Butterflies, Swans, and Supply Chain Risk Management

Stephen DeAngelis

March 21, 2016

“The ‘butterfly effect’,” writes Yolanda Graham, “was a term coined by mathematician, meteorologist and chaos theory expert Edward Lorenz around 1960. It refers to how one small incident can have a huge impact later on down the line.”[1] In the supply chain arena, “butterflies” can flap their wings from any number of directions. “Labor disputes, bad weather, and IT outages are just some examples of disruptions that could affect an otherwise well-designed supply chain,” Graham explains. “They are unpredictable, inevitable, and can cause substantial damage to business operations and financial performance.” I agree with Graham that the timing of disruptions is unpredictable even though such disruptions are inevitable. A study published earlier this year by GT Nexus, in partnership with the research firm YouGov, reported that 40 percent of the 250 senior manufacturing executives who were polled indicated their company experienced a supply chain disruption that impacted their business during the previous 12 months.[2] We all know that disruptions can be costly and many of those costs accrue from resulting perturbations (i.e., butterfly effects).

To mitigate the effects of disruptions, best-in-class organizations maintain an around-the-clock supply chain risk management process. As Alexa Cheater (@Alexa_Cheater) notes, “Supply chain risk [is] a topic that just never seems to go away (nor should it!).”[3] Common sense tells us that we should have a plan in place for dealing with disruptions. This begs the question: Which disruptions are most important? MIT Professor Yossi Sheffi (@YossiSheffi) claims companies should be more worried about rare events (i.e., black swans) than more common disruptive events (i.e., the butterflies) because they are probably already prepared to confront frequently occurring disruptions.[4] He explains:

“When safeguarding their supply chains against disruptions, companies commonly assign the highest priority to events that happen relatively often and hit hard. Focusing on those with the highest likelihood and the greatest potential impact certainly seems like a logical approach to risk management. Except that these are not the worst perils that companies face. In fact, events that rarely happen but wreak havoc pose the most dangerous threat to corporate health. These may be called ‘black swans,’ a term popularized by Nassim Taleb in his 2007 book to describe occurrences that are thought to be impossible. … It’s not that high-impact/high-likelihood disruptions are not worrisome; their impact can be devastating for the ill-prepared. However, because such events occur relatively frequently or hit other companies, enterprises can imagine the outcomes and prepare for them. This may create something of trap for companies, allowing them to believe they have prepared for high risks when they are more exposed than they know.”

The worst possible situation in which a company could find itself is being unprepared for any type of disruption — butterfly or black swan. You might even ask: What does it mean to be prepared? There are so many potential risks that no plan can ever prepare for them all. And as Sheffi notes, “Black swans … are never rehearsed because they are perceived as beyond-the-pale disruptions. Yet the likelihood of a black swan is not zero.” Cheater observes, “By creating, and practicing, any supply chain emergency procedures, you’re rehearsing. So does that then mean we have to start thinking about even more impossible scenarios? Like aliens invading and demanding you ramp up production of a specific SKU in your supply chain by 300%. Improbable? Yes. Impossible? Well that depends on your beliefs on whether or not we’re alone in the universe.” She continues:

“Practically speaking, spending anything more than a couple of minutes contemplating the supply chain implications of these scenarios that live well beyond the farthest perceived edges of reality is probably not a very wise use of your time. Does that then mean it truly is impossible to plan for these black swans? My answer is both yes and no. Yes in the sense that you will never be able to create a plan for every single imaginable scenario — because again, we’re talking about things so far-fetched you would never see them coming. Everything would be running smoothly and then BAM your supply chain is in shambles and you’re left scrambling to put the pieces back together. No, because while you may not be able to guess, or even fathom, what could potentially happen to your supply chain, there are ways to manage your supply chain that will make it easier to respond to any supply chain risk or disruption — no matter if it’s an anticipated risk, an uncontrolled anticipated risk, or a completely unanticipated risk.”

