Risk is an important topic in supply chains. All companies are exposed to risk and need to work on how to minimize risk in order to have a well-working business. Therefore managing risk should be an essential part of supply chain management.
Aven and Renn argue that there is no "agreed definition of risk". The following article is based on the definition presented by Rosa (1998,2003) "Risk is a situation or event where something of human value is at stake and where the outcome is uncertain".
Risks can appear from different types of drivers. According to Chopra and Sodhi (2004) risks can be categorized as disruptions, delays, systems, forecast, intellectual property, procurement, receivables, inventory and capacity. The presented paper concentrates on disruptions, inventory, delays and forecasting due to the fact that discussing all different types of risk would be too broad. The questions to be answered in this article are what type of risk is presented, what went wrong in the supply chain and how the management can minimize risks in the company. To discuss the questions the chosen theoretical framework is presented followed by analysis of chosen problems and possible solutions.
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In order to manage the supply chain effectively first we need to understand what risks are and how they are associated with the supply chain. The components of a supply chain range from sub (2nd or 3rd tire) suppliers, to immediate supplier, to manufacturers, to wholesalers, to retailers to the final consumer. This is just a general outline of an overall supply chain of a business, there are also the activities within a business that comprise the internal supply chain. The risk of transaction costs between a customer and a supplier increasing is dependent on the level of uncertainty in the relationship. For example, the more dependent a customer is on a particular supplier, the greater the cost of switching to another supplier will be and the less certain the customer is that the supplier will not act opportunistically to raise prices, unless other factors, such as contractual arrangements, prevent this. Therefore, risk embraces both the range of outcomes that might occur and the likelihood of their occurring. A key component of risk is choice. Bernstein (1996) maintains that risk is about choice: the actions we dare to take, which depend on how free we are to make choices, are what the story of risk is all about. It has been argued that if a customer chooses to develop and invest in a long-term relationship with a supplier, it can bring significant benefits. However, if either partner defaults or attempts to take advantage of the other, the risks can also be significant. Therefore risk encompasses both the possibility of loss and the hope of gain. Nevertheless, in looking at how organizations perceive risk, it is the negative connotations of risk, loss rather than gain, which seem to preoccupy managers.
Risks may be classified as Systematic; i.e. controllable or avoidable and Unsystematic; i.e. uncontrollable and unavoidable. Also the risks associated with the SCM may be internal or external. Examples of systematic risk may be information asymmetry, lack of coordination and trust between chain members, volatile demand structures, inadequate capacity etc. Uncontrollable risks may be sudden change in demand due to technology advancements, natural hazards, accidents or disruptions etc. Systematic risks can be avoided altogether by careful planning and enhanced coordination among the partners, while the unsystematic risks may be minimized doing the same. Take for instance the example of Neodymium, a rare earth metal required for Hybrid electric vehicles for its magnetic properties. The largest reserve of the metal is currently found in China. From a vehicle manufacturer point of view this poses a great threat, as there is a huge demand and market for the hybrid electric vehicles in the world. Toyota has a target of producing 1 million hybrid vehicles by the end of 2011, and has a strong dependency on the said metal; however the metal is not directly used by Toyota. The 2nd or 3rd tire suppliers who produce the permanent magnet electric vehicle components use it. The down side is that the Chinese Government has now imposed an export restriction on the metal posing difficulties for the automotive manufacturers.
Always on Time
Marked to Standard
Modernization and globalization are resulting in complexity of supply chain composition. It is very obvious from viewing the components that it is no longer confined within the boundary of a single business entity rather it encircles almost everyone directly or indirectly related to a specific business. For example in 1997 due to a fire in one of the major suppliers of brake-fluid proportioning valve; Toyota was forced to close the operations of its 20 assembly lines for a few days, and it took almost one full month to get the production capacity back to normal i.e. 15500 vehicles per day. There are a number of other examples around the world today which prove that disruptions/ problems in one part of the world may have adverse affect on a business running hundreds of miles away, take the example of the financial crisis the erupted from America. Its adverse effects can be seen in the financial sectors of countries across continents like Pakistan, India, Australia etc. So much so that former Federal Reserve Chairman of America Alan Greenspan, called it "once-in-a-century credit tsunami".
