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A direct consequence of making global supply chains more efficient and lean has been the increase in fragility. The billions of dollars of lost sales and costs that Toyota Motor Corp. More pooling reduces the supply chain cost incurred to mitigate recurrent as opposed to disruptive risks; the greater the total amount of pooling of parts and capacity, the greater the total benefit. It is important to realize, however, that pooling provides diminishing marginal benefits when dealing with recurrent risk.

As the Toyota case illustrates, the use of common parts produced by a single supplier in many models can magnify the impact of a quality-related disruption.

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Should managers seek to make their supply chains more lean and efficient by concentrating common parts and single suppliers, or should they seek to reduce disruptions and back off from trying to be more lean and efficient? To answer this question, it is important to recognize that pooling recurrent risks by, say, reducing the number of distribution centers, has diminishing marginal returns for supply chain performance while increasing the supply chain fragility and hence the additional risk of disruptions.

When an auto manufacturer has no common parts whatsoever across different models of cars, building some degree of commonality offers significant benefits. But the marginal benefits grow smaller as more parts are made common. Conversely, going from one distribution center to two can dramatically reduce fragility without significantly losing too many of the benefits of pooling recurrent risks; this is especially true for large companies.

This keeps recurrent risks low by pooling the resource and also keeps fragility of the supply chain low by not taking pooling to extremes. View Exhibit The actual cost of a resource goes up as a result of having multiple warehouses requiring more inventory, while the expected impact of a disruption goes down.

Going from right to left, the total cost decreases as we centralize or pool the resource, but the cost jumps up as we centralize beyond a certain point. Thus, using a single supplier or a single warehouse adds cost. Thus, executives need to keep in mind that dealing with recurrent risks in the supply chain shifts the balance toward more centralizing of resources, pooling and commonality of parts, whereas dealing with rare disruptive risks pushes the balance in the opposite direction.

This is why companies such as Samsung Electronics Co.

Supply Chain Risk Management: Minimizing Disruptions in Global Sourcing

The implications of these principles are obvious. In general, this is true when there are no significant economies of scale in having a large plant or when having inventory in the distribution center is relatively cheap. But even when economies of scale are significant enough to warrant having a single source to address recurrent risks or the cost of maintaining inventory is high, extreme concentration should still be avoided due to the potential impact of disruptive risks.

Ignoring or underestimating the possibility of disruption can be very expensive in the long run, as it means having all of your eggs in one basket. Having even two baskets, while adding to the cost, greatly reduces fragility. Each additional basket typically has a larger marginal cost, while decreasing fragility by smaller marginal amounts.

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In a well-documented example of supply chain disruption that took place in , a fire in a Philips Electronics plant in New Mexico interrupted the supply of critical cellphone chips to two major customers: Ericsson and Nokia. While Nokia was able to find an alternate supply source in three days, Ericsson lost about a month of production.

Realistically, it is impossible to estimate the probability of a plant fire, the bankruptcy of a supplier or a faulty component. Compounding the problem is the human tendency to underestimate the probability of rare events the further removed we are from the time such events last occurred.

Supply chain risk management : minimizing disruptions in global sourcing | UTS Library

Traditional risk assessment comprises estimating the likelihood and the expected impact of an incident. For example, there was no reasonable way for an automaker like Toyota to estimate the probability of a part failure or for airlines to anticipate that European airspace would be closed to air traffic. In such settings, managers have an incentive to underestimate the likelihood of disruptive risks by simply ignoring them — thus avoiding the need to deconcentrate resources or make any trade-offs at all.

After all, preparing for a possible disruptive risk incident requires upfront investment in risk mitigation. That makes it attractive for managers with fixed budgets to underestimate or even completely ignore the likelihood of a disruption. But underestimating disruptive risks, for instance, by completely ignoring them, is a dangerous bet. Our research using analytical models and simulation found that underestimating the likelihood of a disruptive event is far more expensive in the long run than overestimating the likelihood. This was clearly the case for Ericsson: Any savings it might have generated from having a single supplier were overwhelmed by the losses from the plant shutdown.

In contrast, strategies designed to deal with disruption risk such as having multiple suppliers compensate for the upfront cost to some extent by providing some benefits even in the context of recurrent risk for example, supply can be shifted from one supplier to another as regional demand or exchange rates shift. To be sure, investment in additional facilities to mitigate the effect of rare disruptions is a real cost, while the savings from avoided costs of disruptions are hypothetical until a disruption occurs.

