Supply chain disruptions have been around as long as goods have been transported, but because of the lean, far-flung nature of modern supply chains, they’re more susceptible to disruption than at any time in history, exposed to any number of risks at any number of junctures. When the deadly Sendai earthquake and tsunami struck Japan early this year, the risks became all too clear. The disaster disrupted countless supply chains and created economic dislocations around the world.

 

In June, the Federal Reserve Open Market Committee acknowledged that the slower pace of recovery for the U.S. economy “reflects in part factors that are likely to be temporary, including... supply chain disruptions associated with the tragic events in Japan.” A Sendai-like disaster striking 50 years ago would have certainly been a human tragedy and it might have affected the Japanese economy, but auto manufacturers in the American Midwest wouldn’t have been concerned, and it’s unlikely that the Fed would have kept a close eye on the situation either.

That was then. In recent decades, the world has seen the exponential growth of interconnected manufacturing and distribution platforms—the kind that stretch from East Asia across trans-oceanic shipping routes and into the heartlands of North America and Europe. Combined with the pervasive practices of just-in-time manufacturing and mass outsourcing, modern supply chains are a marvel of speed and efficiency unknown to previous generations. They also have fragility built into them.

Sendai might have been an eye-opener in that regard, but it’s also possible that supply chain managers will interpret the disaster as a “black swan” event—so unusual that day-to-day planning can’t anticipate such an event in any useful way. That isn’t so. With the unlikely exception of a disaster that destroys human civilization, there isn’t any risk so fearsome that it isn’t worth planning for. Planning doesn’t guarantee complete success in mitigating supply chain risk—such is the fallible nature of human systems—but not planning guarantees a much more difficult recovery.

Also, the attention given the disaster in Japan might make one forget that most supply chain disruptions aren’t the result of disasters that shake entire economies. They aren’t extraordinary events at all. In truth, they’re devilishly ordinary events that happen often, such as traffic accidents, fires, storms, floods, strikes, civil unrest and even events that, individually, barely qualify as disruptions, but whose gnawing frequency is an impediment to the smooth operation of global supply chains—namely, large-scale cargo theft from trucks and ocean-going containers.

Moreover, despite all the time and effort that has gone into studying such events, disruptions remain unpredictable. For instance, meteorologists can determine that an average of 17.7 hurricanes have hit the United States every decade between 1851 and 2004, with six of those as major (category 3 to 5) storms. They can with some accuracy predict whether a particular hurricane season is going to be more or less violent than the historical norm. But no one can know that a particular storm is going to make landfall at a particular time, closing the ports of Houston or New Orleans or Mobile, disrupting shipments of critical parts for a particular assembly line in Middle Tennessee or Pennsylvania or Wisconsin.

Do supply chain managers appreciate the risks?

In 2008, Beth Enslow, a senior vice president of the Supply Chain Risk Management Practice at Marsh, a major insurance broker and risk advisor, penned a research report about the changing roles and responsibilities of risk managers. Her results remain as fresh and sometimes provocative today as they were then, maybe even more so in light of today’s economic tumult.

One of her more startling conclusions was that despite rising awareness of supply chain vulnerabilities, most organizations didn’t have a very high opinion of their supply chain risk management—and sometimes for good reason. Enslow surveyed 110 risk managers in manufacturing, distribution and retail mainly in North America, whose global supply chains spanned numerous regions. Fully half of the managers worked for companies with US$1 billion or more in revenue.

What did she find? Nearly one-quarter of the respondents (24 percent) said that their company had no formal process to address supply chain risk, while another 14 percent answered that they didn’t know how effective their risk management was. You might call that the “seat of the pants” school of supply chain risk management. Moreover, among those executives whose responsibilities included risk management, only about 20 percent said that supply chain risk was a top-three priority, though most put it as a top-10 priority.