Risks in Supply chain Management
The presented paper is based on the research done in 2004 by Sunil Chopra and ManMohan S. Sodhi which outlines several supply chain risks, internal and external. In detail these risks are:
Delays: The reasons of delays in supply chain management are following:
When a supplier, through high utilization or another cause of inflexibility, cannot respond to changes in demand;
Poor-quality output at supplier plants;
High levels of handling or inspections during border crossings;
Changing transportation modes during shipping
Systems Risk: Causes for systems risk can vary from natural disasters to intentional abuse of computers by own employees or external parties. The reasons are:
Information infrastructure breakdown
System integration or extensive systems networking
Forecast risks: Occur in supply chain management when projections in companies differ from current demand. "If forecasts are too low, products might not be available to sell. Forecasts that are too high result in excess inventories and, inevitably, price markdowns." SOURCE Reasons:
Inaccurate forecasts due to long lead times, seasonality, product variety, short life cycles, small customer base
"Bullwhip effect" or information distortion due to sales promotions, incentives, lack of supply-chain visibility and exaggeration of demand in times of product shortage
Intellectual Property Risk: "This kind of risk has grown rapidly as supply chains become less vertically integrated and more global, and as companies outsource to the same manufacturers used by competitors." The reasons of the risk are:
Vertical integration of supply chain
Global outsourcing and markets
Procurement Risk: "Refers to unanticipated increases in acquisition costs resulting from fluctuating exchange rates or supplier price hikes."
Disruptions: By definition disruptions in supply chain refer to the delays and interferences in the flow of materials or finished goods due to external or uncontrollable factors like natural disasters, strikes and economic disorder, purposeful damages caused by agents such as terrorist attacks and usually arise without warning. Disruptions in supply chain may also arise from supplier bankruptcy or incapability.
Receivables: The risk arising from the inability of a company to collect the revenues of services already rendered, i.e. the receivables. Currently many companies extend services on credit basis to accommodate its customers however there is a major risk associated with the recovery in case of credit sales.
Inventory: The risk arising from either too much or too little inventory. In former case the cost are exponential whereas in later there is a risk of non-fulfillment of customer demand on time.
Capacity: This risk is concerned with the business capacity, i.e. manufacturing capacity or service delivery capacity, and unlike inventory the capacity of a business cannot be enhanced overnight.
The Risk Spiral
Figure 1: SOURCE
The diagram above shows that the lack of confidence in supply chain can lead to chaos and decision risks. "This risk spiral exists everywhere, and the only way to break the spiral is to find ways to increase confidence in the supply chain. To do so, we need to understand the elements of the supply chain that can reduce the lack of confidence - visibility and control.''
Visibility and Control
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"Confidence in supply chain is weakened when end-to-end pipeline time, i.e. the time it takes for material to flow from one end of supply chain to other, is long. It is often the case that one member of a supply chain risks has no detailed knowledge of what goes on in other parts of the chain, for example in finished goods inventory, material inventory, work - in - process, pipeline inventory, actual demands and forecasts, production plans, capacity, yields, and order status." In order to modify supply chain visibility it is necessary to increase information transparency among all supply chain participants. Usually it is described that the information is power but this phrase does not work always in supply chain. If the information is available to all supply chain members the power increases in many times because it will reduce uncertainty. "Mason - Jones Towill (1997 and 1998) have demonstrated that 'information - enriched' supply chains perform significantly better than those that do not have access to information beyond their corporate boundaries. Visibility in supply chain management can help to avoid problems and modify opportunities in the company.
The second important concept in supply chain confidence is the ability to control operations. Supply chain managers should have visibility of the whole pipeline, not only of some parts because if something goes wrong it is not so easy to change it in short time. For reducing variability there is used "Six Sigma" methodology, which is useful to identify the possibilities. Without visibility and control, it is common that the supply chain is plagued with buffer inventories. Buffering is another means employed by supply chain managers to hedge against the uncertainties and risks in the supply chain.
