chapter-6 rsk management.pptx

CHAPTER 6 MANAGING RISK IN THE SUPPLY CHAIN Chapter outline 1. Why are supply chains more vulnerable? 2. Understanding the supply chain risk profile 3. Managing supply chain risk 4. Achieving supply chain resilience 2  Today’s marketplace is characterized by turbulence and uncertainty. Marke...

CHAPTER 6 MANAGING RISK IN THE SUPPLY CHAIN Chapter outline 1. Why are supply chains more vulnerable? 2. Understanding the supply chain risk profile 3. Managing supply chain risk 4. Achieving supply chain resilience 2  Today’s marketplace is characterized by turbulence and uncertainty. Market turbulence has tended to increase in recent years for a number of reasons.  Demand in almost every industrial sector seems to be more volatile than was the case in the past.  Product and technology life cycles have shortened significantly and competitive product introductions make life-cycle demand difficult to predict.  At the same time the vulnerability of supply chains to disturbance or disruption has increased. It is not only the effect of external events such as natural disasters, strikes or terrorist attacks but also the impact of changes in business strategy 3 Why are supply chains more vulnerable ? A study conducted by Cranfield University3 for the UK government defines supply chain vulnerability as: An exposure to serious disturbance, arising from risks within the supply chain as well as risks external to the supply chain. The same study identified a number of reasons why modern supply chains have become more vulnerable. 4 A focus on efficiency rather than effectiveness The prevailing business model of the closing decades of the twentieth century was very much based upon the search for greater levels of efficiency in the supply chain. Experience highlighted that there was an opportunity in many sectors of industry to take out significant cost by focusing on inventory reduction. Just-in-time organizations (JIT) became practices were increasingly widely adopted dependent and upon suppliers. This model, whilst undoubtedly of merit in stable market conditions, may 5 The globalization of supply chains There has been a dramatic shift away from the predominantly ‘local for local’ manufacturing and marketing strategy of the past. Now, through offshore sourcing, manufacturing and assembly, supply chains extend from one side of the globe to the other. For example, components may be sourced in Taiwan, sub-assembled in Singapore with final assembly in the US for sale in world markets. Usually the motivation for offshore sourcing and manufacturing is cost reduction. 6 However, that definition of cost is typically limited to the cost of purchase or manufacture. Only rarely are total supply chain costs considered. The result of these cost-based decisions is often higher levels of risk as a result of extended lead times, greater buffer stocks and potentially higher levels of obsolescence. – particularly in short life-cycle markets. A further impetus to the globalization of supply chains has come from the increase in crossborder mergers and acquisitions that we have witnessed over the last decade or so. 7 Focused factories and centralised distribution One of the impacts of the implementation of the Single Market within the European Union and the consequent reduction in the barriers to the flow of products across borders has been the centralization of production and distribution facilities. Significant scale economies can be achieved in manufacturing if greater volumes are produced on fewer sites. Some companies have chosen to ‘focus’ their factories – instead of producing the full range of products at each site, they produce fewer products exclusively at a single site. As a result, production costs may be lower but the product has to travel greater distances, often across many borders. Incidentally, at the same time, 8 flexibility may be lost because these focused factories tend to be designed Focused factories and centralized distribution Simultaneously with this move to fewer production sites is the tendency to centralize distribution. Many fast moving consumer goods manufacturers aim to serve the whole of the western European market through a few distribution centres, e.g. one in north-west Europe and one in the south 9 The trend to outsourcing  One widespread trend, observable over many years, has been the tendency to outsource activities that were previously conducted within the organization.  No part of the value chain has been immune from this phenomenon; companies have outsourced distribution, manufacturing, accounting and information systems, 10 The trend to outsourcing This is leading to the creation of ‘network organizations’, whereby confederations of firms are linked together – usually through shared information and aligned processes – to achieve greater overall competitiveness. However, outsourcing also brings with it a number of risks, not least being the potential loss of control. Disruptions in supply can often be attributed to the failure of one of the links and nodes in the chain and, by definition, the more complex the supply network the more links there are and hence the greater the risk of failure. The case of Mattel, highlighted below, illustrates how this loss of control can significantly impact the standing and financial performance of a company. 