I thought that from a supply chain perspective, the quake in Japan was bad.  Really bad. Until, that is, I came across this post from the @risk blog.  The post highlights a study from commercial/industrial insurance company FM Global.  The study examines how reliant the companies involved in the study were on China for some or all of their manufacturing and supply.  Some interesting points from the study;

• 86 percent of companies surveyed are more reliant on China than Japan for key product lines
• 83 percent of companies surveyed think supply chain disruption is a moderate or higher risk to the financial wellbeing of their companies
• 94 percent of companies surveyed are concerned about natural disasters in China as a result of the Japan earthquake
• Over 60 percent of companies surveyed are evaluating their supply chain risk in China as a result of the Japan earthquake

The study goes on to suggest you assess your resiliency to a disaster in China by asking the following questions;

1. Does your senior management view resiliency as a competitive advantage and has it made the necessary commitment?
2. Has your organization examined how it can mitigate risk within its products and processes?
3. How well does your company collaborate with its suppliers to assess and mitigate risk?
4. Does your corporation have appropriate business continuity and disaster recovery plans for supply chain disruptions emanating from emerging markets such as China?

A significant earthquake in China is going to happen.  China shares many Geologic features with Japan and a quick Google search shows significant seismic activity including earthquakes over the last several years (2011, 2010, 2009). So, the question is when (not if) will an earthquake hit a major manufacturing center?  When this happens, it doesn’t take a doctorate in supply chain to see that the impact to unprepared businesses will be devastating.  Do you agree this is a concern? What steps are you taking to mitigate the impact of an event like this?  Comment back and let us know.

As most know, Thailand has been hit hard by flooding during this year’s monsoon season. There has been a horrible human cost with hundreds dead, and millions of people affected. What many don’t know is that Thailand is a major manufacturer of hard drives and major brands like Seagate and Western Digital have factories there…thus the price increase for hard drives.  Not only is Thailand a primary producer of hard drives, they also produce components that go into hard drives, so even companies that don’t manufacture in Thailand are affected because they can’t get components.

As you would expect, the hard drive shortage is affecting upstream manufacturers too.  Many companies only have a few weeks of supply on hand and are seeing shipments impacted because they can’t get components.   Fortunately, it looks like the flood waters are starting to recede and some hard drive manufactures will start producing again this month, although forecasts show that high hard drive prices and shortages will continue well into 2012.

From a supply chain perspective, these events have again highlighted the need for companies to implement and maintain a supply chain risk management process. There is much content on risk management, but there are a few key points relevant to what we’ve seen recently;

• Identify key components and where they come from.  If you have multiple suppliers for these components, GREAT!  If these suppliers are in the same geographic region, however, you still can be at risk.
• For your key components, be sure to look at where your suppliers are getting their components from.  Thailand also has significant hard drive component manufacturers that supply hard drive manufacturers around the world.  Even if you source from different hard drive manufacturers in different regions, they all may get their components from a single supplier or region.
• Review your key components on a regular basis.  Many companies do this as part of their S&OP cycle as there is a logical affinity between risk management and S&OP.
• Make sure that you have the tools in place to be able to quickly assess and respond to a significant event like the Thailand flooding. ERP systems and Excel can’t do this fast enough to make a difference.  You need a tool that can model your entire supply chain, allow simulation and reporting to be able to get on top of a fast moving situation like this.

2011 has been another record year for major events with supply chain impact.  Japan is still recovering from the effects of the earthquake and tsunami.  The flooding in Thailand has impacted other manufacturing segments besides hard drives.  Companies operating on a global scale must look at how a regional event could impact their  supply chain.

For further reading, I (and others) have covered Supply Chain Risk Management in some detail over the past couple of years, including a white paper titled Essential Characteristics of a supply chain risk management strategy.  Has your company been impacted by the Japan earthquake or the Thailand floods?   Comment back and let us know

1)      “…further standardize parts across Japanese automakers so they could share common components that could be manufactured in several locations”

2)      “…ask suppliers further down the chain to hold enough inventory – perhaps a few months’ worth – for specialized components that cannot be built in more than one location”

3)      “…make each region more independent in its parts procurement so that a disaster in Japan would not affect production overseas”

Step 1 – Standardizing of parts will definitely reduce the risk and reliance on single sourced components. This practice is commonly employed in the electronics industry. However, undertaking this initiative will clearly require more effort as a result of additional engineering efforts to standardize these parts. Given Toyota’s strong reputation in the area of quality (likely somewhat as a result of unique and arguably better design), will corners have to be cut or sacrifices have to be made in the name of standardization? What will the longer term impact be on the brand image should this happen? Remember the Sticky Gas Pedal recall that Toyota went through in 2009-2010?

