Plan B: How to prepare for a major supply chain disruption?
While it is clear that one cannot anticipate acts of god, or even those of men, one does have the capacity to limit their impact on operations… We can learn lessons from the past but also from the present. The risk of disruption, is real and it is known. What we can do to mitigate disruption is equally known. Internal risks are prevented and monitored through the usual risk monitoring and mitigation management techniques such as governance, policies, guidelines, trainings, insurance etc… External risks require a different more eclectic and varied treatments. These external risks are typically linked to geographies, currencies, suppliers, regulations, natural events and in general; higher volatility. While these risks are outside of a company’s control, their consequences are not necessarily. With the globalisation and the acceleration of supply chains, these risks have increased in probability, scope and impact. Addressing these effectively, requires a systemic and structured approach which is built-into the supply chain at the outset. The remedies and treatments to and of the risks need to be planned for ahead of time, ideally when the supply chain is set-up.
Companies pressed for cost reductions and share price increases are geared towards Just-in-Time (JIT) and integrated supply chains without often paying due consideration to the elevated risk, which these naturally entail. JIT is rife with lead-time disruption potential and integration is rife with dependency. Companies regularly award business to the lowest bidders and do so mostly to Low Cost Countries (LCC) suppliers. This obviously increases the risk of JIT disruption and thus the need for increased and closer integration. It is a virtuous cycle in the absence of disruption, but a vicious one when disruption occurs, because it considerably limits the capacity to react and to switch.
Integration with suppliers is the result of a focus on cost efficiency, whereby transacting should be as much as possible, free of costs. Hence, the interest and hopes which are placed in technologies such as Blockchain, Machine Learning (ML) and Artificial Intelligence (AI). While there is an initial set-up cost to integrate from an IT and thus data exchange point of view, through EDI for example, the closer integration aims at drastically reducing the transaction costs and increasing the control of the supply chain through digitalisation.
Further, as companies face human resource limitations, they also factor in, the cost to change suppliers or to re-procure which are considered both as an additional risk and cost. So once, a lowest bidder won the competitive award and is integrated, companies tend to stick with that supplier, devoting their attention to managing the relationship. Inadvertently and unconsciously, companies by bringing suppliers into their echo-system in such a fashion, de-facto internalise an external risk.
There are strategic remedies to the JIT and integration risks. It is wise to build a sourcing strategy for critical supplies which considers split awards. Split awards need not be more costly than sole awards if the cost of integrating and transacting are or become negligible. Split awards ensure that there is a back-up supply in place especially if suppliers are not in the same geographies, depending on the same tier 1, 2 suppliers or at least not likely to be subject to the same risks at the same time. Key to executing this strategy successfully, is reducing the cost and time of integrating multiple suppliers thus the cost and speed of switching from one supplier to another. The out-of-pocket costs of such a strategy, e.g. the price differential between the lowest bid suppliers and the others can be compensated by higher savings target in non-critical supplies.
A corollary approach to mitigating the supply risk for companies is the requirement for suppliers to provide bonds and/or warranties. These financial instruments provide companies with the means and resources not only to better enforce contract delivery but also to pre-finance any risk mitigation activities. These financial instruments are submitted by suppliers as part of their bid to the sourcing exercise, not only to warranty the seriousness of their bid, but also the execution/fulfilment of the subsequent contract. It also implies that customers have a higher chance to receive “Most Favored Customer” treatment, that is retain supply priority with suppliers in case of scarcity and/or disruption. The bond value becomes part of doing business with the company for all concerned suppliers. It can be collected and put to good use by the company when the risk materialises and the supplier defaults. It could cover for example, the negative differential between the price paid to the incumbent and the price paid to the alternative suppliers when default occurs.
Let’s take the current COVID-19 pandemic and the shortage of Personal Protective Equipment (PPE), as an example: What could have been done to alleviate the scarcity of PPEs and much more the confusion in trying to secure these in acute state?
Obviously, apart from having higher safety stocks than necessary merely to bridge the supply lead-time (JIT), it could have been opportune to identify suppliers ahead of time in a variety of locations, assessing their overall production capacities, their certifications, quality level, supply history and digitally integrate with the most relevant suppliers. This could provide for the ability to read supplier stocks and their production schedules, runs, raw material stocks, shipments in real-time to gain reassurance with regard to their capacity to deliver. It could also have allowed to place orders faster, to secure supplies, as well as relaying forecasts to offer suppliers visibility and allow them to ramp-up production accordingly.