Managing Supply Chain Risks

By Vinod R. Singhal
College of Management
Georgia Institute of Technology

Senior executives are becoming aware that their company’s reputation, earnings consistency, and ability to deliver better shareholder returns are increasingly dependent on how well they manage supply chain risks.  National and local media are filled with news report on the increase in supply chain risks, and the fact that many companies are unable to cope with these risks.  Some recent examples, include the supply chain disruptions due to Hurricane Katrina, Mattel’s unprecedented recall of 21 million toys due to safety issues; Boeing’s unexpected delay in introducing its much anticipated 787 Dreamliner because of difficulties in coordinating global suppliers; disruptions in air service because of the recent grounding of planes at American Airlines and Southwest Airlines; and recall of contaminated meat, pet foods, and pharmaceuticals. 

As supply chains have become more efficient, have they also become more vulnerable to risk of disruptions.  Lean, globally dispersed networks of suppliers, producers, distributors and customers must live with the possible consequences of more frequent supply chain disruptions.  As supply chain complexity increases, so does the potential for operational disruptions. 

The negative economic consequences of supply chain disruptions are staggering.  Kevin Hendricks at the Wilfrid Laurier University and I have analyzed the effects of nearly 800 supply chain disruptions that were disclosed between 1989 and 2000 by publicly traded companies.  We found that for these 800 companies:

• Shareholder returns averaged 33 to 40% lower relative to their benchmarks over a three year time period around disruptions.
• Share price volatility in the year after the disruption is 13.5% higher when compared to the volatility in the year before the disruption.
• Operating income declined by 107%, returns of assets declined by 114%, returns on sales declined by 93%, and sales growth declined by 7%.

The potential negative consequences of supply chain disruptions underscore the need as to why companies must understand the primary sources of supply chain risks and develop strategies, plans, and actions to mitigate these risks.  However, it seems that many companies are not adequately prepared for assessing and addressing supply chain risks.  For example, a recent report by Marsh Inc. reported that not a single respondent out of 110 risk managers surveyed indicated that their current supply chain risk management practices are highly effective. 
A study by FM Global found that insufficient time, inadequate personnel, and insufficient budget were the biggest obstacles in dealing with supply chain risks.  This is worrisome given that supply chain risks have increased in recent years and the negative economic consequences are getting worse. 

A recent survey by Accenture of 151 supply chain executives in US companies found that 73% of respondents said that their companies experienced supply chain disruptions in the past five years.  A study by FM Global of more than 600 financial executives around the world found that supply chain risks pose the most significant threat to profitability.

The importance of managing supply chain risks raises the natural issue of what are some of the best strategies and practices in supply chain risk management.  I highlight some of these using examples from Wal-Mart, Mattel, and Boeing.

Hurricane Katrina, a low frequency event with a one in 200 annual odds, caused unimaginable devastation and disruptions in communities in Louisiana and Mississippi.  Although the federal, state, and local governments failed miserably to respond to the devastation caused by Katrina, Wal-Mart was one of the few success stories in how organizations should respond to such disruptions.  The key to Wal-Mart’s success was a clear strategy for dealing with disruptions, detailed planning, and careful execution of the plan.

Wal-Mart started tracking and monitoring Katrina six days before the storm hit New Orleans.  Using data from the National Weather Service and private meteorologists, Wal-Mart managers closely followed the storm’s likely path and began shipping critical items to the distribution centers near the stores in the area where Katrina was likely to hit.   These items were based on studies of customer buying patterns in hurricane-prone areas and the items that store managers usually need to ensure that their stores are operational.  The trucking and transportation division was alerted to the need to load and ship critical items like backup generators and dry ice to stores at short notice.  Backup communications plans with store managers and other key personnel were established and their roles and responsibilities in dealing with the disruption were reviewed and clarified.  Plans were adjusted and modified on a real-time basis as Katrina changed its path.  This detailed planning paid off as Wal-Mart turned out to be the only lifeline for many victims of Katrina. Wal-Mart provided relief days before FEMA could reach the affected areas, and was able to reopen it stores in record time, which provided further help and relief to its customers.

Wal-Mart success in dealing with Katrina highlights the importance of developing capabilities to deal with supply chain risks.  Developing these capabilities requires leadership, commitment of resources, and detailed and tedious planning.  Building robust capabilities for dealing with supply chain risks involves the following steps:

1) Analyze what could potentially go wrong:  This may require brainstorming, thinking about the unthinkable, observing disruptions that your company and other companies have experienced, and involving experts in creating scenarios of what could go wrong.

2) Identify and analyze possible alternatives to deal with different types of risks:  This may require benchmarking of best practices with other companies, scenario analysis, and idea generation.  Various alternatives should be considered to mitigate the high risk factors.  Such alternatives include developing contingency plans to deal with the risk should it surface, options for spreading and transferring risks through insurance, forward contracts, flexible contracts, and making changes in how the supply chain is designed and operated so that these risks are mitigated in the future.

3) Develop plans to deal with disruptions:  This involves outlining what needs to be done to deal with disruptions, when it will be done, how it will be done, and who will do it.  The plan needs to assign responsibility and authority to employees to carry out the plans.  Without such plans, employees are left clueless about what to do, which actually creates more chaos and magnifies the negative consequences of disruptions.

4) Monitor the situation:  Companies should develop a system to monitor risks.  Leading indicators need to be tracked, control limits need to be set to identify out of control conditions, two-way communication with supplier and customers must be done on a continuous basis, and visibility systems must be in place.

