Before embarking on his trip around the world, Portuguese explorer Ferdinand Magellan noted, “The task is not to make sure that the sea is calm, but to prepare oneself to sail in stormy, unknown waters.”
Although Magellan didn’t make it, his fleet did thanks to its contingency plans, including Magellan’s untimely death.
Risk managers, like Magellan, face stormy, unknown waters everyday as they struggle to predict what lies ahead. Some of those risks are frequent, low impact, predictable and manageable. Others may be rare but could have devastating consequences for a firm’s supply chain. Striking the right balance between risk mitigation and efficiency is an inexact science at best. Just ask Magellan.
Looking at the first half of 2011, you would think our planet was the set for one big disaster movie. Earthquakes, tsunamis, volcanic eruption, floods, a nuclear power plant meltdown, heat waves and political unrest in the Middle East resulted in business disruptions far outside the events’ epicenters.
Disasters such as these can cause a cascading effect all along the supply chain. Consider that the Japanese disaster shut down manufacturers exporting supplies to waiting businesses on the other side of the world. Ash from Iceland’s volcanic eruption grounded 17,000 flights to and from Europe, costing the airlines more than $200 million a day. Flooding along the Mississippi River disrupted the United States’ largest inland shipping route from the Gulf of Mexico, delaying cargo and natural gas supplies to the rest of the country. Countless numbers of businesses, small and large, experienced some disruption as a result.
Risk managers awakening to the fact that these so-called “Black Swan” events, thought to be rare and unpredictable, may not be so rare after all. They are finding the consequences for not preparing for them can do irreparable damage to the financial health and reputation of a business. “Black Swan” is a term coined by Nassim Taleb, author of a best-seller on the subject, to describe rare and unpredictable occurrences: Think September 11, 2001. The problem is that Black Swans are becoming more frequent and a serious threat to supply chains.
Globalization has opened up a world of opportunities to business, lengthened the supply chain and expanded the choice of suppliers. Businesses no longer buy locally or from multiple sources. Suppliers can be spread across the world. As a result, supply chains are more vulnerable. A Black Swan event anywhere along the line can disrupt business downstream.
A drive toward eliminating waste and duplication in the 1990s also exposed supply chains to more dangers. To cut costs, many businesses introduced the “Deming” method of “just-in-time” inventory, single-source suppliers and offshore outsourcing for services and manufacturing. In addition, competition today requires businesses to offer more frequent new products (think Apple), which require new components.
An industry study by AMR research in 2006 showed that 42% of companies use more than five supply chains because they produce multiple products for multiple markets. The more chains, the more likely something will go wrong in one of them.
Companies can take the following steps to protect themselves against these risks to their supply chains. A business has to carefully weigh the cost and benefits, of course, but in the long run protecting the supply chain may be a matter of survival.
Have the right insurance coverage in place. A business interruption policy will cover certain events but not all. Trade disruption insurance is designed to protect businesses against disruptions to the supply chain, regardless of whether there is any physical loss to their assets.
Have options. If a firm single sources critical parts and the supplier is on the other side of the world, then it’s important to have a backup plan in case the supplier can’t deliver (as was the case following the Japanese earthquake). Find multiple suppliers, manufacturing in multiple factories and located in multiple geographic areas.
Consider using standard components instead of custom-made parts so it’s easy to find a suitable replacement.
If the risk is great enough, having additional capacity to manufacture may be worth the cost. Equipping a factory to build a variety of products can also reduce risk.
Interruption in IT systems is a growing concern for risk managers. Create redundant systems housed off-site, and back up your data daily.
Having only one way to deliver and receive products and goods is risky. If the railroad breaks down, business is interrupted, particularly if inventory is kept low. Using multiple logistics partners gives a business options.
To remain competitive, companies have to rethink how they do business. Brokers play a critical role in helping educate clients on the threats to supply chains and how to reduce exposure by developing contingency plans, using other risk management tools and making sure the right coverage is in place.