Step 2 – Asking suppliers further down the supply chain to maintain higher levels of inventory can surely provide an insulating layer against both volatility in demand and short term supply disruptions, however the question is….what is the cost of this and who bears that cost? Traditionally in the automotive industry, larger OEMs and Tier 1 suppliers have a reputation of pushing the cost burden downstream to lower tier suppliers by such methods as imposing penalties for stock outs (line down situations) and applying cost negotiation pressures. Another recent article by Bob Ferrari points to a new study which while referring to these types of behaviors, also refers to a trend of automotive supply chains working to become more collaborative, which in my opinion, is what is needed in times where everyone is being squeezed. Having said that, this article also references the practice in this industry to be very focused on the short term pains, rather than longer term gains that can be realized through investment in technology solutions to enable better collaboration. These seem to conflict with each other. So what is the reality? Truth is that it’s probably a bit of both. I can speak to the fact that I personally know some companies in the automotive industry that are “getting it” and being more collaborative with their extended supply chain, however, I am sure there are many that are still stuck in the past.

Step 3 – Independent parts procurement – This reduces regional risk in manufacturing sourcing however increases the risk of inconsistent quality and reduces ability to leverage overall purchasing power when negotiating supply contracts. Industry trends in supply chain (especially in high tech) are leaning towards more and more companies looking to a centralized procurement strategy that leverages the volume of business they do with suppliers globally to negotiate more favorable procurement terms. This is even true of companies which outsource portions or all of their manufacturing to companies in the EMS industry. This strategy that Toyota seems to be employing is actually the opposite of this trend.

So what is the “right” answer? Good question! While I agree that all the steps that Toyota has outlined will assist in reducing some areas of supply chain risk, the biggest risk I still see is that all these strategies seem to come at a cost which doesn’t have some sort of ROI specifically tied to it….as would be the case with an investment in technology.  So…..what do you think? Is this the right strategy or will this just drive up the cost of the next car you buy? What would you do?

A post by “the doctor” over on the Sourcing innovation blog, led me to this article in Industry Week. In it, they present a short case study about how a company survived the chaos and upheaval of Hurricane Katrina, only to fall victim to other risks:

• Rapid growth – Rapid growth sounds like a great situation to be in, and it can be. But it can also cause significant problems. Companies have growing pains just like people do and processes that worked before can become problematic with higher volumes. Suppliers might not be able to grow at the same pace you are and qualified people might not be available to meet hiring demand.
• Expanded and new facilities – New facilities are really systems wrapped in a building and like any system there can be problems getting things working.  As you bring new facilities on-line or as you renovate and expand existing facilities, you need to plan for potential start-up issues.
• Increased and changing product range – Things can be simple when we have one or two products but as the product offering grows, complexity grows with it. Care must be taken when adding new products not to kill demand for existing products, at least until supply has been whittled away.  Apple is a master at this – when a new product is coming, even before it is announced, supply starts to dry up for existing products so that as Apple transitions to the new product, they reduce the risk that they will be left with large quantities of the outgoing product.
• New, large (and more demanding) customers – New customers are wonderful. Large customers, even better! But… there can be a downside. Maybe others have noticed this little truism – the larger the customer, the more demanding the customer. They want what they want, when they want it. And because this customer now makes up a healthy portion of a company’s revenues, the incentive is there to make sure these customers are satisfied.  The risk is that if you have successfully ramped the company to meet this demand and the customer subsequently leaves, you are left with significant excess capacity and expense.
• Changes to the supplier base – Suppliers come and go.  As the supplier base changes, so does the performance characteristics of your supply base.  Quality, on-time delivery performance, lead times, costs, all impact profitability.
• Changes to IT systems – This can be a killer.  IT systems are often the brains of the operation.  If the brains aren’t working, not a lot of stuff can get done.  Companies are often lured into huge projects to overhaul and replace their systems.  If done right, the change can be quite beneficial.  If done incorrectly, the results can be disastrous, sometimes leading to litigation.