I agree with Cheater that exercising continuity of command plans and emergency response plans is a good idea. Constant practice helps people feel more comfortable in otherwise uncomfortable situations. What else can be done to make your company more resilient? Joseph Fiksel (@OhioStateEEDS), Executive Director of the Sustainable and Resilient Economy program at The Ohio State University, writes, “As managers grapple with the challenges of climate change and volatility in a hyper-connected, global economy, they are paying increasing attention to their company’s resilience. Sudden natural disasters and unforeseen supply chain disruptions are increasingly common in the new normal. To cope with these challenges, businesses need a new paradigm that takes an integrated view of the systemic risks in today’s dynamic business environment.”[5] According to Fiksel, resilience involves a lot more than traditional supply chain risk management. He explains, “Resilience is not a substitute for the established methods of enterprise risk management; rather, it enables companies to embrace change by expanding their portfolio of capabilities.” He continues:

“Our definition of enterprise resilience is quite simple: ‘Resilience is the capacity of an enterprise to survive, adapt, and flourish in the face of turbulent change and uncertainty.’ From this perspective, resilience is not just the ability to bounce back quickly and recover from a disruption. Rather, resilience is a strategic approach to embracing change that addresses both downside and upside possibilities. Resilient enterprises adapt successfully to turbulence by anticipating disruptive changes, recognizing new business opportunities, building strong relationships and designing resilient assets, products and processes.”

Fiksel asserts leading companies are shifting “from a reactive mode to the proactive design of resilience strategies.” He divides these resilient strategies into four categories: Steer and adjust; sense and respond; adapt and transform; and survive and flourish.

Steer and adjust — “When the pace of change is slow and manageable, involving relatively minor fluctuations, companies can use orderly, well-defined business processes that operate precisely and efficiently. The concept of continuous improvement, based on a ‘plan-do-check-act’ cycle, enables periodic midcourse corrections to ensure that companies learn from experience and achieve ever-higher performance goals.”
Sense and respond — “Every business may experience unexpected disruptions that interfere with normal business operations. … Risk analysis and emergency response procedures help anticipate common types of disruptions and ensure business continuity. For disruptions that are rare or unpredictable, companies can supplement traditional risk management processes with the capacity to sense early warning signals and respond in a flexible manner.”
Adapt and transform — “Gradual changes in the business environment eventually may erode a company’s competitive advantages. By using trend forecasting and scenario planning, companies have become more proactive in identifying major paradigm shifts that could influence their strategy, such as the growth of Internet commerce and the emergence of new market segments.”
Survive and flourish — “Increasing globalization and complexity have amplified the turbulence of the business environment, forcing companies to abandon reactive approaches and become wary of future predictions. Catastrophic disruptions are becoming more common, and it has become clear that ‘business as usual’ is a fallacy. Disaster recovery is merely a survival strategy. To remain successful and flourish under these challenging conditions, companies must anticipate possible futures, develop adaptive capacity and embed resilience thinking into their business processes.”

I like Fiksel’s holistic approach to resiliency. At Enterra Solutions® we call this kind of holistic approach Enterprise Resilience Management?. Enterprise Resilience Management takes advantage of the capabilities offered by cognitive computing (e.g., the ability to analyze a limitless number of variables, integrate and analyze structured and unstructured data, automate processes, and calculate perturbative effects). Fiksel concludes, “Today, increased variability in the business environment requires greater flexibility in business processes, implying a shift from rigid, prescriptive processes to more fluid processes that are sensitive to changing conditions.”

Footnotes
[1] Yolanda Graham, “How can you prepare your supply chain for disruptions?Quintiq Blog, 17 February 2015.
[2] Staff, “Global Supply Chain Report: 40% of Respondents Faced Supply Chain Disruptions in Past 12 Months,” Supply Chain 24/7, 9 February 2015.
[3] Alexa Cheater, “How Prepared Are You Really? Supply Chain Black Swans,” 21st Century Supply Chain Blog, 4 December 2015.
[4] Yossi Sheffi, “Guest Voices: Black Swans and the Risks in Supply Chains,” The Wall Street Journal, 28 October 2015.
[5] Joseph Fiksel, “How businesses can build resilience by design,” GreenBiz, 24 October 2015.