Risk Planning, the Black Swan and the Resilient Supply Chain
By Karim Aroui
The COVID-19 outbreak is shaking the global economy and disrupting supply chains. Companies in nearly every industry are confronting existential threats. In order to deal with the uncertainty and prepare themselves for the next disruption, many are implementing scenario management planning. Scenario management helps companies future-proof their supply chains. They can rapidly determine an accurate response to unforeseen disruptions and enhance the long-term resilience of their supply chains.
COVID-19 has already delivered a severe blow to the global economy. Most countries took measures including enforced social distancing, home confinement policies, factory and store shutdowns in an attempt to keep the virus from spreading. These pandemic measures, in turn, caused even more disruption to companies, forcing them to react and in some cases, fundamentally change the way they do business in order to survive.
Historic “shock-doctrine” reminds us that significant disruptions also serve as a catalyst to implement long-term manufacturing and supply chain transformation strategies.
According to a recent McKinsey & Company report, the outbreak will cause a slowdown in global growth for 2020. In their base case scenario of the contingency, growth could be between 1.8% and 2.2% instead of the 2.5% envisioned at the start of the year. The pessimist scenario could result in a global recession.
Even though the total impact of the COVID-19 outbreak cannot yet be accurately known, major companies declared a trenchant drop in sales. Adidas announced that sales in Greater China had plunged 80%, compared to last year, during the period between Jan. 25 and the end of February. On a note to shareholders released in March, Starbucks estimated that store sales in China will be down approximately 50% versus the prior year. Major airlines reduced services as demand slipped to a halt following widening travel restrictions and lockdowns to contain the spread of the virus.
During the peak of the exposure in China, many global automakers stopped production lines because of shortages of Chinese parts. By the end of March, trade groups representing the companies including General Motors Co, Volkswagen AG and Toyota Motor Corp, noted in a letter that analysts expect U.S. auto sales to fall by 40% in March as about 95% of U.S. auto plants were closed.
Disruption is NOT New
Disruptions in the supply chain are not new. They have always existed. Even in the past decade, we have experienced the SARS pandemic, the Fukushima nuclear disaster, Brexit and the US-China tariff war. What are the lessons learned from these past disruptions? Naturally, there will be similar disruptions in the future. But are they foreseeable?
Some disruptions are partly foreseeable (politically inspired disruptions such as military conflict, Brexit, trade wars), but the real impact of the disruption is not. Other disruptions, like earthquakes, hurricanes and other natural disasters are not foreseeable or are foreseeable in a short horizon (SARS). Many are events with a very low probability of occurring and consequently are difficult to predict, however, they have a potentially catastrophic impact. These events are often referred to as Black Swans. A Black Swan is an event that has an almost zero likelihood of occurring, but, if it does, can have a major impact. Black Swan events are difficult to define because they may have never before occurred.
Supply Chain Resilience Can Provide a Competitive Advantage
Major disruptions can act as a catalyst to implement long-term supply chain strategies. Organizations that can react better to disruption have a better chance of staying in business and can sometimes thrive by having a more responsive supply chain than the competition. A responsive supply chain allows businesses to react more quickly and more flexibly to external threats.
In my opinion, supply chain resilience to unforeseen events should be a core competency and be a business differentiator. But what makes a supply chain resilient? What are the characteristics of a resilient supply chain?
Key to a responsive supply chain is the ability to identify and understand the potential threats that could menace supply chain operations. For example, node and supply chain process vulnerabilities can be linked to single sourcing, single point of income, outsourced operations, technology reliance, energy reliance, foreign currency exposure or specific human talent.
Building resiliency affects the ways companies perform supply chain planning. Plans need to be more probabilistic and less deterministic. Future demand, supply, lead times, costs, and capacities will never be 100% accurate. But to build resiliency, companies should calculate a likely worst-case “range” of these values and develop scenarios accordingly. To plan for the Black Swans and develop a resilient supply chain, companies should employ a scenario management strategy to identify and prepare general responses to a range of possible situations.
Scenario management, which should include representatives from all functional business areas, is based on a collaborative process and allows different teams of the enterprise to work on the same assumptions. Scenario planning should address the following areas:
- Anticipate demand shocks
- Monitor for supply shocks
- Optimize your inventory strategies
- Continually evaluate points of risk in the network
Scenario Management Should Be Deployed within a Risk Management Process
Scenario management should be deployed within a global risk management process. It should include collaboration across all the functions of the organization as well as a governance model to evaluate every identified scenario, based on key indicators, that is periodically reviewed.
Times of crisis present companies with the motivation and opportunity to improve their supply chain processes in ways that can future-proof them from the next manufacturing and supply chain disruption. Supply chain leaders should use the current situation to up their risk management game and adopt strategies that can lower their supply chain’s exposure to disruption while identifying avenues that will help them survive during the next crisis.
(The author is Business Consultant at QAD Inc., a cloud-based enterprise software and services for global automotive manufacturing companies and the views expressed in this article are his own)