The Industry Week article has a number of suggestions for improving a company’s ability to assess and mitigate risks of all kinds. If you were to pick one that you absolutely must implement, it would be to build risk management into all aspects of your business.  Make risk assessment and mitigation a key part of your decision making process.  A good place to start would be to add risk assessment and mitigation to your monthly S&OP process. What better place to ensure that all teams are thinking in terms of what risks exist and how best to manage them?

Have you experienced some of these risks? How did you overcome them? Comment back and let us know.

On its own, the list is quite interesting.  As noted in the article, the 10-K filings were made before the Japanese tsunami.  I would expect that more recent filings would include Supplier/ vendor concerns (#7) and Natural disasters (#12) which would elevate the ratings for these risks.

I also find it interesting to study the risk factors that have gained prominence in the last year.  The table below shows the top five risks ranked by percentage change between 2011 and 2010.

The fastest growing concern is “Inability to maintain operational infrastructure and systems.” Perhaps this is an indication that executives are concerned that they have too many systems and that the systems they have are too complex or too difficult to integrate.

Clearly, the prevalence of world conflicts and natural disasters, coupled with global markets and suppliers, explains the rise of “Natural disasters, war, conflicts and terrorist attacks.” As mentioned above, I would expect this category to be cited even more frequently in 2011/2012 reports.

I find the rise in “Failure to properly execute corporate strategy” fascinating.  From being mentioned in 27 percent of 10-K filings in 2009, it has jumped to being cited in 93 percent of 2011 filings. I wonder what impediments are worrying executives.

It has always been difficult to “Predict customer demand and interest, innovation.”  However, this risk factor is also growing as a concern for executives.

Finally the rise in, “Credit or financial risk of customers, vendors or suppliers” tells me that executives are either dealing with riskier business partners or that the general economic situations is putting more companies at risk.

What is not discussed in the Virtual Strategy article is what companies can do to mitigate the impact of these risks.

I think there is actually a common, underlying theme to these five fastest-growing risks:

Systems supporting key business processes are too complex and too cumbersome to support the rate of change in today’s technology companies.

There is a clear an obvious link between my above statement and the fastest rising risk factor. To my mind, the remaining four rising risks are all related to managing the business despite rapid, uncontrollable change. Current business processes, and the systems supporting them, frequently take a month or more to detect a business-altering change and to change course to adapt to that change (whether the change is seen as a problem, an opportunity, or both). I suggest that new processes and response management strategy are required so that the time to detect and react to change can be shrunk to days, even hours.

For example, following the Japanese tsunami, I have heard anecdotes about some companies launching response teams and securing alternative sources within hours of the disaster. On the other hand, I have also heard of companies, months later, which are still figuring out the parts that are likely to be in short supply and how to select alternative suppliers. Clearly, the latter will have much more difficulty maintaining production in the face of global supply shortages.

What do you think?  Does your company need systems and processes which are simpler to use, more flexible, and more responsive? Do you know of examples where fast, responsive, flexible systems gave you a competitive advantage, or where their absence resulted in serious losses?

Will this problem ever go away? It is argued that if you have brand loyalty then the risk of perishable demand and worried investors is low. This argument holds for Apple where customers are willing to wait. Does the same hold true for BMW when their entire supply of 5 Series was consumed in one month in 2010? Some people just need to get a car. Brand loyalty may not be as influential. Which companies plan for limited supply versus the risk of excess inventory? The article talks about the Kentucky bourbon called Rip Van Winkle. Have you heard of it? Probably not as it is usually hidden behind the counter of the liquor store. They would rather keep production low than risk having inventory. Other companies with short life cycles may do the same. They must get their product to market as soon as possible but cannot risk the bottom line impact of scrapping product when demand is not meeting forecast. There is also the case where limited supply is not planned and can have serious consequences. Canadian company Lululemon faced shortages when their apparel line exceeded expectations and were forced to pay premium freight to accelerate supply. Margin erosion is often a result of demand exceeding supply.

