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Supply Chain - A house of cards or a firm foundation?

Globalization has introduced new interconnected risks with systemic elements which were not present in the past. This can be extremely challenging for the process of supply chain management. More risk mitigation and exposure control measures have to be taken.

Supply Chain Risk

Supply chain risk was a high profile topic well before the earthquake and tsunami in Japan earlier this year. If you search the web you will find conferences, consultants and even entire companies solely dedicated to the issues and how best to deal with them. Yet, despite all that has been said and written about supply chains, the exposures involved are not always very well understood and optimization strategies even less well addressed. If this were not the case, the negative impact on global automobile output would be significantly less than it is at present.

The rapid globalization of business over the past 20 years has created conditions whereby risks that were previously seen as unrelated are now closely connected. In fact, these risks are now best described as systemic. This means that events occurring in one industry or country can now rapidly transmit to others around the globe. The massive physical damage in Japan was there for all to see, but it is the cascading contingent business interruption that creates disruption within the supply chains of many global companies.

What actually is a supply chain and what can make it so vulnerable to disruption?

A supply chain can be defined as all the processes involved in manufacturing, distributing, storing or servicing goods, from the basic raw material producer through to the final customer. A supply chain for a typical manufacturing operation is shown in the diagram below.

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Supply chain for a manufaturing operation

The past 20 to 30 years has seen the development of business strategies that promote the ideas of “lean manufacturing” and “just-in-time” supply. In reality this means rationalizing supply, centralizing distribution and, in the most extreme cases, even holding virtual inventories. Added to these strategies has been an increasing trend to source globally in order to reduce costs yet further, all along the chain. This has become the dominant economic model, but its success has been achieved at the expense of a significantly increased risk of disruption within companies’ overall supply chains. The very flexibility that provides the supply chain with its cost advantages has also caused its inherent vulnerability.


Growing complexity of Supply Chain Management

The automobile industry

The automobile supply chain is not only one of the most complex examples of modern industrial organization but, because of this complexity, it is also one of the most vulnerable to disruptions. There are somewhere between 15,000 and 20,000 parts in a typical car: if only one of those parts is not available, the product cannot be finished and shipped to the distributors. Below is a fairly simple diagram of an automotive supply chain. The raw materials suppliers feed the next link in the chain. Generally described as tier 3 (sometimes with 2 or 3 subtiers within this level), these companies manufacture small components etc. for the tier 2 firms. Tier 2 firms sell component parts, such as transmission gears, to tier 1 companies. Tier 1 companies then sell finished goods, such as transmissions, directly to the original equipment manufacturer (OEM).

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The typical just-in-time inventory for most car manufacturers is now measured in hours of production rather than in days or weeks. Sole sourcing of supply can sometimes mean that just a few components are bought from a single company. As a result of the earthquake, supplies to all Japan’s car manufacturers were halted. In May, Toyota said that its domestic production fell by over 74 percent compared with the same month last year, and Honda declared an 81 percent reduction. Yet, it has been the contingent element following the event that has created the greatest concern, as the losses are impossible to calculate initially. Within insurance, contingent business interruption provides coverage for an interruption of business functions resulting from disruption to a customer’s or supplier’s operations due to an insurable event. In respect of the Japanese automobile industry, this could mean multiple layers of impact because of the number of tiers within the supply chain. 


Dealing with the threat

It is accepted that supply chain risks can be extremely challenging, but they are by no means insurmountable and there are some measures that can be adopted in order to provide a higher degree of resilience within the chain. Clearly, the first step should be to identify those risk factors that could impact the business, and then to provide some appropriate mitigation measures. As part of a group level business interruption analysis, Allianz Risk Consulting will assess interdependencies that exist between an insured company’s manufacturing location and those of its key suppliers and distributors. Sometimes, this will require a physical inspection of critical facilities in order to identify the areas that are most vulnerable to disruption and then provide a risk mitigation strategy. An inspection of a key location will also provide the opportunity to investigate how suppliers and distributors deal with exposures within their own supply chains. The analysis of business continuity plans (BCPs) is another area where Allianz Risk Consulting can provide clients with some detailed guidance. As part of an extended business interruption study, the suitability of an existing BCP can be checked and then verified against predefined international standards, e.g. BSI Standard 25999 Business Continuity Planning.

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How can you manage vulnerability to disruption within complex supply chain systems?

Summary

Even full knowledge of the economic consequences of the Japan earthquake will not lead to the abandonment of just-in-time production methods. A business model that has been developed and refined over many years will not be sacrificed, however severe the disruptive events. Globalization has significantly increased the potential exposures by accelerating the process of interconnected risk, thereby introducing a systemic element that was not present in the past. There is no doubt that these conditions have served to significantly raise the need for more sophisticated risk mitigation and exposure control measures. Some companies which thought they had adequate business continuity plans have been rudely awakened by recent events; and those companies that actually had well developed plans will now revisit them in order to further optimize their resilience to systemic shocks. Supply chain complexity means that a business impact analysis can be time-consuming and mitigation measures costly, yet even relatively small investments in supply chain design can often result in significant increases in overall resilience.

Allianz Risk Consulting can assist clients by improving their resilience to disruption through the identification of potential exposures within their internal and external supply chains. They can assess the suitability of business continuity plans to deal with these exposures, and then provide risk mitigation measures where these are not fully addressed by the existing planning process. Accepting that there is an inherent degree of risk and uncertainty within all supply chains is simply part of the risk mitigation process. After all, as Harold S. Geneen, the former CEO of ITT, said: “Uncertainty will always be part of the taking charge process.”