Supply chain Risk Management
The Risk Spiral mentioned above is one of the risk reduction pre-requisites. However there is still high need for effective supply chain management with respect to the risk aspect. The term used in recent literature is Supply Chain Risk Management. Research shows the SCRM is still in its infancy stage in most businesses. However due to the globalization and more agile supply chains the need for SCRM is increasing day by day. Also many organizations are actively involved in the identification of the risks but lack when it comes to mitigation practices. A study by the Bearing Point Group and Supply Chain Magazine in 2009 shows that the most organizations are not involved in risk management and the ones that are consider only the risks related to Purchases (Supply Risks), Planning (Demand Risks) and Inbound Logistics (Distribution Risks). The same research study by the Bearing Point Group and Supply Chain Magazine has recognized four steps for effective SCRM. The steps are:
Stage 1: Risk Identification: As the name suggests, this stage deals with the potential risk detection.
Stage 2: Risk Assessment: The second stage is the probability and impact assessment, i.e. what are the chances that a certain problem will occur and what will be the consequences for the organization.
Stage 3: Risk Treatment: This involves with setting up risk prevention and protection measures
Stage 4: Risk Monitoring and Control (Resilient Supply Chain): this is the most important part and deals with diminishing the risk factors and there recurrence. It suggests that the organizations should set up Resilient Supply Chains, with the help of identification of vulnerable points and creating agility throughout the supply chain, further more the organizations should create a risk culture and take necessary actions for implementations of the same. And lastly built on experience to avoid or decrease the impact of future perturbations.
As was described in the theoretical part delays in a supply chain management can occur in information channels, for example in the transmission of information, in flows of people, resources, goods, money.As an example we described the most popular company Apple Inc. They launched iPad, which is defined as the future of mobile and computing devices. The problem was that due to the high sales the company was forced to delay international shipments of new iPad tablet computers. The risks of the supply chain are interconnected. The delays of the Apple iPad were also caused because of the fact that company did not predict so high demand as it was in the real. They have delivered more than 500,000 iPads in the first week. They also have taken a huge number of pre-orders.SOURCE The main customer-base of Apple is in the U.S. and the output is focused there. Nevertheless, international sales accounted for 58 percent of Apple's revenue in the December quarter, up from 46 percent a year earlier. Although international markets are increasingly important to Apple's growth, investors appeared unfazed by the delay and the company's shares rose more than 1% to touch yet another all-time high. "This latest delay is the second time Apple has pushed back shipments of the iPad. Back in January, it had announced that the device would be sold worldwide in late March, but after analysts reported delays in production it postponed the United States launch of the iPad to April 3 and the worldwide launch to late April.
What's causing the delays? A combination of both: supply-chain problems and marketing strategy."SOURCE Also the problem of the delays with iPad is in production quality - iPad's display. Due to this fact Apple's engineers should learn more about this problem and also eliminate defects. According to JacobsSOURCE these problems can be resolved within about a month.
In order to manage supply chain risks Apple should follow the described four stage strategy. At first, it is essential to identify the risk and also to recognize other potential risks in supply chain. As we see in the example, Apple Inc. could not predict that a new product like Ipad would be so popular in demand in the US, but it should be ready for such demand. In order to avoid delays in international shipment they should balance capacity and inventory, depending on the cost of products. In the second stage it is necessary to assess the potential impact of the various risks (financial, media coverage, etc) and measure their degree of criticality. Apple Inc forte is that this is the only product in the market, so one month delay is not so dramatic because they are able to provide Ipad for international customers as soon as possible. "Broadpoint AmTech analyst Brian Marshall said there was no danger that the international delay would cause the iPad to fall short of sales estimates for the June quarter. Analysts expect 1 million devices or more for the period." In the third and fourth stages it is necessary to draw up an action plan including risk prevention and protection measures. Also it is significant to control risk recurrence. In the case of Apple an action plan would be useful. It could help to prevent forecast risk and delay risk.