So what does this really tell us? For the most part, forecasts are inaccurate. It has been proven that improving forecast accuracy results in higher customer service with the same inventory or the same service level with less inventory. How do you improve forecast accuracy?  Companies are finding more innovative ways to address this. Many are recognizing that improving demand response will reduce the cost and error of forecast error. Improved collaboration with trading partners; customers and suppliers also improves forecast accuracy. Duncan Klett has written an interesting white paper http://www.kinaxis.com/campaign/demand-planning-reduce-risk-and-impact on Demand Planning where he is really talking about the value of response management in the demand planning arena. He statistically proves that by focusing on customers with high demand variability, reducing cycle time (more frequent demand updates) will improve service and reduce inventory. Collaboration is another component where the sharing of up-to-date forecast information between trusted partners results in improved accuracy and reduced latency.

What are your thoughts?

Why Donald Rumsfield? While speaking about the government of Iraq and weapons of mass destruction in a 2002 press conference, Rumsfeld, who was U.S. Secretary of Defense at the time, noted that there are known knowns, known unknowns and unknown unknowns. In other words, there are things we know that we know, things we know that we don’t know, and there are things we do not know that we do not know. It’s these so-called “known knowns,” “known unknowns” and “unknown unknowns” that are at the heart of risk assessment mitigation.

The first step in risk assessment and mitigation is to visualize and analyze the known knowns. Think of the supply base for example—including your own internal manufacturing as well as suppliers. The supply management team must identify poor-performing, higher-risk and redundant suppliers, then transition away from them. When evaluating suppliers don’t forget that suppliers also have companies that supply them.  Your assessment should consider high risk components throughout the entire supply chain. Companies with many suppliers may want to do an assessment based on the value contribution of the components used (those components used in the highest revenue producing end items would be have their supply chain evaluated first).

The second step is to identify and assess potential risks to determine which ones have a probable chance of occurring based on the nature of the product and supply line. I’ll call these risks the known unknowns. So, for instance, supply managers realize that events such as the power outage that effected Toshiba’s production of NAND flash memory chips or inclement winter weather that wreaks havoc on supply chain operations can—and very well, may—come to pass. By proactively identifying, assessing and studying those events and potential resolutions, it’s possible to mitigate those risks using strategies such as developing plans to source from different suppliers, developing supply sources in other locations or using alternate modes of transportation.

At other times, however, an unanticipated event takes place that wasn’t planned for, so there isn’t a mitigation strategy. Alternatively, an anticipated event may occur, and while there is a mitigation strategy for the event, there are unanticipated complications such as material shortages or quality issues. I’ll call those the unknown unknowns.

In these cases, your ability to respond makes the difference between a minor blip or a full blown disaster.   There are several elements that are required for fast response;

1. You must receive a timely alert that indicates not only that the event has taken place, but more importantly that the event will have an impact on your business.  Consider two events occurring; a lost supply shipment of a commodity component for a low value, low volume item, and a shipment of a unique component for a high value, high volume end item that is delayed due to weather.  The first event may have no revenue impact at all.  The second event could significantly impact revenues for the quarter.  Without this differentiation, you might be spending your time dealing with the lost shipment when the late shipment will actually impact your bottom line.
2. You must have the ability to model the event. Your simulation must be backed by analytics that allow you to accurately model the event and the possible resolutions in real time.  While simulating the event and the resolutions, you must also be able to collaborate with other people and other teams to ensure that the resolutions take all factors into consideration and will have the best chance of succeeding.
3. Finally, You must be able to compare the different possible resolution options to determine which resolution will best resolve the situation.

All of this must be accomplished in hours, not in days or weeks.

Risk assessment and mitigation clearly are important and should be part of a complete supply chain risk management strategy. However, the ability to respond quickly and effectively when the unexpected happens is also critical. Without both capabilities, your supply chain risk management strategy will be incomplete.

More importantly, the ash cloud itself presented significant business ramifications for companies around the world. I believe we will study the volcano’s eruption—and, consequently, the disruptions to supply chains around the world—for years to come because the impact was both so widespread and pronounced.

