Daily Archives: June 10, 2008

The Economist and The Fragility of Perfection

It’s nice to see a major publication like the Economist tackle supply chain, even if the picture painted isn’t all that rosy, as in The Fragility of Perfection. The article, which starts off “ONLY Connect”, the words of the novelist E.M. Forster that tidily sums up globalization today, notes that an international company may buy its software from California, send its data to India, purchase its electronic equipment from China and staff its canteen with workers from eastern Europe. And that this specialization is all fine and dandy, but it depends on one critical factor: the reliability of supply.

This dependence on supply reliability is a vulnerability of the global industrial system, but how bad is it? And more importantly, how bad does it have to be? The article quotes David Bowers of Absolute Strategy Research who draws an analogy between today’s supply chains and the recent boom in structure finance which saw banks distribute risk to specialist vehicles like conduits. These banks worried less about the creditworthiness of borrowers, but the risks ended up back on the banks’ balance sheets when the sub-prime crisis broke. Mr. Bowers believes that just as the banks mispriced credit risk, so companies have misjudged strategic risk. And I have to agree. Way too many companies are single sourcing or running their global supply chains too lean when there are dozens of things that can go wrong. (Why? Some companies don’t understand the risk, and some don’t know how to make good sourcing decisions when multiple companies are involved. But there’s no excuse for either, especially when there are good strategic sourcing decision optimization tools on the market to help a company, by way of constraints, mitigate risks AND save money.)

However, what I really liked about the article is Mr. Bowers’ belief that loose monetary policy in America is leading, via the currency markets, to inflation in developing countries. This, in turn, undermines the cost advantages of outsourcing, as the prices of raw materials and labor rise. I’m sure my fellow blogger over at Spend Matters would agree that poor monetary policies, like free trade restrictions, will only hurt the economy.

Furthermore, disruption to the supply chain is a huge strategic risk. Supply chain disasters have bankrupted companies in the past. Remember Aris Isotoner, Webvan, or Foxmeyer? No? Well, they were destroyed by supply chain fiascos. Although just-in-time inventory levels create savings opportunities, they also cause huge losses when suppliers do not deliver in time. The reality is that the more independence there is in the system, the wider the effects of disruption in any one part of it will be felt. A disruption anywhere in the world could prove catastrophic in dozens of countries simultaneously, as the recent earthquake in China might just do if certain factories stay offline for too long. And the resulting losses could be far greater than the fallout of the recent subprime-mortgage crisis.