Supply Chain Disruptions Are Growing More Serious but Risk Management isn’t Keeping Pace

Stephen DeAngelis

December 28, 2012

Sean Kilcarr reports that “the 2013 Third-Party Logistics Study: The State of Logistics Outsourcing compiled under the auspices of Penn State University, [indicates that] economic losses due to supply chain disruptions increased by 465% over the last three years – climbing from $62 billion in 2009 to well over $350 billion in 2011.” [“Study: Supply chain disruptions growing more serious,” FleetOwner, 26 November 2012] By any measure, those are frightening statistics that should capture the attention of any corporate executive whose company utilizes extended supply chains. Kilcarr concludes that these disruptions, “caused largely by natural disasters and unplanned system ‘outages,’ [are] giving fair warning to the transportation and logistics industry that more work needs to be done to mitigate risks from such events.” After looking at all the disruptions that occurred in 2011, the editorial staff at Supply Chain Digest wrote:

“Many pundits said it was time for companies to once again think more comprehensively about supply chain risk, and be more concerned with looking beyond first tier suppliers to their suppliers’ suppliers, among other improvements. But now almost a year past the Japanese earthquake, has much really changed in how companies manage supply chain risk? Yes and no – depending on who you ask.” [“Did Major Supply Chain Disruptions from Natural Disasters in 2011 Really Change Approach to Supply Chain Risk Management?, 19 January 2012]

A report released by the World Economic Forum shortly after the Supply Chain Digest article was published highlighted “the urgent need to review risk management practices to keep pace with rapidly changing contingencies facing the supply chain, transport, aviation and travel sectors.” [“World Economic Forum tackles supply chain risks,” Supply Chain Standard, 25 January 2012] The report, which was entitled New Models for Addressing Supply Chain and Transport Risks, was produced by the WEF in collaboration with Accenture. The Supply Chain Standard article went on to state:

“Trends such as globalisation, lean processes, mass travel and the geographical concentration of production have made supply chain and transport networks more efficient, but have also changed their risk profile. Major disruptions in the past five years – including the global financial crisis, the Yemen parcel bomb scare, flooding in Thailand and the Japanese earthquake and tsunami – have highlighted how risks outside the control of individual organisation can have unintended consequences that cannot be mitigated by one organisation alone. Encouragingly, more than 90 per cent of those surveyed by the World Economic Forum and Accenture initiative indicate that supply chain and transport risk management has become a greater priority in their organisation over the past five years.”

The question is: Has the higher priority given to supply chain risk management actually translated into tangible improvements? The answer to that question, as noted by the folks at Supply Chain Digest, is mixed. They note, “Making changes that cost money today for the sake of mitigating risks that may or may not ever emerge is not highly popular in the executive office.” They go to note that an article published in the Wall Street Journal reported that “awareness of new supply chain risks ‘hasn’t necessarily led to action.’ … That’s partly because boosting inventory even slightly to provide a cushion against supply disruptions can cost big companies millions of dollars, taking a noticeable bite out of the bottom line.'” The SCD article continues:

“One problem is that it is extremely hard if not impossible to cost justify adding certain supply chain redundancies absent an actual major disruption that can demonstrate what the impact would have been if the steps had not been taken. That makes it hard to get much executive enthusiasm behind such mitigation moves unless the pain of a recent disruption is still fresh in mind. The WSJ article quotes Sean Cumbie, vice president of global supply chain at German genetics-testing company Qiagen, as saying ‘If we’re lucky, [we get] absolutely zero return’ from such risk mitigation moves. The implication: often the moves cost money in the short term, and even the long term if certain feared risks never materialize. The article notes that while large companies themselves may therefore be reluctant to take certain risk mitigation steps, they are happy to give advice to key suppliers about moves they should be making.”

