence. “You are totally reliant on whether that supplier will take action or not, and if they don’t and there is a problem, you still can’t get your stuff.” Day adds that suppliers could instead offer to take responsibility for risk, and charge the customer in line with that.
Executive sponsorship and the support of stakeholders – and making colleagues aware of the necessity of risk management – is also critical. Wildgoose believes there is now a considerable opportunity for CPOs to do this, in light of recent events.
And it is also the job of the CPO to make sure risk isn’t pushed off the table by other pressing agenda items. “The CPO has the responsibility to stand up to the CFO and say that while cost is still extremely important, it is more important to ensure continuity of supply because the cost of disruption of a single event could easily offset all the savings during a fiscal year,” says Campi.
Companies increasingly employ risk directors – a survey by insurer Aon says 31 per cent of companies now have a chief risk officer. But their focus is often primarily on insurance. Recent events offer the opportunity to share experience and build a collaborative approach to risk mitigation.
But it is overall attitude that Linton says is key to success. “If you have a war-room mentality – knowing how you react and act, the communications you make vertically and horizontally in the company, the contingency plans you have in place – that is what makes truly people successful.”
☛ Paul Snell is deputy managing editor at CPO Agenda’s sister magazine Supply Management