2.2 Inventory risk
Inventory can be defined as "The amount of raw materials, work in process, and finished goods being held for sale at a given time". Holding inventory can lead to significant costs for a company. Due to this fact it is increasingly important to manage inventory efficiently to improve the supply chain and as well to generate competitive advantages.
The main reasons for a firm to hold (excess) inventory are to reduce costs and to satisfy the consumer needs on time. The key problem is to find the right extent between holding too much inventory and too little inventory. Excess inventory leads to high warehouse costs and can decline the firm's financial performance while too little inventory can implement lower sales. Nearly every firm holds excess capacity to minimize the uncertainty about future occurrences. Thereof inventory can be seen as an firm's insurance to provide customers services for cases if something goes wrong in the upstream production process. This begs the question of how much inventory a firm should hold at what time and furthermore when to order additional inventory. The best extent of hold inventory is exactly the lowest plenty, which allows satisfying the consumer demand.26
The inventory risk depends on four risk drivers: the degree of obsolescence (and the length of the product life cycle), the product value, inventory holding costs and the uncertainty of consumer demand and supply.25 To get the most efficiently supply chain, a company must understand and analyze these risk drivers and try to control them.26 After indentifying the drivers a company can start to use a risk mitigation strategy.25
The following example of the automobile manufacture Toyota shows how a company manages their inventory in the kind of way to hold as little stock as possible to reduce inventory cost but be still able to satisfy the consumer demand on time. Toyota pursues the strategy of lean manufacturing which contains the element of just in-in-time production. Just-in-time-production aims the target to eliminate every kind of waste and improve all types of business processes. A process operated after the JIT-principle works in that goods are produced and delivered just in time to be sold. Since all the production parts arrive at the point when they are needed there is no use of holding a large stock. For this kind of strategy good relationships/partnerships to suppliers are necessary to keep the production working.
The strategy of holding nearly no inventory involves many risks. There exists no buffer if any step in the supply chain fails. Because of the uncertainty of changes in the customer demand or problems with the suppliers there could occur that Toyota cannot produce as much as they want and the sales could decrease. The main advantage of this strategy is the reduction of inventory costs but as a tradeoff it has to deal with many dangers.
There exist different theoretical strategies to minimize the inventory risk according to Chopra et.al.25 One of them is the pooling of inventory and is what the online bookseller Amazon.com uses. A few warehouses are placed through all of the United States and each warehouse is responsible for a special geographic area. This leads to lower total inventory and with that to lower inventory costs. Another strategy is the creation of a common product component, which is commonly used in the pain industry. Instead of holding a lot of different colors it is more efficient just to hold a common base and mix the wished color after the specific customer's orders. Finally another strategy could be delaying the last step of production until all order are in hand.24 All these strategies allows a firm to manage their inventory efficiently and to improve the supply chain. Regarding to the example of Toyota it would be most important to get good partnerships to their suppliers. This ensures the delivery of all products components if they are needed. Delays in delivering components would cause production stops and lead to less sales. Therefore partnerships can be seen as a risk minimizing strategy.
2.3 Forecasting risk
Forecasting in supply chain management is a necessary and important process for any company that produces products for inventory and is not as important for products made to order. Forecasting is a means that is meant to foretell what the future will bring. The idea behind forecasting in supply chain management is that "manufacturers will use material forecasting to ensure that they produce the level of material that satisfy their customers without producing an overcapacity situation where too much inventory is produced and remains on the shelf" (Murray, n.d). According to Copra and Sodhi (2004), forecasting risk is the development of "a mismatch between a company's projections and actual demand". By forecasting the manufactures hope to reduce the costs and keep the inventory at a reasonable level, as well as avoiding price markdowns. The "reasonable" level of inventory depends on what type of product the business is producing and so on. Producing too much inventory can lead to very high costs regarding storage and markdowns, but on the other side producing too little can cause a business to miss out on sales and it can cause the business to loose customers.