As indicated by the facts presented in the Penn State report, there has been a dramatic rise in supply chain disruptions over a relatively short period of time. According to Ben Bland and Robin Kwong, companies simply didn’t anticipate such a steep rise in disruptions. “From large multinationals to niche factories,” they write, “most manufacturers have some sort of contingency plan to cover natural disasters and political risks. But while the phrase ‘supply chain risk management’ has become firmly established in the management lexicon, the more than 1,000 manufacturers affected [by recent events] had not envisaged a situation so bad.” [“Supply chain disruption: sunken ambitions,” Financial Times, 3 November 2011] Bland and Kwong continue:

“Following two big shocks to the global supply chain in quick succession, and amid growing fears that climate change will lead to more frequent, more unpredictable natural disasters, multinationals are coming under increasing pressure to rethink the way they produce and distribute. … ‘Companies need to rethink the clustering model,’ says Richard Little, an academic from the University of Southern California who specialises in disaster preparation and mitigation. ‘Yes, you get benefits but you also have common vulnerabilities for an entire industry or sector. If all your chipmakers are in one place and they get hit by a natural disaster, you lose all the benefits of clustering.’ … [Nevertheless,] manufacturers remain under pressure from customers, competitors and investors to cut costs.”

The truth of the matter is that resilient supply chain risk management strategies aren’t cost free. Maintaining redundant suppliers or increasing inventory levels can be expensive and they come with their own risks. Bland and Kwong conclude:

“Will companies therefore spend more on preparing for the unexpected? USC’s Mr Little, who has advised the World Bank on the dangers of big infrastructural failures, argues that there is a slim window of opportunity for governments to tighten disaster regulations for companies, which otherwise tend not to invest to protect against catastrophic risks. ‘There’s a huge spike in awareness after something bad happens and we want to do something to feel safer,’ he says. ‘Over time, that awareness settles down under a level where you get any positive action.’ He suggests it is dangerous to leave it to cost-conscious manufacturers and their shareholders to protect themselves and their employees from calamities: ‘Markets don’t reward prudence. Investors won’t value companies that do it right – they’ll probably punish them.'”

Wise executives, however, need to be more prudent. Kilcarr notes that, on a conference call in November, Shanton Wilcox, one of the authors of the Penn State study and a principal at Capgemini Consulting, “warned that the probability of supply chain disruptions is only going to increase in the future, with the economic impact of such disruptions increasing as well.” Wilcox noted that nearly 40% of disruptions can be traced to Tier 2 firms. That’s why supply chain analyst Lora Cecere has argued for some time that, at a minimum, a company must have visibility down to a supplier’s supplier. Wilcox went on to argue that companies must map their supply chains. “If you don’t understand the structure of your supply chain, you won’t know how to fix it,” he warned.

 

According to a 2011 study by the consulting firm A.T. Kearney, the vast majority of large companies are at risk to supply chain disruptions. [“80 Percent of Companies Vulnerable to Major Supply Disruption,” SupplyChainBrain, 10 November 2011] The study also concluded “that leading companies excel at managing risk by using risk-impact analysis, financial risk management (such as hedging) and disaster planning to protect against unforeseen threats.” With so many analysts nearly screaming that supply chain disruptions are going to continue to increase if action isn’t taken, you might find it surprising that, according to Gene Tyndall, an executive vice president at consulting firm Tompkins Associates, “that companies have perhaps talked more about taking additional steps to reduce supply chain risk coming out of the disasters than have taken real action.” He told the staff at Supply Chain Digest:

“‘Despite lots of talk about risk management, its actual applications in supply chains are fewer than expected. … Our benchmarking and corporate experiences indicate that while many companies do have contingency plans, especially for weather and labor disruptions, most do not actively change suppliers and/or sourcing locations.’ He added that ‘international sourcing and routings are complicated, and changes are not easily done with efficiency. A best practice is to work more closely with logistics service providers so that flow impacts from supply chain disruptions are better managed.'”

MIT professor David Simchi-Levi agrees that “most companies talk about risk but do very little to change their approach.” He told the staff at Supply Chain Digest, “A prime reason most companies do very little in response to the major disruptions over the last few years is because they are not sure what to do.” The staff concludes, “One thing everyone can agree on – globalization and Lean supply chain practices have made today’s supply chains a lot more risky than ever before.” No one can accurately predict what lies ahead in the New Year; but, it’s a near certainty that major natural disasters will once again make news and disrupt supply chains.