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In the last decade, supply chain visionaries have promoted outsourced manufacturing, vendor-managed inventory (VMI), and third-party logistics providers (3PLs) to handle everything from procurement and materials handling to manufacturing, transportation and warehousing. And while the projected cost savings were compelling, many businesses worried that sacrificing control of these critical operations would introduce a number of business risks-specifically, would outsourced vendors act in their own self interest, as opposed to supporting the needs of the end consumers?
Vast amounts of capital have been released from bloated supply chains by requiring suppliers to stock their own components in just-in-time (JIT) warehouses next to their customers. For brand owners, VMI has nearly doubled inventory turns while allowing them to reinvest windfall savings into new product development and marketing. As more money was spent on research and development, a new wave of consumer demand was spurred for smaller computers, smarter phones and more innovative internet network equipment, enabling global access to information in real time. This explosion of innovation benefited everyone in the supply chain: brand owners were able to create new markets, and suppliers were able to provide more components to contract manufacturers (CMs) and to absorb fixed costs more predictably. As long as market demand grew, supply did not seem to be a problem as new competitors rushed into business fueled by cheap money and the capacity to grow their share of the ever expanding market.
Everything seemed "just right" as supply chain professionals took on even more risk through initiatives like supplier rationalization (more volume to fewer suppliers for greater cost reductions), larger centralized manufacturing industrial parks, and the consolidation of air and ocean freight carriers. Throughout the '90s, good supply chain people were practically minting money by concentrating on fewer providers doing more value-added work. While most chief financial officers recognized the profitability potential of the next "new product," they also knew that the current quarter required their supply chain organizations to relentlessly extract pennies from millions of components day in and day out.
By the end of the '90s, most supply chains had successfully leaned out their inventories, reduced a great deal of overhead waste, and were tuning JIT deliveries across the globe with incredible precision. Supply chain speed and flexibility was the mantra as customers began to expect unparalleled levels of service. Products that should take months to procure and manufacture were promised within days of customer requests.
And then nature took its course...
• A tsunami devastated critical nuclear reactor capacity in Japan, which served electricity to semiconductor manufacturers supplying nearly 40 percent of the world's 12-inch wafers capacity
• Airfreight passed reawakened volcanoes near Iceland, disrupting transportation and deliveries into and out of Northern Europe
• Supplies of components passing hot spot areas (e.g., Sudan) experienced cargo theft and transit delays
• An increase in extreme weather events, including tornadoes, high winds, and snowstorms, caused thousands of missed shipments worldwide
• And most recently, a massive flood in Thailand swamped production of critical high-tech products and equipment
Companies around the world began realizing that one catastrophic supply chain event could wipe out years of profits and hard-earned market share gains. Suddenly, chief operating officers everywhere began asking themselves some pretty pointed questions: why would we single source from a supplier whose factory is located in a known earthquake zone? Have we offshored too much production capacity?
Some players in the hard drive industry were hit particularly hard, serving as a costly example of how concentrating manufacturing operations to achieve economies of scale can have disastrous consequences. In the '90s, hard disk drive makers were among the first industries to move production to lower-cost countries. Beginning in Singapore, these companies soon transitioned their manufacturing operations to China and Thailand, in search of ever-lower labor costs. Since then, Thailand has become the second-largest maker of hard drives and a major supplier of parts to the industry worldwide. With the catastrophic Thailand floods in the fall of 2011, the industry faced shortages of over 30 million drives per quarter. Some executives at HDD companies were forced to explain a glaring oversight: why had they concentrated so much capital in a country located in a high-flood risk area?
Outsourcing Risk Management
As supply chains have increased in complexity and scope, the skills needed to understand international law and trade insurance have transitioned beyond the scope of the traditional procurement professional. In response, many companies created a new breed of "risk management professional," specially trained in international trade laws-but with little experience or insight into the complex operations of today's end-to-end trading networks. This new type of professional was not well positioned to spot the structural risks accumulating in global production systems, a shortcoming that would make itself all too obvious in the record-setting year of 2011.
