Current enviroment in business operations.
Breakthroughs in communications and processing capability have enabled an exponential increase in the complexity of supply chains. The potential benefits of such complexity are unquestionable. However, the increased interdependencies multiply and fragment the risk points and dramatically complicate their detection and evaluation. Supply chain operations become particularly vulnerable to events brought about by hard-to-predict risks. The main risks that can typically occur are:
a. Sudden and significant changes in demand.
b. A catastrophic by some partner in the extended chain, which may be a vendor or a distributor.
c. Interruptions in a link due to natural events (for instance, floods, landslides, earthquakes, etc.).
d. Interruptions in a link due to social or political events (coups d’état, expropriations, statutory changes, etc.).
e. Risk due to sudden fluctuations in the price or availability of key inputs.
Each of these involves a series of specific difficulties and each of those hurdles must be expressed independently.
Importance of a business focus to risk management (RM )
An error that companies can commonly make is to assume that risk can be expressed in some sophisticated mathematical model. The probability
of being able to predict a potentially catastrophic event is very unlikely.
Therefore, any successful strategy must be based on the existence of business-wide mitigation and contingency plans and on the nimbleness and precision of the responses.
Multinational companies acknowledge that their operations are continually affected, and although many of them gave mitigations and continuity plans, it is estimated that one out of five companies has experienced significant losses due to inadequate responses to disruptive events. A study at Georgia Tech found that the effects of supply-chain disruptions can have significant impact. This arose while examining the impact on a company’s stock value after disclosing a supply issue. Based on a sample of 800 media releases, the study includes a shipment delay at Sun Microsystems in 2000 and component shortages at Boeing in 1997.
Typically, stock prices dropped 8% the next day after the disclosure, a reaction that is worse than the average stock-market reaction to other
types of corporate bad news, such as delays in the launch of new products (5%), financial problems (3-5%) or IT problems (2%). Even worse, the effects may be long lasting. Both sales and profitability decreased along the two years following a disruptive event. Obviously, it should be stressed that this single fact justifies a reassessment of our organization’s risk management strategy.
As discussed above, modern supply chains are acutely vulnerable. This is due to several current trends:
a. Optimization-oriented approaches that eliminate much of the inventory. This depends on keeping in close touch with vendors, clients and haulers in order to achieve quick responses. Any failures put the operation in jeopardy.
b. Elimination of alternate routes or vendors in the supply of our products. This helps reduce costs but may increase the company’s exposure to risks.
c. Lack of a comprehensive approach to decision analysis. The business cases that validate initiatives usually attempt to consider all the rewards, but fail to consider all potential costs.
d. Low visibility of the most vulnerable points of our chains in the event of any sudden change.
The following example illustrates the importance of having a riskmanagement approach. In March of 2000, a semiconductor manufacturing
was severely damaged by fire and its associated complications. The plant, operated by Philips, told its clients that delays were to be expected.
The clients included Nokia and Ericsson, which accounted for 40% of the plant’s volume. Although Philips communicated the problem to both at the same time, their responses were quite different from each other.
Nokia built a team to seek alternate sources for certain key. It worked closely Philips to relocate production to other plants and find methods to increase the production of parts Nokia was unable to source anywhere else.
On the other hand, Ericsson failed to extensively communicate the potential consequences of the disaster and took very long to identify the magnitude
of the issue. When they eventually tried to react, Nokia had already used up the surplus capacity of Philips, and many other alternate vendors were already producing inputs for Nokia.
A year after the fire, Ericsson was out of the market as an independent player, being forced to seek an alliance with Sony as its only option to remain in the market, via a 50-50 joint. Meantime, Nokia had raised its market share from 27% to 30%.
The question is very simple: How could this happen? How come the same catastrophe could have so different impacts on two large, sophisticated organizations within the same industry?
The answer is that risk management isn’t an issue to deal with behind closed doors; instead, it should be directly related to supply-chain management.
A company depends on its network of vendors, haulers, and many other facilitators. This means that quick response, the existence of an action plan and the flexibility of the chain are crucial elements to face disruptions.