A recent BusinessWeek article described how automotive manufacturer Nissan Motorwas forced to shut down three auto assembly lines in Japan because the factories ran out of tire-pressure sensors when a plane carrying a shipment from a supplier in Ireland was grounded.

I’ll wager that you expect disruptions from hurricanes and possibly tropical storms, and maybe even a blizzard across the Great Plains. Since those events are likely, it’s smart to create contingency plans that account for alternate transportation routes or even modes. Furthermore, you may even have contracts in place with suppliers for alternate parts, and perhaps even contracts with alternate suppliers for necessary parts or components. But sometimes an unexpected event—like a volcano eruption—disrupts the supply chain. The question then becomes: How will your company respond to this unanticipated event?

Obviously, the first challenge is to realize that an event of some type has occurred or is about to occur. But even more significant, is the response. How quickly your company responds and just what that response is, may have substantial impact on the company’s performance and, possibly, its bottom line.

That’s why it’s critical to have tools and processes in place to respond quickly to unanticipated events that aren’t covered by a mitigation strategy.

• These tools must deliver visibility across the supply chain and provide alerts when an event is imminent, they must also include analytics so users can understand the importance of the event and the impact it will have.
• Secondly, the tools must allow users to collaboratively simulate possible solutions, such as splitting orders, expediting orders and finding alternate sources.
• The next capability may well be the most important. Once simulations are created, they must be compared and contrasted to determine which one best meets corporate goals and objectives. Using a multi-scenario scorecard allows users to compare the possible solutions and measure the impact of each potential resolution on key corporate metrics.

Consider these two possible solutions to a critical parts shortage….

The first solution is to use existing inventory and split apart orders. Customers will not receive their full order, but they will at least receive part of it. A second possible solution is to expedite shipment of parts from an alternate supplier to your facilities, fill the orders, and then expedite shipment to your customers.

The first possible solution results in a decrease in on-time delivery and, potentially, a decrease in revenue for the quarter. The second, however, will result in an increase in cost of goods sold and a corresponding decrease in margin.  How do you know which route to take?  These results, compared against a given target and appropriately weighted, provide an overall score for each solution. Thus, an analyst can then use those scores to determine which scenario best suits corporate objectives.   How you make those quick decisions and how well they align with corporate objectives can make or break a company’s bottom line.

Let me know what you think; either about responding to unanticipated supply chain events or photos of lightning in clouds of volcanic ash.

There is, however, a second required element for successful outsourcing. It’s the human aspect, which sometimes proves to be more challenging than implementing software. In fact, various research indicates that chief among the barriers to globalization are: lack of supply chain flexibility, lack of internal competencies to manage external partners and a reliance on partners who are unable to meet flexibility requirements.

A recent SupplyChainBrain article reports on a new paper that goes even further, asserting that for outsourcing to truly be effective, an organization must not rely solely on contracts with suppliers. Instead, companies must also work to foster an informal supplier-buyer relationship.

Chwen Sheu, Paul Edgerley Chair in Business Management, professor and interim head of the department of marketing at Kansas State’s College of Business Administration, studied how nearly 1,000 companies worldwide manage outsourcing, and co-authored a paper—“What makes outsourcing effective- a transaction cost analysis”—along with John Wacker from Arizona State University and C.L. Yang from Chung Hau University, Taiwan.

Data was collected and analyzed from 970 manufacturing firms in 17 countries, and the researchers found that most of those organizations depend on both legal contracts and an informal supplier-buyer relationship. Sheu says both methods are effective, but informal relationships with suppliers deserve more attention from management since in outsourcing, it’s impossible to cover every risk and outcome contractually.

When an unexpected event occurs, and the contract doesn’t specify how to respond, it’s imperative to be able to sit down and resolve the issue with suppliers, Sheu says. This is really a trust and information sharing issue, which allows both parties to deal with unforeseen risks and uncertainties more effectively. In a truly trusted relationship both parties recognize that all decisions need to be mutually beneficial in order to achieve success.  The people are the difference between a satisfactory relationship and an exceptional one, where both parties will over achieve to ensure their partner’s success.