The alternations in the market is a major part of what makes it problematic to forecast what the customers want and need, as the demand changes constantly. It can be financially fatal for a business to overestimate or underestimate the market. Forecasting inaccuracy can be a result of "long lead times, seasonality, product variety, short life cycles, and small customer base" (Copra and Sodhi, 2004). The uncertainty in the market is, as mentioned, an important part of the forecasting risk as well as other information distortions. Examples of information distortions can be "promotions and incentives that lead to forward buying; batching of purchases, which leads to higher volatility in orders" (Copra and Sodhi, 2004). Another critical disruption can be the level of knowledge of the end customer. According to Copra and Sodhi, if the supply chain consists of a great number of tiers, the level of knowledge is normally decreasing the further away from the end consumer the business is situated, and this is know as the "bullwhip effect". This effect "refers to the tendency of the variability of orders rates to increase as they pass through the echelons of a supply chain towards producers and raw material suppliers" (Disney, 2009). One possible solution to the "bullwhip effect"-problem can be as described in the theory part about the risk spiral, to increase the visibility and control.
An example of forecasting risk can be seen in a real life example from the pharmaceutical industry and the production of acetonitrile. Acetonitrile is "an inexpensive chemical not mixed in the drugs themselves but used in tiny quantities to measure impurities" (Bolgar, 2010), and it is a by-product of acrylonitrile which is used in the production of plastics used in car parts and in the production of carpets. The problems started when the Chinese government decided to shut down a plant producing chemicals in August 2008. A month later a hurricane destroyed a similar chemical plant in Texas, and at the same time the financial crises hit. As an effect of the financial crisis, the sales of cars dropped as well as the sales of carpets. And naturally the production of acetonitrile decreased; seeing it was a by-product of acrylonitrile, and this again lead to a shortage for pharmaceutical companies. As an effect of the shortage, pharmaceutical companies ran out of the chemical needed (acetonitrile) for testing the drugs and therefore could not get any further in their production process. The by-product became the "star of the show" (Bolgar, 2009) selling at a much higher price as the pharmaceutical companies tried to get a hold of the last few gallons there was. Some of the pharmaceutical companies had done a good job forecasting a shortage and was prepared. They had successfully identified the first step of the steps for effective Supply Chain Risk Management described in the theory part. The potential risk in their production process, in this case being the possibility of a shortage of a seemingly "insignificant" product used in very small quantities, was identified at an early stage of the decreasing production of cars and carpets. They assessed the probability of a shortage by keeping an eye on the identified decrease in car and carpet production, trying to identify the probability of a shortage actually happening. As a part of the assessment, the business would assess the impact and consequences a shortage would have for the business. In this case a shortage would be lethal because it would mean that the business would have to stall both its production and its further research on the pharmaceutical drugs.
Stage three in the Supply Chain Risk Management is concerned with setting up risk prevention and protection measures. The mentioned pharmaceutical firms dealt with the risk by buying extra supply in advance. By doing this they were certain that they had some inventory of acetonitrile and therefore they would be able to continue their production, at least for a while longer. Another strategic precaution they made was to make agreements with suppliers of the chemical that was advantageous for their business. And this way the pharmaceutical company made sure that their supply of the much-needed solvent was kept at a higher level than most companies.
The last and fourth step of the Supply Chain Risk Management model is called 'Monitoring and Control'. In this step one identifies what is needed for the road ahead, how one can work towards better forecasting and better results. What is important here is to identify sensitive tiers and suppliers, in this case the dependency on the one specific chemical needed for the production process. It could be profitable for the pharmaceutical company to research the possibility of either more suppliers of the chemical or for different ways to test the drug (or both) in order to minimise the imaginable future happenings. This is done in order to create agility and activity throughout the supply chain.
