Originally posted on on the e-Sourcing Forum [WayBackMachine] on Saturday, 22 July 2006

Yesterday we defined supply chain risk, discussed the reasons why supply chain risk is increasing, and indicated how prevalent it is in today’s enterprises with some recent statistics. Today we are going to discuss the different types of supply chain risk that an organization needs to prepare for, the need for resiliency in its daily operations, and the classic strategies used to prepare for risk.

Risks arise at many levels. They can be internal risks that result from daily operations, network risks within your supply chain or partner interactions, industrial risks common to all companies operating in your industry, or environmental risks beyond anyone’s control. They range in severity from minor deviations in supply and demand through supply chain disruptions that can knock out part of your supply chain to serious disasters that will force a temporary irrecoverable shutdown of (a substantial) part of your supply chain.

We use the definitions of R. Gaonkar & N. Viswanadham of The Logistics Institute (Asia Pacific) at the National University of Singapore, as found in their Indian School of Business Working Paper “A Conceptual and Analytical Framework for the Management of Risk in Supply Chains”. Specifically, a deviation is when one or more parameters stray from an expected value without any changes to the underlying supply chain structure. A disruption is when the structure of the supply chain is radically transformed through the unavailability of certain facilities, suppliers, or transportation options. A disaster is when a temporary irrecoverable shutdown of the supply chain network occurs due to unforeseen catastrophic system wide disruptions.

Within your organization, you face machine related issues, quality problems, materials and parts shortages, and communicable illnesses among you staff on an almost daily basis that could lead to deviations. Furthermore, unexpected employee strikes and opportunistic behavior by senior management could lead to significant supply chain disruptions in the long term.

From a network perspective, you are subject to the risks associated with increasing customization, outsourcing, and collaboration. A disruption to your supplier or third party logistics carrier is a disruption to you. Their organizational risks and performance problems become your network risks. Furthermore, you risk deviations due to fluctuating transportation capacity constraints, disruptions due to failures in your lines of communications, customs delays, port slowdowns, supplier bankruptcy, and government (over) reactions to crisis situations (such as border closings).

From an industry perspective, the emergence of a new technology or a new business model could cause considerable deviations and disruptions to your business across the spectrum.

From an environmental perspective, you are subject to variations and deviations in expected demand, supply, and lead times that can result from shifts in consumer spending, inflation, and unpredictable economic changes such as foreign exchange fluctuations, governmental policy changes, and free trade zones. You are also subject to disruptions from human perpetrated acts such as sabotage, theft, strikes, and slowdowns and disasters that result from terrorist attacks, large scale natural disasters, and major geopolitical events.

In order to effectively manage these disruptions when they occur and maintain profitability and effective operations, your organization needs to be resilient to predictable and recoverable supply chain risks. Resilience is the inherent ability of an enterprise to return to normal performance levels following a supply chain disruption. Resilience can be achieved through classic redundancy mechanisms or built-in flexibility.

Classic mechanisms for dealing with unforeseen supply chain deviations and disruptions included adding safety margins to lead times, maintaining extra “just in case” inventory, frequent queries of order status, reserving capacity, lining up distribution alternatives, dual sourcing, and order expediting when a disruption occurred.

However, most of these margins come wrought with disadvantages. Adding safety margins to lead times and maintaining extra “just in case” inventory increases costs and decreases an organization’s ability to respond rapidly to demand changes or shifts in consumer preferences. Frequent querying of order status wastes everyone’s time and decreases operational efficiency and reserving capacity decreases the value of, and return on, your investment. Order expediting drives up costs and diverts capacity away from other products. In fact, the only classic mechanisms that make sense are dual sourcing, which is a fundamental strategy of good supply base management, and lining up distribution alternatives, which is a principle of good network design.

Tomorrow we will discuss modern strategies for supply chain risk management and supply network planning.

For more information on supply risk management, see the Supply Risk Management: Mitigate Risks and Reap Rewards wiki-paper over on the e-Sourcing Wiki [WayBackMachine].