The common understanding that you have to give up profits to reduce risk is incorrect. Companies are seeing that they can reduce risk in their supply chains and, by doing so, actually improve their earnings. So, there is no risk-return trade-off – this is because most supply chains are not efficient from a risk perspective.
What makes supply chains inefficient from a risk perspective? Companies have many commodities, components, and finished products in their supply chains. These are bought, made, moved, or sold in multiple locations, creating complexity and that too in the face of conflicting performance metrics. And there is supply chain risk: demand fluctuations or trends, supplies that are unexpectedly late, and disruption to transportation due to storms. Companies are not only chasing performance but also having to mitigate risk in complex supply chains sprawling all over the globe. They are just not very good at doing both.
Leading companies are simplifying their supply chain operations. In doing so, they are also getting higher performance, whether it is higher profitability or higher revenues or both. There are at least three ways companies are seeking to achieve simpler operations and hence lower risk as well as higher profits: (1) segmenting the supply chain; (2) regionalizing the supply chain, and (3) de-concentrating resources: suppliers, plants or warehouses. While these strategies are helping large companies with global supply chains, small or medium-sized companies can apply the same ideas to their smaller supply chain operations.
Segment your supply chains
Many large companies are splitting product lines into separate supply chains. The resulting supply chains are quite different from each other as regards vulnerabilities and what drives performance, but within each supply chain the products are similar as regards demand characteristics or supply sources. These supply chains are simpler to manage separately and can be run optimally for improved performance.
Apparel maker Zara takes this approach. For fast-moving essential products with low margins, the company runs lean supply chains, sourcing from multiple low-cost suppliers in Asia for the European market. For low-volume (high-fashion) products with high demand uncertainty and higher margins, Zara runs agile supply chains with (mostly) centralized capacity in Spain to aggregate demand fluctuations across Europe.
Segmentation can be done even for the same product by having two different supply chains: a lean one for the regular part of the demand and an agile one for fluctuations on top of that steady base. The separate supply chains lower risk while improving performance. Dell used to order the same part for short-term fluctuations by air from China while meeting the steady part of the demand for components by sea.
Regionalize your supply chains
Another way simplify supply chains is to regionalize supply chains. Regionalizing means sourcing (and processing) within the region to meet demand in the same region. Risk is therefore contained within the region as there is no spillover of a risk incident from one region to another. Regionalizing also reduces transportation and related sustainability costs, even though the motivation is to reduce risk.
Diageo, the world’s largest distiller, has changed their production and distribution networks from the ground up. Of course, not all supply chains can be regionalized: Scotch whiskey has to be sourced from Scotland. But beer and other drinks that are not country-specific have been regionalized. Diageo regional supply chains with local sourcing and distribution, often organized at the country level, have also helped it to increase market share. Similarly, SAB Miller sources sorghum from Zambian farmers to manufacture and sell sorghum-based beer in Zambia.
De-concentrate your resources
Managers have learned that putting all their eggs in the same supply chain basket for economies of scale creates risk exposure. They are therefore trying to introduce redundant suppliers, more distribution centers, and more plants to reduce their exposure to a single risk incident in any concentrated facility. De-concentration increases operational and overhead costs. You can view this increase in costs as an insurance premium for lowering risk, but de-concentration can help increase revenues even more through improved service level, thus giving positive net change in profits. Managers should also consider lower transportation costs. Moreover, more sources allow for regionalization of supply chains discussed in the previous section.
Having common parts across different products is another manifestation of the same motivation. The higher the total amount of pooling of parts and capacity, the higher is the full benefit. But this can make the overall supply chain more vulnerable to disruption risk. As the brake recall by Toyota in 2014 shows, the use of common parts produced by a single supplier in many models can magnify the impact of one quality-related disruption.
And the benefit of economies of scale from concentration need not be diluted by having multiple resources. Samsung Electronics ensures there are multiple external suppliers where it needs them, but with the lead supplier supplying 80% or so of the goods. This way, economies of scale are maintained while having multiple suppliers mitigates the exposure to any one supplier.
Chasing cheaper sources and more customers in every city in every country has led to the globalization of supply chains. Doing so has led to complexity in the supply chain and inefficiency as operational policies become one-size-serves-all. These supply chains are also quite vulnerable to disruptions. As companies seek to mitigate risk even at the price of having to give up some performance, they find the simplification as noted above has led to gains in performance instead.
Focusing on risk also helps companies understand how complex their operations have become. Segmenting products into different supply chains and sometimes the same product as well, regionalizing supply chains for regional sourcing for regional demand, and de-concentration which in turn allows for more regionalization are ways to lower risk. One consequence of reducing risk this way is improved performance not only on the financial front but also non-financial ones like environmental and social sustainability.
By ManMohan S Sodhi, FIMA, FORS, Professor and Head of Operations and Supply Chain Management at Cass Business School at City University of London; his doctorate is in management science from the University of California, Los Angeles.