Nonetheless, given that even rare events will actually occur, the average costs from disruptions are typically much larger than any savings from avoiding upfront investments. Overinvesting in protection against disruptions may be more economic in the long run than not doing enough. View Exhibit Underestimating the likelihood of a disruption results in a larger increase in long-run cost compared to overestimating the likelihood of disruption. However, small misestimates have very small consequences. For a typical supply chain, we found that the total expected cost of a robust supply chain is not very sensitive to small errors in estimating the likelihood of disruption.

Large costs from future disruptions can be avoided as long as the risk of disruption is not completely ignored. So rough estimates of disruption risk are sufficient, and overestimating is better than underestimating. This knowledge should help managers make better trade-offs between reducing the risk of disruption and accepting reduced cost efficiency. Senior managers cannot ignore disruption risk management because effective solutions are unlikely to be identified and implemented at the local level.

Executives should carefully stress test their supply chains to understand where there are risks of disruption.

If no risk mitigation strategies are in place for a particular source of disruption, a disruption probability of zero has effectively been assumed. This significant underestimation can be very expensive in the long run and should be avoided if at all possible. It is often cheaper in the long run to assume some arbitrary but positive probability of disruption rather than to ignore it. For large companies in particular, building resilience is often relatively inexpensive, and in many cases it can be done without increasing costs.

Segmenting the supply chain based on product volume, variety and demand uncertainty not only increases profits; it also improves the ability of the supply chain to contain the impact of a disruption. Similarly, for many products, especially those with high transportation costs, regionalizing the supply chain both reduces cost and improves supply chain resilience.

But even when implementing a risk mitigation strategy seems expensive, it is important to remember that in the long run, doing nothing can be much more costly.

Approaches to managing global sourcing risk

To be sure, overestimating the probability of disruption requires senior managers to overcome two challenges. First, they must be willing to invest in additional supply chain resilience even though the benefits may not follow for a long time. Since ignoring disruption is always cheaper in the short term, companies must be willing to absorb the additional costs and maintain their commitment to the additional investment such as a backup supplier even when no disruption occurs for a few years. The second challenge relates to how supply chain resilience gets measured and implemented.

Building a reliable backup source at a high-cost location may make sense globally, even when each location may prefer to source from the lowest-cost location. Chopra and M. Lim, A. Bassamboo, S. Hayes and S. Birchall and E. In the past, Diageo largely sold a few premium brands globally such as premium Scotch whiskey. These were sourced from a central location and distributed globally. As Diageo has grown in emerging markets, it has started selling many other products locally. While the sourcing for Scotch whiskey cannot be decentralized for obvious reasons, Diageo has worked hard to locally source as many products as possible, creating a more regional supply chain.

Sodhi and C. See, for instance, L. Actual costs go up with the square root of the number of pools of resources, while expected costs of disruption go down as the inverse of the number of pools. Sodhi and S. In a different setting, Tomlin observed results similar to Lim et al. He found that underestimating the duration of a disruption typically led to significantly larger increases in cost than overestimating the duration of a disruption.

It seems important to consider fragility rather than focusing on building lean and cost effective supply chain systems. How does one quantify the benefits of segmentation and regionalization strategies to insure against the risk of disruption? More than often, a firm incurs significant fixed cost while augmenting from say 1 warehouse to 2. Also, we have weak prior distributions to effectively model the random event of disruption which further undermines the ability to take investment decisions.

The strategies suggested in the article are effective and have other side benefits for large firms. Could you suggest some alternatives where medium size firms can battle the risk of disruption?

I guess this would be challenging as medium size firms, when in their growing phase, have financial crunch and managers require quantifiable insights to take action. First, benefits for segmentation and regionalisation should be quantified only in cost or other economic terms. The benefits as regards risk reduction are an added plus as we argued in the first half of our article so the basic economic case must stand on its own.

Second, we had limited ourselves to large companies in the article but medium-sized companies are potentially more vulnerable owing to less diversification and fewer locations. Upon reflection, the same solutions still apply as long as fixed costs can be avoided by outsourcing storage and distribution, by renting facilities, or by working with distributors. The four approaches we laid out still apply:. Segmenting the supply chain by separating the fast moving items from the slow moving ones also allows separate low-cost warehousing for the slower products that is farther away or rented.

This would require an analysis of orders that the company gets from its customers to ensure entire orders can be met quickly. Regionalizing is still possible if the company can outsource distribution in another region.

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