5) Execute the plan:  When disruptions occur, the appropriate plans are activated and the effectiveness of these plans in mitigating the negative impact is continuously monitored and adjustments need to be made on real-time basis. 

6) Improve the risk management process:  Firms must continuously strive to improve their risk management processes.  As and when risk is dealt with, efforts must be made to document the outcomes of the risk mitigation plans and highlight what worked and what did not work.  These lessons should be shared across the organizations and used to improve the risk management process.  Benchmarking a firm’s process against other firms that have well functioning risk management process can identify best practices and help make a firm’s process more robust and effective.

Mattel Inc.’s recall of nearly one-million lead-tainted toys underscores the challenge companies face when they source globally in search of low costs. The toy industry has moved so much manufacturing to China to cut costs that now 80% of the toys that come to US are made in China.   The relentless pressure that Chinese manufacturers face to cut costs creates incentives for manufacturers to cut corners to reduce costs.  Lead paint is not only cheap and readily available but its use can speed up the production process, all of which leads to lower costs.  In addition, Mattel allowed the manufacturer to do its own testing because it had a trusted 15-year relationship with it, but the manufacturer did not perform the tests.  Furthermore, the regulatory agencies did not have the resources to police the large volume of toy imports from China.

There are four key lessons for managing supply chain risks from Mattel’s recall.  First, relentless focus on cost reduction can often have unintended consequences. Companies should consider backing off somewhat on cost reductions to avoid creating incentives where suppliers cut corners on quality and safety.  Second, even if you are not responsible for the disruption, you still pay.  Interestingly, lead-tainted toys accounted for about 5% of the total toys recalled by Mattel.  Yet, the damage to the overall reputation of Mattel’s brand and image from the recall is far more than the direct cost of recalling 5% of the toys.  Third, while much has been said about building long-term relationship with suppliers and trusting suppliers, companies must still be very watchful and monitor the processes at their key suppliers, particularly those that affect safety and heath issues. 

Finally, as supply chains become more global, companies must make sure that they have traceability capabilities in their supply chains.  This is critical because without isolating the source, it is difficult to solve the problem.  This issue has become urgent because of contamination problems in food products, pet foods, and pharmaceuticals.  The most recent case is the recall of the blood-thinning drug heparin.  Nearly 80 deaths in US are attributed to contamination in heparin.  The lack of traceability in the heparin supply chain has made it very difficult to trace the source of the problem to address the contamination issue.

The Boeing 787 Dreamliner has been very popular with orders for 892 planes from 60 airliners and delivery slots sold out beyond 2014.  Unfortunately, Boeing cannot meet the promised delivery dates for these planes.  Recently, Boeing announced the third delay in the production of the plane, pushing first deliveries at least 15 months later than initially promised.  Obviously, Boeing’s customers and investors are not happy.

The delay in the Dreamliner is an example of how outsourcing and globalization can create significant supply chain risks, which if not managed well can derail a company’s best laid plans.   To lower the cost to develop the plane on its own, Boeing outsourced the design and build of major sections of the aircraft to suppliers.  The supply chain is quite global with nearly 15 major suppliers across 9 countries.  For example, the forward fuselage and the wing are manufactured in Japan, the center fuselage and the horizontal stabilizer in Italy, the wing tips in Korea, the trailing edge in Australia, the landing gear in the UK, the cargo access doors in Sweden, and the passenger-entry doors in France.  Each of these first-tier suppliers uses its own set of suppliers, and so on, resulting in a highly complex and distributed supply chain. The subassemblies are transported by ship, air, road and rail to facilities around Seattle for final assembly.

The supplier problems range from language barriers to glitches when some suppliers further outsourcing the work.  Boeing overestimated to ability of suppliers to do the tasks that Boeing could do with its years of experience.  Boeing also did not have deep insight of what was actually going on in the factories of the suppliers.  Suppliers faced major issues in ramping up capacity.  Coordinating across the various suppliers across the globe turned out to be more challenging than Boeing anticipated.
To deal with the delays Boeing has bought the interest that one of its supplier had in a joint venture.  Boeing has hinted that similar moves are under consideration as it attempts to take control of key parts of its supply chain.  Boeing managers are taking a more aggressive role in getting insight into suppliers’ operation, including stationing Boeing employees in every major supplier’s factory.  Boeing is also trying to build real-time visibility of its suppliers’ operation as well as developing a better understanding of how the plane comes together.   Boeing’s CEO is actively engaged in monitoring the plane’s progress.  Companies should be careful when they make outsourcing decisions and must balance the benefits of expected cost savings against the increased costs of managing supply chain risks.  Boeing strategy underscores the limits and hazards of outsourcing.

Vinod Singhal is the Knoll Professor of Operations Management at the College of Management at Georgia Tech, Associate Dean of the MBA programs, and Associate Director for the Center for Paper Business and Industry Studies, an industry center funded by the Sloan Foundation.  He received his Bachelor in Mechanical Engineering (1979) from the Birla Institute of Technology, Pilani, India; Master in Business Administration from the Indian Institute of Management, Ahmedabad, India; Master of Science in Operations Research (1984) and Ph.D. in Operations Management (1988) from the Simon School of Business, University of Rochester, New York, USA.  From 1986 to 1989 he worked as a Senior Research Scientist at General Motors Research Labs in Detroit, USA.  His teaching and research interests include operations strategy, supply chain management, total quality management, and performance measurement.  He has served on the Board of Examiners of the Georgia Oglethorpe Award, Bell South’s President Quality Award, and is currently on the Baldrige Board of Examiners.  He is a member of ASQ and INFORMS.  He is frequent presenter at various academic and practitioner conferences and at universities.

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