Munich Re, the reinsurer behind many of the largest insurance companies in the world, recently reported that 2011 was the highest-ever loss year on record, five times higher than the average since 2001. In December of 2011, Bloomberg reported that insurers and reinsurers may soon negotiate higher prices and limit the coverage they offer for supply chain disruptions in response to record claims from natural disasters in Japan and Thailand. Following an excess of insured losses of $70bn from natural disasters in the first half of 2011, it was speculated that the Thailand floods would push up premiums for business interruption insurance as an add-on to business property coverage.
This string of natural disasters has served as a wake-up call for the unprepared. With the onset of a new crisis, today's supply chain professionals must attempt to rebalance consumer demand with supply that is controlled primarily by outsourced suppliers. War rooms are re-commissioned to serve as the "nerve centers" for the recovery effort. White boards are filled with minute-by-minute reports streaming in from all corners of the globe as supply chain professionals attempt to stabilize the situation and re-establish balance between supply and demand.
What is becoming clear is that the ability to rapidly "sense and resolve" supply chain disruptions is now part of the job. Natural disasters and other large-scale disruptions leave no time to re-plan. Global supply chains are beginning to re-think network design in order to gain the ability to identify risk probabilities and prepare recovery scenarios in advance.
Leading companies are deploying business networks to more effectively manage end-to-end supply chain risk. Beginning with any-to-any electronic connectivity across multiple tiers, business networks provide the business process logic needed to put real-time information into action. The network relies on a cloud-based platform that offers visibility into inventory levels and partner activities, as well as a mechanism for collaborative problem solving. With these functionalities as a starting point, brand owners are able to access and share real-time information with their trading partners-and to collaboratively adjust plans as disruptions arise (without the need for complete re-planning).
According to a 2011 research brief by Aberdeen Group, "When it comes to unplanned events...it is clear that companies perform better, and demonstrate more execution agility when they operate on a collaborative technology platform that allows for bidirectional data flows on a near real-time basis." Such cloud-based, business network platforms offer companies unprecedented insight into current and projected performance with adequate time to redeploy or redirect assets in motion to solve problems. Visibility into all network shipments and inventory also enables brand owners to "virtualize inventory," allowing them to rapidly resolve exceptions using work-in-progress (WIP) inventory throughput and goods in transit as available supply to project against future demand.
How to Manage Supply Chain Risk Using a Business Network
A survey by FM Global published in early 2011 indicated that a growing share of supply chain losses was caused by sub-tier suppliers (upwards of 50 percent). Additionally, in a December 2011 publication in Harvard Business Review, co-authors Thomas Choi and Tom Linton suggest that "Lower-tier suppliers that serve a number of markets often spot shifts in the economy early on-and can warn customers about them." These trends serve as additional proof points for a collaborative, business network approach, and emphasize the growing importance of multi-tier supplier management.
Brand owners should start by keeping a closer eye on all their suppliers' key performance indicators - such as order responsiveness, on-time delivery, and the frequency of partial shipments - for signs of trouble at the sub-tier level. Keep in mind that small suppliers are the most vulnerable to disruptions because they keep their businesses very lean. Even if not directly affected by a natural disaster or other large-scale disruption, these partners can still suffer crippling cash-flow problems if customers have to temporarily suspend shipments.
Suppliers of all sizes should be monitored closely to determine financial solvency and to ensure that credit lines are adequate to support raw material and production requirements. Additionally, risk managers should be in close communication with suppliers to understand their recovery plans. Following unforeseen disruptions, suppliers' on-time delivery metrics should be watched as they regain their footing. These metrics can be early warning signals of much deeper problems, such as insufficient cash flow to pay their suppliers.
Finally, dual sourcing is becoming a new requirement of supplier rationalization. For many companies, this will mean finding new ways to manage more supply sources through an increased number of CMs. Supply chains that are accustomed to using single sourcing to reap short-term cost reductions (at the expense of long-term risk exposure) will have to find new ways to manage this increase in complexity. Here again, the multi-tier functionalities of a business network can add significant value. The ability to see, collaborate and resolve disruptions as they occur-whatever the magnitude-is what defines a risk-resistant and resilient supply chain.
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