11 12 13 Reduction of the supplier base A further prevailing trend over the last decade or so has been a dramatic reduction in the number of suppliers from which an organization typically will procure materials, components, services, etc. In some cases this has been extended to ‘single sourcing’, whereby one supplier is responsible for the sole supply of an item. Several well-documented cases exist where major supply chain disruptions have been caused because of a failure at a single source. Even though there are many benefits to supplier base reduction it has to be recognized that it brings with it increased risk. 14 Understanding the supply chain risk profile Many organizations today are addressing the issues of what has come to be termed ‘business continuity’. In practice, however, there tends to be a limited focus for much of business continuity management. There is a strong focus on IT and internal process management but often the wider supply risk dimension is not considered. 15 Understanding the supply chain risk profile This is paradoxical since it can be argued that the biggest risk to business continuity may be in the wider network of which the individual business is just a part. To widen the focus on supply chain vulnerability it is suggested that a supply risk profile be established for the business. The purpose of the risk profile is to establish where the greatest vulnerabilities lie and what the probability of disruption is. In a sense this approach takes the view that: Supply chain risk = Probability of disruption × Impact 16 Sources of risk in the supply chain To help identify the risk profile of a business it is helpful to undertake an audit of the main sources of risk across the network. This audit should examine potential risk to business disruptions arising from five sources: 17 1 Supply risk How vulnerable is the business to disruptions in supply? Risk may be higher due to global sourcing, reliance on key suppliers, poor supply management, etc. 2 Demand risk How volatile is demand? Does the ‘bullwhip’ effect cause demand amplification? Are there parallel interactions where the demand for another product affects the demand for ours? 18 3 Process risk How resilient are our processes? Do we understand the sources of variability in those processe, e.g. manufacturing? Where are the bottlenecks? How much additional capacity is available if required? 4 Control risk How likely are disturbances and distortions to be caused by our own internal control systems? For example, order quantities, batch sizes and safety stock policies can distort real demand. Our own decision rules and policies can cause ‘chaos’ type effects. 5 Environmental risk Where across the supply chain as a whole are we vulnerable to external forces? Whilst the type and timings of extreme external events may not be forecastable, their impact needs to be assessed. 19 Managing supply chain risk - Figure 10.3 below suggests a seven-stage approach to the management of supply chain risk. Each of the seven stages is described in more detail in the following sections. 20 1 Understand the supply chain There is in many companies an amazing lack of awareness of the wider supply/ demand network of which the organization is a part. Whilst there is often a good understanding of the downstream routes to market, the same is not always true of what lies upstream of first tier suppliers. First tier suppliers are often dependent themselves on second and even third tier suppliers for their continuity. 2 Improve the supply chain ‘Improving’ the supply chain is all about simplification, improving process reliability, reducing process variability and reducing complexity. For more long established businesses it is probably true to say that rarely have their supply chains been planned or designed in a holistic way. Rather they have developed organically in response to the needs and opportunities of the time. Suppliers may 21 have been chosen because of their ability to meet the demands for 22 - 23 3 Identify the critical paths Supply networks are in effect a complex web of interconnected ‘nodes’ and ‘links’. The nodes represent the entities or facilities such as suppliers, distributors, factories and warehouses. The links are the means by which the nodes are connected – these links may be physical flows, information flows or financial flows. The vulnerability of a supply network is determined by the risk of failure of these nodes and links. As there will be potentially thousands of nodes and links the challenge to supply chain risk management is to identify which of them are ‘mission critical’. In other words, how severe would the effect of failure be on the performance of the supply 24 chain? Companies need to be able to identify the critical paths that must be managed and monitored to ensure continuity. Critical paths are likely to have a number of characteristics:  Long lead time, e.g. the time taken to replenish components from order to delivery. A single source of supply with no short-term alternative.  