Good OM Reading: Reducing the Risk of Supply Chain Disruptions
For supply chain executives, recent years have been notable for major supply chain disruptions that have highlighted vulnerabilities for individual companies and for entire industries globally. (The Japanese tsunami in 2011 left the world auto industry reeling for months. Thailand’s 2011 floods affected the supply chains of computer manufacturers dependent on hard disks. The 2010 eruption of a volcano in Iceland disrupted millions of air travelers and affected time-sensitive air shipments.) This excellent article in the MIT Sloan Management Review (Spring, 2014), by Professors Sunil Chopra and ManMohan Sodhi, is worth the 23 minutes it will take you to read it–especially if you teach Chapter 11 and Supp.11 in our text.
Today’s managers, they write, know that they need to protect their supply chains from serious and costly disruptions, but the most obvious solutions — increasing inventory, adding capacity at different locations and having multiple suppliers — undermine efforts to improve supply chain cost efficiency. While managers appreciate the impact of supply chain disruptions, they have done very little to prevent such incidents or mitigate their impacts.This is because solutions to reduce risk mean little unless they are weighed against supply chain cost efficiency. Financial performance is, we know, what pays the bills.
Supply chain efficiency, which is directed at improving a company’s financial performance, is different from supply chain resilience, whose goal is risk reduction. Although both require dealing with risks, recurrent risks (such as demand fluctuations) require companies to focus on efficiency in improving the way they match supply and demand, while disruptive risks require companies to build resilience despite additional cost.
The authors suggest two strategies for reducing supply chain fragility through containment while simultaneously improving financial performance: (1) segmenting the supply chain or (2) regionalizing the supply chain. In many instances, though, reducing disruption risk involves higher costs. The reason executives are reluctant to deal with supply chain risk comes from the perception that risk reduction will reduce cost efficiency significantly. Managers can do much to ensure that loss of cost efficiency is minimal while the risk reduction is substantial by avoiding excessive concentration of resources like suppliers or capacity. And nudging trade-offs in favor of less concentration by overestimating the probability of disruptions can be much better in the long run compared to underestimating or ignoring the likelihood of disruptions.