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2 Potent Supply Chain Risk Reduction Strategies

Reducing the fragility of global Supply Chains in the event of disruption through natural or other disasters is a major concern for most senior executives.  This rings true more so now than ever, as the world grapples with COVID-19, the worst human health crisis in 100 years.

The strategies to enhance the effectiveness and readiness level of Supply Chains and to reduce risks associated with disruption come with a price.  These costs are critical to build Supply Chain Resilience across all industries.

However, these expenses are, generally, considered a hindrance in the implementation of risk reduction strategies by many leaders.  This is one of the major factor that precludes them from anticipating and managing Supply Chain Risks.

Able leaders anticipate these risks and invest in building organizational resilience.  They leverage a couple of potent Supply Chain Risk Reduction Strategies that have nominal impact on cost efficiency but offer substantial reduction of disruption risks:

  1. Diversify supply base
  2. Overestimate likelihood of disruptions

Diversify Supply Base

It is vital for organizations to diversify their supplier base to avoid disruption of their Supply Chains in the event of a natural disaster.  Manufacturers have been found to have been using pooling—combining resources, inventory and capacity by maintaining fewer distribution centers—and producing common parts to help reduce costs.  However, too much pooling and commonality can make the Supply Chain vulnerable to disruption.

For instance, relying too much on a single supplier and common parts—in an effort to be as lean and efficient as possible—became a Supply Chain Analysis nightmare and cost Toyota billions of dollars in terms of lost sales and product recalls in 2010.  Back then, the auto manufacturer was counting on a single supplier for a common part for many of its car models, which was effective in curtailing costs, but turned out to be a disaster.

Organizational leadership should evaluate the trade-offs between having a leaner and efficient Supply Chain—with common parts and single suppliers—and preparing for and reducing the risks of disruptions.  Minimizing the number of distribution centers offers diminishing marginal returns for Supply Chain Performance and increases the Supply Chain Fragility.  Creating little bit of commonality presents significant advantages, but when more parts are made common the benefits shrink and it rather becomes detrimental.

The key for senior leaders is to find an optimal balance between resource pooling, creating common parts, and deciding on whether to decentralize or centralize their Supply Chains.  Decentralization (e.g., by having multiple warehouses or plants) increases costs as it requires more inventory, but it does curtail the effect of disruption significantly.  Centralization or pooling of resources, on the other hand, reduces total costs, but the cost again goes up by centralizing beyond a reasonable degree.  Recurrent Supply Chain Risks necessitate focusing more on centralization and pooling of resources and commonality of parts, while rare disruptive risks necessitate decentralization.  Achieving a state of equilibrium between pooling of resources, parts commonality or fewer plants helps keep Supply Chain Risks low.  Ignoring the possibility of disruption can be very expensive in the long term.  Samsung Electronics Co. Ltd. always maintain at least two suppliers, no matter if the second supplier supplies only a fraction of the volume.

Overestimate Likelihood of Disruptions

The risk of disruption of supply chains due to any unforeseen event is typically considered a rare possibility and goes unaccounted for during planning by most executives.  A fire break out at a distribution center, defective auto part, or a supplier’s facility closure for a prolonged period of time can happen anywhere, but we tend to underestimate the likelihood of such events.  The reason for this is attributed to the requirement of assigning a significant chunk of investments upfront from the already limited resources and budgets, to prepare for and mitigate likely disruptive risks.

Most of our typical risk assessment measures involve approximating the probability and the likely damage caused by an event.  Estimating the likelihood of disruptive risk to a reliable degree isn’t easy even for large multinationals—even an auto manufacturer like Toyota could not anticipate the occurrence of the part failure issue until the damage had been done.  These risk estimations do not have to be strictly precise.  Rough estimates of disruption risk are fine—any small mis-estimates that occur have negligible consequences.

Senior leadership needs to cautiously contemplate the areas that are likely to get affected the most due to potential disruption.  Building resilience does not cost much for large organizations.  In the long term, doing nothing costs much more than investing in preparing for a probable disruption.  When disruption occurs, the loss incurred greatly exceeds the amount of saving executives save by not investing in risk mitigation strategies.

Interested in learning more about the subject in detail?  You can download an editable PowerPoint on Supply Risk Reduction Strategies here on the Flevy documents marketplace.

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About Mark Bridges

Mark Bridges is a Senior Director of Strategy at Flevy. Flevy is your go-to resource for best practices in business management, covering management topics from Strategic Planning to Operational Excellence to Digital Transformation (view full list here). Learn how the Fortune 100 and global consulting firms do it. Improve the growth and efficiency of your organization by leveraging Flevy's library of best practice methodologies and templates. Prior to Flevy, Mark worked as an Associate at McKinsey & Co. and holds an MBA from the Booth School of Business at the University of Chicago. You can connect with Mark on LinkedIn here.

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