How to Prepare Your Supply Chain for the Unthinkable
One is the mistaken belief that no corporation can prepare for such events; they can't even be predicted. For instance, the scenario that an earthquake, a tsunami, and a nuclear crisis would simultaneously hit Japan Inc. seems far-fetched, so most companies hadn't drawn up a suitable Plan B.
The other is the persistent feeling that supply chains represent a cost. Most companies focus on minimizing costs rather than maximizing flexibility, which would entail making large investments in supply chains. For instance, many companies feel they don't need to develop alternatives to Japanese suppliers because they buy so little from them nowadays. However, they forget that their Chinese suppliers are big customers; nearly 19% of Japan's exports went to China last year...........
CEOs can take several measures to tackle the Black Swans that may affect their supply chains.
Be Prepared to React
Could anyone have anticipated a 9.0 earthquake, a tsunami, and a nuclear power plant crisis? The question is irrelevant. Companies don't have to anticipate such events; they only have to be prepared to respond to them. They can ensure that by:
Diversifying supply bases. It isn't enough to have several suppliers if they're all clustered in the same country or region. For example, many US companies depend on China as a supply base. What would happen to their costs if the renminbi's value rises overnight from RMB 6.5 to RMB 4.5 to the US dollar? How would they cope if the price of oil quickly jumped to $150 per barrel? Companies have to develop suppliers in different places — some close to home, some further away.
Locking up supplies. Companies must lock up supplies the moment a low-probability event occurs. As soon as the earthquake hit Japan, a few smart companies placed large orders with suppliers outside that country and rerouted materials, so they could continue supplying products to customers. When shortages persist, only their competitors will pay the price.
Invest in Flexibility
Companies keep costs down by building supply chains that generate economies of scale. That was effective when companies made products in their home markets using locally produced components. Supply chains now span the globe. Japan, for example, produces approximately 40% of the world's electronic components including parts and materials for semiconductors, computers, automobiles, radios, telephones, and other communications equipment. Companies need to create dynamic supply networks that can adjust rapidly to sudden changes. They can do that by:
Producing locally. Scale generates economies, but companies often find they have to make costly tradeoffs when they consolidate manufacturing units. A large consumer products company thought it could reduce costs by setting up a few regional manufacturing hubs rather than numerous local ones, for instance. It discovered that although costs did fall, the delivered price to customers rose. Local manufacturing had enabled the company to tailor products and to shift production from one facility to another when commodity prices differed or demand shifted.
Variabilizing costs. Companies can lower their fixed costs and increase those that fluctuate with the market. One way of doing that is to outsource production. Many vendors, who apportion fixed costs among different companies, charge on a per unit basis. Alternately, companies can sign short-term contracts that carry few obligations.
Producing locally. Scale generates economies, but companies often find they have to make costly tradeoffs when they consolidate manufacturing units. A large consumer products company thought it could reduce costs by setting up a few regional manufacturing hubs rather than numerous local ones, for instance. It discovered that although costs did fall, the delivered price to customers rose. Local manufacturing had enabled the company to tailor products and to shift production from one facility to another when commodity prices differed or demand shifted.
Variabilizing costs. Companies can lower their fixed costs and increase those that fluctuate with the market. One way of doing that is to outsource production. Many vendors, who apportion fixed costs among different companies, charge on a per unit basis. Alternately, companies can sign short-term contracts that carry few obligations.
Variabilizing costs requires constant management attention as well as flexible suppliers. The advantage is that it gives companies more maneuvering room to buy, sell, or cancel orders as needs and costs change. The disadvantage is that they will have to pay market prices for fuel, raw materials, and components.
Static supply chains may save companies some money, but they have hidden costs that rise precipitously when unforeseen events occur. The Japanese crisis should convince executives that they can manage risk best by creating dynamic supply chains.
Harold L. Sirkin is a Chicago-based senior partner of The Boston Consulting Group.
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