Enterprise supply chains must be both responsive and resilient says Martin Christopher (extract from FT Mastering Risk) Coping with complexity and chaos

There is a widely held belief among managers that recent years have seen a palpable increase in the risk of business disruption. This risk has many sources- not just the obvious and current threats from terrorism and geopolictal events, but also the unexpected impact of particular business decisions. There is also strong evidence that the continued search for business efficiencies and the rise of what has been termed ‘’ the extended enterprise’’ have been the cause of a major change in the risk profile of many companies. This risk increasingly lies not within the organisation itself, but in the wider supply chain.

Growing turbulence and uncertainty

In recent years, market turbulence has tended to increase for a number of reasons. Demand in almost every industry sector seems to be more volatile than before. Product and technology life cycles have shortened and competitive product introductions make life-cycle demand difficult to predict. Considerable ‘chaos’ exists in our supply chains through the effects of such actions as sales promotions and quarterly sales incentives.
Sometimes this chaos can be exacerbated by the imposition of arbitrary ‘rules’ such as minimum order quantities or safety stock decisions.

At the same time, the vulnerability of supply chains to disturbance or disruption has increased. In 2003, the Gartner Group, as US-based research company, predicted that one in five businesses would be impacted by some form of supply chain disruption and that, of those companies, 60 percent would go out of business as a result.
Further more, many companies have experienced a change in their supply chain risk profile as a result of changes in their business models. For example, the adoption of ‘lean’ practices, the move to out-sourcing and a general tendency to reduce the size of the supplier base can all potentially increase supply chain vulnerability.

The impact of unplanned and unforeseen events in supply chains can have severe financial effects across the network as a whole. Research in North America suggests that, when companies experience disruptions to their supply chains, the impact on their share price once the problem becomes public knowledge can be significant. The same research reported that companies experiencing these sorts of problems saw their average operating incomes drop by up to 107 percent, return on sales fall by 114 per cent and return on assets decrease by 93 per cent year on year.

In 2002, Land Rover, part of the Ford Motor company, announced that it might have to halt production of its discovery four-wheel drive vehicle because its sole supplier of chassis- UPF-Thomson had gone into liquidation. It was estimated that it could take up to six months for an alternative source of supply to be brought on stream. At significant cost, Land Rover had no alternative but to finance the supplier to enable production of the chassis to continue.

Clearly there are risks that are external to the supply chain and those that are internal. External risk may arise from natural disasters, wars, terrorism and epidemics or government imposed legal restrictions. Internal risks refer to th erisks that arise as a result of how the supply chain is structured and managed. While external risk cannot be influenced by managerial actions, internal risk can.

Why are supply chains more vulnerable?

A study by Cranfield University for the UK department of transport identified a number of reasons why modern supply chains have become more vulnerable. These factors include:

• A focus on efficiency rather than effectiveness
  The prevailing business model of the closing decades of the 20th century was 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 practices were widely adopted and organisations became increasingly dependent upon suppliers. This model, while undoubtedly of merit in stable market conditions, may become less viable as volatility of demand increases. The challenge in today’s business environment is how best to combine ‘’lean’’ practices with an agile response.
  
• The globalisation 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, then sub-assembled in Singapore with final assembly in the US for sale in world markets.
  The motivation for offshore sourcing and manufacture is usually cost reduction. 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 potential higher levels of obsolescence- particularly in short life-cycle markets. A further impetus to the globalisation of supply chains has come from a consolidation of the supplier base as a result of the increase in cross-border mergers and acquisitions that we have witnessed over the past decade or so.
  
• Focused factories and centralised distribution
  One of the impacts of the implementation and subsequent enlargement of the single market within the European Union and the consequent reduction in barriers to the flow of products across borders has been the centralisation of production and distribution facilities. Significant scale economies can be achieved in manufacturing if greater volumes are produced on fewer sites.
  In some cases 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 has to travel greater distances, often across many borders. At the same time, flexibility may be lost because these focused factories tend to be designed to produce in very large batches to achieve maximum scale economies
  Along with the move to fewer production sites is the tendency to centralise distribution. Many fast-moving consumer goods manufacturers aim to serve the whole of the European market through a few distribution centres.
  
• The trend to outsourcing
  One widespread trend, observable over many years, has been the tendency to outsource activities that were previously conducted within the organisation. No part of the value chain has been immune from this phenomenon; companies have outsourced a wide range of activities including distribution, manufacturing, accounting and information systems. In some cases, these companies might today more accurately be described as ‘’virtual companies’’.
  There is strong logic behind this trend, based upon the view that organisations are more likely to succeed if they focus on the activities in which they have a differential advantage over competitors. This is leading to the creation of ‘’network organisations’’, whereby confederations of companies 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 the potential loss of control. Disruptions in supply can often be attributed to failure of one of the links and nodes in chain. By definition, the more links there are, hence the greater the risk of disruption.
  
• Reduction of the supplier base
  A further prevailing trend over the past decade or so has been a dramatic reduction in the number of suppliers from which an organisation typically will procure materials, components and services. 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 by a failure at a single source. Even though there are many benefits to supplier base reduction, it has to be recognised that it brings with it-increased risk.
  
• 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 that ability of a system to return to its original or desired state after being disturbed. Resilient processes are flexible and agile and are able to change quickly. Supply chain resilience also requires ‘’slack’’ at those critical points that can be adversely affected by changes in the rate of flow.
  Supply chain resilience depends on rapid access to information about changed conditions. Through collaborative working with partners, this information can be converted into supply chain intelligence. Because networks have become more complex, they will rapidly descend into chaos unless they can be connected through shared information and knowledge. The aim is to create a supply chain community where there is a greater visibility of upstream and downstream risk and a shared commitment to mitigate and manage those risks.
  Ultimately, it may be necessary for companies to re-engineer their supply chains not, as in the past, with cost minimisation in mind but to maximise their flexibility and agility. Today’s changed conditions are forcing companies to question past decisions on sourcing, outsourcing and the pursuit of ‘’lean’’ solutions. Responsiveness and resilience must be the twin goals of supply chain design and management.