WHAT´S THE RIGHT RM APPROACH THAT AN ORGANIZATION NEEDS?
The two key concepts to define an organization’s focus vis-à-vis risk are redundancy and flexibility. These two items may seem mutually exclusive, but itthey’re appropriately combined they provide the best possible protection against risks. The clearest example of redundancy is the availability of “safety” inventories of finished goods, product in process, or raw materials. Nonetheless, very few organizations have the capability to maintain large-scale redundancies of this type. Therefore, the other key element—flexibility—gains the upper hand.
The concept of flexibility is based on interchangeability, i.e., the ability to swap elements of the supply chain in a nimble and effective fashion. We could say that flexibility is the ability to create redundancy without incurring the costs that the latter involves. Below are some examples of flexibility:
- Standardization of processes and facilities along the chain.
- Interchangeability of components and of finished goods.
- Integration of the various links of the change under a single command structurePostponement.
- Alignment of the procurement strategy to the types of vendor for each type of component.
- Collaboration with members of the extended chain.
As discussed above, the pressures of today’s business environments keep pushing companies to become increasingly leaner and more efficient.
However, this renders them especially vulnerable to sudden changes of demand, the failure of partners in the extended chain, natural disasters or shortages of an essential input. This means that any cost-reduction strategy for the chain should be supplemented by analysis that makes it possible to identify the trade-offs between the degree of “leanness” and the degrees of flexibility and redundancy, pursuant to the logic outlined below:
1. Analyze the initiative’s exposure to risk,
2. Simulate the impact of potential disruptive events,
3. Formulate containment strategies (redundancy and flexibility analyses).
Additionally, a fundamental factor that can make a difference Is the organization’s culture in the face of change. There are several qualities that any organization needs to possess in order to ensure a nimble and efficient response in the event of disruptive events:
- Constant communication among highly informed employees. For instance, the employees of Dell have ongoing access to information on production and shipments, as well as about the general state of the company. This enables them o react more intelligently in case of a disruption.
- Decentralized decision-making. The U.S. Coast Guard was able to respond swiftly to the devastation brought about by Katrina thanks to its operational principle of “Initiative on the Trenches”, in which initiative is rewarded when it yields good results but isn’t punished if the results are bad.
- A passion for work. A successful organization strives to generate synergistic efforts to achieve shared goals. At Southwest Airlines, the operative principle is take the bricklayer and make him understand that he’s building a home, not just laying bricks.
- Conditioning to confront disruptions. At UPS, for example, in a business subject to many variables that are beyond the control of the organization, recovery processes are tested practically on a daily basis. Even companies with relatively predictable environments may inject some uncertainty into their training processes. For instance, there is a special team at Intel that routinely visits plants worldwide and introduces simulated disruptions, such as failures by critical vendors or unexpected changes in the demand for certain products. The team runs a comprehensive exercise to identify alternate suppliers, increase transportation and production capabilities, and so forth. The keyword is to prevent complacency.
CONCLUSIONS
Any organization operating in today’s environment has a complex supply chain and is prone to many disruption risks, whose negative impact may be significant and long lasting. Organizations need to formulate a risk management strategy built upon a rigorous understanding of the vulnerable links of the extended chain, and on the application of containment and mitigation schemas based on the appropriate mix of redundancy and flexibility. Besides, they need to foster cultural change that sees risk as one of the many challenges an organization faces on a daily basis, instead of something that’s impossible to prepare for.
About Sintec
Sintec is the leading consulting firm focused on generating profitable growth and developing competitive advantages through the design and execution of holistic and innovative Customer and Operations Strategies. Sintec provides a thorough and unique methodology for the development of organizational competencies, based on three key elements: Organization, Processes and IT. Furthermore, Sintec has successfully carried out more than 300 projects on Commercial Strategies, Operations and IT issues with more than 100 companies in 14 countries throughout Latin America. Our track record of more than 25 years makes Sintec the most experienced consulting firm in this area of expertise in the region.
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