Dependence on specific infrastructure, e.g. ports, transport modes or information systems.  A high degree of concentration amongst suppliers and customers.  Bottlenecks or ‘pinch points’ through which material or product must flow.  High levels of identifiable risk (i.e. supply, demand, process, control and environmental risk). To help in identifying where the priority should be placed in supply chain risk management a useful tool is failure mode and effect analysis (FMEA). 25 Failure mode and effect analysis (FMEA).  The purpose of FMEA is to provide a systematic approach to identifying where in a complex system attention should be focused to reduce the risk of failure. It is a tool more frequently associated with total quality management (TQM) but it is especially applicable to supply chain risk management. FMEA begins by looking at each node and link and asking three questions:  What could go wrong?  What effect would this failure have?  What are the key causes of this failure? The next step is to assess any possible failure opportunity against the following criteria:  What is the severity of the effect of failure?  How likely is this failure to occur?  How likely is the failure to be detected? A rating system such as the one shown below is then used to create a combined priority score by multiplying the three scores together. 26 27 4 Manage the critical paths Once the critical nodes and links have been identified the first question is how can the risk be mitigated or removed? At its simplest this stage should involve the development of contingency plans for actions to be taken in the event of failure. At the other extreme, re-engineering of the supply chain may be necessary. Where possible statistical process control should be used to monitor the critical stages along the pipeline. 28 Cause and effect’ analysis is another tool that can be used to identify CAUSE AND EFFECT ANALYSIS 29 30 5 Improve network visibility Many supply chains suffer from limited visibility. What this means is that a particular entity in the network is not aware of the status of upstream and downstream operations of the levels and flow of inventory as it progresses through the chain. In such a situation it can often be weeks or months before problems become visible, by which time it may be too late to take effective action. The often cited case study of Nokia and Ericsson demonstrates the advantage that supply chain visibility can confer. 31 6 Establish a supply chain continuity team All the foregoing stages in the supply chain risk management process require resources to undertake them. One way to do this is to create a permanent supply chain continuity team. Many companies already have business continuity teams in place but, as was suggested earlier, often their focus is more limited and largely IT/IS focused. Other companies look at risk mainly from a financial perspective. All of these activities are necessary and essential but the argument here is that these teams should be expanded in their scope to take account of the fact that the biggest risk to business continuity lies in the wider supply chain. 32 7 Work with suppliers and customers Given the complexity of most supply networks, how can risk be better managed upstream and downstream of the focal firm? Ideally, if each entity in a network took responsibility for implementing risk management procedures of the type advocated here with their immediate first tier suppliers and customers then a far more resilient supply chain would emerge. There are some good examples of collaborative working with both suppliers and customers to develop a greater understanding of the potential vulnerabilities in specific industries. At BAe Systems – a major aerospace company – they have a strategic supplier management process with about 200 key suppliers based upon an industry initiative ‘Supply Chain Relationships in Action’ (SCRIA). BAe put small teams into these key suppliers to find ways of aligning supply chain processes and improving visibility. With their biggest suppliers such as RollsRoyce there is ongoing contact right up to board level. 33 Achieving supply chain resilience Because even the best managed supply chains will hit unexpected turbulence or be affected by events that are impossible to forecast, it is critical that resilience be built into them. Resilience implies the ability of a system to return to its original or desired state after being disturbed.5 Resilient processes are flexible and agile and are able to change quickly. In this latter respect it is important to realise that velocity alone is not enough – it is acceleration or the ability to ramp up or down quickly that matters so far as resilience is concerned. Supply chain resilience also requires ‘slack’ at those critical points that constitute the limiting factors to changes in the rate of flow. 34 - 35