Some all-too-human tendencies are at work in the disconnect between the risks posed by the modern world and the lack of urgency with which many companies see the problem. For one, it may be hard to learn from other people’s misfortunes. The fact that Toyota and its suppliers and dealers are suffering from fractured supply chains is something of an abstraction for most companies, no matter how large the impact on the auto industry. Also, many corporate cultures are fundamentally reactive in outlook, not proactive. Anticipating emergencies simply isn’t something they do well.

Yet, the costs of poor planning can be quite high. The classic example—practically a B-school example—of contrasting corporate reactions to a supply chain disruption occurred in early 2000. It might be a familiar story, but it’s worth reiterating. At the time, European consumer electronics giants Nokia and Ericsson both relied on a single microchip manufacturer in New Mexico for their lines of cell phones. Early that year, the facility suffered a small fire, extinguished quickly. At first the manufacturer assured both companies that their supply of chips would be unaffected.

Ericsson thought so as well, but Nokia apparently wasn’t so sure, and rushed to source chips from every other available manufacturer. Nokia was right to be worried, since millions of chips had been ruined by the least imaginable amount of smoke. Production was seriously disrupted for Ericsson, as Nokia got all the available chips, and the company lost $400 million in sales. That was the beginning of the end for Ericsson in the cell phone business.

Arguably, the 2000 fire is something of a black swan too, since how often will two major companies in a single ultra-competitive industry be dependent on one critical suppler? Still, the incident illustrates that sudden supply chain disruptions can be very costly indeed.

Moreover, the spectrum of potential harm arising from supply chain disruptions is broad. It’s easy enough to understand how a disruption of critical components might adversely affect an assembly line, but that’s only one potential situation. Supply chain disruptions can also discourage customers from placing orders, even after the crisis is over (people have long memories about that kind of problem); impair the utilization of income generating assets; affect a company’s ability to differentiate itself from its competitors; give its competitors a leg up (just ask Ericsson); and possibly expose a company to backlash from aggrieved customers, suppliers or shareholders.

What can be done?

The size and scope of risk to the modern supply chain might seem daunting, but there are best practices to help mitigate risk. In implementing these, large companies may have a chief risk officer with access to the C-level, which would be critical in times of crisis. In smaller firms, there may not be anyone specifically tasked to deal with supply chain disruptions, but experts within an organization, such as procurement, security, logistics, IT, and so forth can be put together on an ad hoc basis.

New and ever cheaper surveillance technologies can be brought to bear on the chronic, low-level supply chain disruptions caused by thieves. For high-value, theft attractive cargo, embedded tracking devices are proving themselves more effective and more cost effective with each passing year, either to track goods directly, or to establish virtual perimeters for cargo shipments to detect the unauthorized movement of goods.

Besides deterring thieves with new strategies, other steps that businesses should take to mitigate their supply chain risk are within their own organizations. These steps are useful not only for large businesses overseeing a multitude of operations, but for smaller ones as well.

First of all, businesses need to identify their entire upstream supply chain. That includes suppliers, naturally, but also their suppliers and sub-suppliers. Without that information, a supply chain manager is whistling in the dark. Next, businesses need to assess vulnerabilities in each link of their supply chain, including such fine points as geographic risk and operational risk. An example of the latter would be a situation in which all of a company’s suppliers use the same sole source for raw materials. Even if the suppliers are geographically spread out, their dispersion isn’t going to help the downstream business much if something goes wrong at the single raw material source.

No business, however, can anticipate every possible disruption. Instead, companies need to prepare for capacity losses, whatever the nature of the disruptions. Continuity planning is at the heart of this effort. That is, figuring how, in advance, to keep the company’s vital systems running no matter what causes them to fail. Such an approach frees the supply chain manager from the impossible task of preparing for everything that might disrupt a supply chain.

Finally—and this might be the most difficult step for many companies—executives must foster a corporate culture that takes supply chain risk seriously. Remember that nearly four out of 10 risk managers surveyed by Marsh said they did not have a supply chain risk management strategy or that they didn’t know enough about it to form an opinion. That’s essentially taking the attitude of, “What, me worry?” When times are normal, no harm is likely to come of that attitude, but the last time you want to start worrying about a supply chain disruption is when one happens to you. wt