Shorter Supply Chains and Risk Management Pay Off Big

When the largest earthquake to ever strike Japan rocked the country on March 11, it triggered a devastating tsunami leaving a wake of destruction and disaster at a nuclear power plant. It also shut down production for many major global manufacturers in Japan— in particular, those related to the auto and hi-tech industries.

Though the impacts of the disaster are still rippling through industry – with many effects yet to be realized – companies are trying to figure out how to respond in the medium-term. Business leaders are plotting out strategies to deal with increasing volatility, created not only by natural disaster, but also by political uprisings in the Middle East, skyrocketing gas prices, and a shaky global economy.

“There is a lot of demand uncertainty right now given the ongoing global financial crisis, and there is obviously a lot of supply uncertainty in certain regions as well,” said Sandor Boyson, research professor and co-director of the Supply Chain Management Center.

Boyson says the uncertainty has produced two major shifts in supply chain strategy that have big implications for the global economy: Shorter supply chains and a new intense focus on calculating risk.

Shortening the Supply Chain

“The longer the supply chain, the more that can go wrong and the more it costs with high gas prices,” says Boyson. Companies are realizing this and beginning to open new production and distribution facilities in each market they serve, drastically shortening their supply chains to increase the efficiency and cut shipping costs. Some of the larger companies are creating manufacturing capabilities on every continent. “The idea is to shorten the lead times to the end consumers,” says Boyson.

Shorter supply chains make it easier for companies to monitor production and respond quicker to production problems that emerge, adds Thomas M. Corsi, professor and Boyson’s co-director at the Supply Chain Management Center. Shorter supply chains also respond faster to demand fluctuations, reducing the likelihood of running out of stock and lowering inventory costs.

The United States is seeing some pick-up in manufacturing coming from this type of strategy, say Boyson and Corsi. As emerging economies like China and India continue to grow and automation replaces medium-skilled human labor, global competition is not so tied to cheap labor costs, but now is based on overall total cost advantages.

“When we started analyzing this back in 2006, there were indications that this trend could be emerging, but it’s accelerating now,” Boyson said. “We’re even seeing Asian countries diversifying in this strategy.” For example, Taiwan-based Foxconn, which produces the iPhone and iPad for Apple and is the largest contract electronics manufacturer in the world, is making a significant investment in Brazil to set up a production center for the Latin and U.S. markets.

Calculated Risk

Boyson and Corsi say risk management is also becoming an enterprise imperative. This has always been standard practice for global shipping companies such as FedEx, but now diverse global manufacturing companies have elevated risk management to an executive-level function. Global companies are proactively tracking natural-disaster related precursor events so they can get early warning signs that could impact their operations. Companies like Cisco are taking a very active approach to tracking seismic activity in areas where they operate and pre-arranging alternative sites and suppliers as hedges against disaster.

The Japanese earthquake demonstrated the vulnerability of supply chains and the importance of risk management: “One critical metallic additive to automotive paint is produced in a single facility about 28 miles from the Fukushima nuclear plant,” said Corsi. “This facility was damaged and put out of service by the earthquake and tsunami. There are no alternative locations for the production of this additive. As a result, car manufacturers have been forced to take certain car colors out of production.”

A Fragile Economy

Global manufacturers are also worried about production costs, with raw material costs spiking. Rising oil prices don’t just affect gas prices – they also drive up costs for plastics and anything petrochemical-based. Boyson says with these concerns, companies are very focused on costs, and consumers should be worried about inflation in the economy.

For companies struggling to grow or maintain revenues, shortening their supply chain and managing risk could have big payoffs. According to recent research from the Council of Supply Chain, companies who can reduce total supply chain costs as a percentage of revenue by 1 to 2 percent will see a financial return equivalent to that from a 4 to 12 percent increase in revenues. In a demand-constrained environment, this kind of ROI from supply efficiency gains is a critical contribution.

“It’s so strategic for companies to manage costs and risks in the supply chain right now,” Boyson says. “In this kind of market, it’s a viable option for competitive advantage.”