Supply Chains Can Be Both Resilient and Cost Efficient

Relatively few managers have done much to protect their supply chains from critical, costly disruptions, even though they know that disasters like the 2011 Japan tsunami and Thailand floods can hit business for months, a recent MIT Sloan Management Review article notes. The problem, according to the authors, is that  protective measures can be at odds with supply chain managers’ goal of improving cost efficiency.

The most obvious steps to protect against serious supply chain disruptions – increasing inventory, adding capacity at different sites, using multiple suppliers – “undermine efforts to improve supply chain efficiency,” Northwestern University Kellogg School of Management Professor Sunil Chopra and City University of London Cass Business School Professor ManMohan S. Sodhi wrote for the magazine’s Spring 2014 issue.

The authors say, however, that managers actually can reduce the risk of major disruptions while improving supply chain efficiency by taking certain steps, such as supply chain segmentation, to achieve both goals.

“Supply chain efficiency, which is directed at improving a company’s financial performance, is different from supply chain resilience, whose goal is risk reduction. Although both require dealing with risks, recurrent risks, such as demand fluctuations that managers must deal with in supply chains, require companies to focus on efficiency in improving the way they match supply and demand, while disruptive risks require companies to build resilience despite additional cost,” they wrote.

Addressing the risk of a fire in a supply plant may require a company to hold additional inventory, which it can’t do “without a substantial loss in cost efficiency,” the article says. “By contrast, recurrent risks such as demand fluctuations or supply delays tend to be independent. They can normally be covered by good supply chain management practices, such as having the right inventory in the right place.”

Supply chains have become much more cost efficient since the 1990s, as managers improved planning and execution to mitigate recurrent risks, the authors note. “However, reliance on sole-source suppliers, common parts and centralized inventories has left supply chains more vulnerable to disruptive risks,” the say. “Low-cost offshore suppliers with long lead times leave companies vulnerable to long periods of shutdown when particular locations or transportation routes experience problems.”

So what’s a manager to do to keep the supply chain both resilient and efficient?

The authors analyzed a network model of a supply chain “that could be made more resilient by building some reliable but high-cost facilities among other lower-cost facilities that could fail and disrupt the supply chain.” They compared these costs to the relative losses from misestimating the disruption probability.

Managers, they say, can design supply chains to contain risk to one part of the network rather than allow a disruption it to ripple through the chain. To reduce supply chain fragility through containment while improving financial performance, companies can segment or regionalize the supply chain, the authors say.

The article cites the example of Spanish fashion retailer Zara, which is known for successfully using “responsive sourcing” from Europe. For years, however, the company also has used lower-cost offshore suppliers for basic items like while T-shirts, after realizing that making everything in Europe wasn’t the most profitable way to do business. Zara continues to produce its “trendiest” items in Europe, the authors note. Moving some production to lower-cost countries also reduced the effect of a potential disruption in one geographic region, they say.

“Large companies can segment their supply chains to improve profits and reduce supply chain fragility,” the authors say.

Lake Forest, Illinois, industry supply company W.W. Grainger also uses segmentation to reduce risk, keep fast-moving items at its stores and distribution centers and slower-selling items at a distribution warehouse in Chicago, the authors say. This design lowers transportation costs and isolates the effects of potential disruptions, they note.

Companies also can contain disruption effects by regionalizing supply chains rather than simply locating production where costs are lowest, the article says.  Japanese automakers didn’t do this and, as a result, the 2011 tsunami disrupted production in plants worldwide for months, the authors note. Regionalizing supply chains allows companies to lower distribution costs and reduce risks, they say.

“Even when implementing a risk mitigation strategy seems expensive,” the authors wrote, “it is important to remember that in the long run, doing nothing can be much more costly.”