It’s important to note that not all of a company’s suppliers need to be involved in this level of collaborative discussion. Instead, it’s really only necessary to closely communicate with a few, trusted suppliers. For instance, your company may purchase a number of commodity components from several suppliers. It isn’t necessary—or appropriate—to closely collaborate with all of them.

On the other hand, you should collaborate closely with those few key suppliers that represent the majority of your spend on components, supply components used in products that represent a major portion of your company’s revenue, and supply long lead-time components—especially when there is a potential for excess and/or obsolete inventory.

Successful outsourcing requires developing better relationships with long-term, key suppliers. When that’s done, the brand manager and supplier can share business strategies, mutually evaluate risks and threats, and jointly investigate opportunities. In the end, that allows both companies to realize significant benefits.

The other, while it appears to be the exact same part is a cheaply made counterfeit.   If you’re lucky, it will fail as soon as you put it in.  If you are unlucky, it will fail as it is being used by your customer.  Depending on what this chip does, the failure could simply result in a return and an unsatisfied customer.  However, it doesn’t take much of an imagination to see that if this chip is part of a critical component in an aircraft, automobile or healthcare product, the failure could result in injury or death.

As I started to look into this subject, I came to the realization that it is HUGE.  To help me keep things straight, I’ve broken counterfeiting down into two broad categories;  Counterfeit retail products  and counterfeit components.  Both have different risks associated with them and have different mitigation strategies that should be considered.

We’ll look at retail products first.    People have been selling cheap knockoffs for as long as I can remember; clothes, purses, shoes and jewellery ($10 Rolex anyone?), and more recently, DVDs and video games.  If counterfeit watches and DVD’s aren’t enough, we are starting to see counterfeit medication too.  Everything from Tamilflu to Viagra have been counterfeited and sold as the real product…at significant risk to the person using the drug.

Ominously, counterfeit products and components are making their way through the military as well.  Counterfeit components are finding their way into missile systems, fighter jets and nuclear submarines.  Recently, the FBI discovered 400 routers in use in military installations were counterfeit and likely have been used for espionage.

From the brand owner’s perspective, counterfeit products are very damaging;  they impact sales, they drive up costs, they impact your good name, and they can harm your customers.

It seems that protecting yourself from counterfeiters is devilishly difficult.  Options include;

• Holographic labels (like you have on  your credit card)
• Micro-print (I’ve seen these on cheques)
• Unique / obscure marks (small dot on a label)
• Serial numbers
• RFID tags.

Unfortunately, counterfeiters keep coming up with ways of fooling the unsuspecting public. However scientists and engineers are also working to find ways to identify the real thing and have developed new ideas like  nano-artwork.

Let’s look at the supply chain side now.   Counterfeit components can range from relabeling of components (from a generic brand to a known brand), to a replacement of good parts with non-functioning mock-ups. A few months ago, NewEgg discovered that they had been shipping new Intel I7 processors that were in fact clever reproductions of packages that contained non-functioning models of the processor.  I’ve talked about counterfeit components of a different nature in an earlier blog post that talked about components manufactured on a ghost shift.

From the supply chain perspective, counterfeit components are a disaster waiting to happen. This disaster can occur at many levels;  counterfeit components intercepted and identified as part of incoming inspections has the least impact on your company.  If the counterfeit component is caught before your product leaves the factory, you have also been lucky.  Once the product containing counterfeit components gets into  your customer’s hands, failure of the component is your fault in the customer’s eyes.  A more distressing problem is what will happen when that component fails?  Will it just go pop?  Or will it burn like a poorly made lithium ion battery?

To avoid counterfeit parts, here are some ideas

• Beware of prices well below market values
• Know your suppliers
• Test your components often.  Ensure your testers are well versed in counterfeit detection practices including x-ray imaging, solvent body softening, component de-lidding and jet or plasma etching (these methods allow you to see below the surface of a chip and compare to a known good item)
• China is one of the leading sources of counterfeit electronic components.  While it’s difficult to avoid sourcing from China, be aware of the counterfeit risks.

Additional information on avoiding counterfeits can be found here, here and here.

Do you have a counterfeit story?  Do you have advice on how to avoid falling prey to counterfeit components or products? Comment and let us know.