2.4 Disruption risk
By definition these are operational risks for example technical malfunctions, discontinuation of materials and products supply, strikes etc. They maybe caused by economic disorder, vandalism, natural hazards, terrorism, political instability etc. In recent times these types of risks have received increasing attention as with high globalization and lead times, there are more opening for disruptions and a smaller margin for error if a disruption occurs. In many researches this type of risk is named as 'Environmental Risk' and hence are uncontrollable or external risks. From explanation we can see that the environmental risk may cause disturbance on supply side or demand side. Some of the very common examples are the terrorist attacks on the World Trade Center on September 11, 2001, and the August 14, 2003 blackout in the North-eastern U.S. A study by Hendricks and Singhal (2004) shows that companies experiencing such disruptions do not perform as efficiently as their peers in stock performance as well as in operations which is clearly reflected in costs, sales, and profits.
A very significant and recent example of such a risk maybe witnessed by the effects of the recent floods in Pakistan, South Asia. The United Nations has rated the floods in Pakistan as the greatest humanitarian crisis in recent history, more people have been affected in Pakistan than the 2004 South-East Asian tsunami and the recent earthquakes in Kasmir and Haiti combined. On a rough estimate 20 million Pakistanis have been displaced from their homes and put at risk for disease. The damages are ranging from humanitarian perspective, to economic downturn and infrastructure damages. Displacement of millions of people is one part of the catastrophe, the other one is the impact on the countries national and international trade. An estimate suggests that the floods in Pakistan have destroyed up to 30% of the country's cotton crop, with around 700,000 acres of growing land under water. Pakistan is the world's fourth largest cotton producer after China, India and the USA. John Flanagan, who heads Flanagan Trading Corp, a North Carolina-based business that specialises in cotton futures and options and prepared hedge strategies for the industry suggests that if the Pakistan's crop is not available to the market inÂ a timely manner, the world stocks to use ratio could fall to 33%. As a result the retailers might raise prices following the rise in cotton prices, even though the raw material accounts only for a small share of the product's cost.
Pakistan is an agricultural country and there have been many incidents with respect to monsoon rains in the past. According to a source the Pakistan Meteorological Department cautioned the government earlier on the probability and impact of the heavy rains. In past years several crops had been destroyed due to untimely, heavy or no rains. Hence the impact of such an event was well known.
The basic reason for such a massive disaster is lack of implementation of the third stage, i.e. risk treatment. Even though the potential risk was noted and impact assessment was done earlier on, no precautions were put in place by the government to avoid such an event. The government lacked in the prevention and protection measure and hence the worst calamity in 80 years was undergone by the country. As mentioned earlier, the floods resulted in economic and infrastructure disasters. At the moment Pakistan is facing huge losses in exports, massive increase in imports and the roads and transportation lines have been severely damaged. According to estimates, the cost of rebuilding the flood-hit areas could be as high as USD 15 billion. The impacts of the floods in Pakistan have been seen in other parts of the world as well. For some it became an opportunity, e.g. for China, India and USA, to increase there market share. However there have been negative impacts on the home as well as world business. According to a study by the Economic division in Pakistan, the GDP may turn negative ranging from -2% to -5%. On the international scale, the textile market may be forced to raise prices. Another significant effect may be seen in the European Union. The EU trade granted concessions for flood-ravaged Pakistan, this rebate has backfired as the textile manufacturers in Portugal, Italy, Romania etc have expressed negative feeling. Due to China's high exports it has become difficult for the EU to compete on global markets. From the above discussion the importance of the forth stage of the SCRM process becomes clear. We can clearly see that events in one part of the world creates massive ripples all around it. In this case the risk arose from an external uncontrollable factor. However with so many technology advancements the weather predictions have become so convenient. The governments should take in account the 'what if' scenario when deciding on the policies and should have separate Disaster and Crisis Management departments set up for such events.
From the above detailed discussion of the few risks it may also be concluded that supply chain risks are not singular in nature rather all are inter-related. The delays risk for IPad maybe seen as a forecasting shortfall or inventory miss-match. Similarly the disruptions caused in Pakistan may give rise to supply side risks including delays, lack of inventory etc.