LESSON 3 Supply Chain Risk Management and Mitigation 29 August 2014

Lesson Objectives Upon completion of this lesson, you should be able to: Discuss the importance of conducting risk management activities on a supply chain Identify the nine types of supply chain risks and their drivers Determine the types of actions to take for eliminating, reducing or mitigating supply chain risks Analyze a risk to a project using a decision tree

Lesson Topics This lesson will cover the following topics: Importance of Supply Chain Risk Management Supply Chain Risks and Drivers Mitigation Strategies

What’s In It For Me? Your understanding and ability to identify and monitor risks associated with your supply chain will be vital to the successful performance of your job responsibilities

Lesson Introduction How do contractors identify and mitigate risks?

Importance of supply chain risk management Lesson Topics: Importance of Supply Chain Risk Management Supply Chain Risk and Drivers Mitigation Strategies Decision Trees in the Risk Management Process

Importance of Supply Chain Risk Management Supply chain problems result from: Natural disasters Labor disputes Acts of war Terrorism Inaccurate forecasts Economic downturns Lack of communication … and many more Adopt proactive risk management approaches to reduce impact of these risks

Supply Chain Disruption It’s a delicate balancing act to keep inventory, capacity and other elements at appropriate levels across the supply chain

Example: Plant Fire Class Activity Refer to Module 8, Lesson 3, Scenario 1 CME130_M8_L3_S1_Scenario_FINAL.docx Read directions on Philips Manufacturing Plant Fire Complete the activity as a class

Scenario Analysis Philips fire in Albuquerque 10-minute fire Supplied chips to two competitors: Nokia and Ericsson 10-minute fire Production at plant ceased for weeks Much longer than Philips originally estimated

End Result Strategic advantage for Nokia over Ericsson Ericsson stock price dropped about 50% Ericsson eventually merged with Sony (10/2001) Two different outcomes from one event demonstrates the importance of proactively managing supply chain risk

Question and Answer What was the primary reason why Ericsson wasn’t able to respond to the crisis as quickly as Nokia? Limited capital investment Poor supplier relationship management Nokia interfered with Ericsson’s communication network The lightening strike wasn’t too severe

Question and Answer The scenario illustrates the vulnerability of supply chains. A preventive measure that organizations can use to reduce their supply chain risk is to: Be mindful of weather forecasts Don’t rely on supplier feedback Partner with numerous suppliers Adopt proactive approaches to Risk Management

supply chain risk AND DRIVERS Lesson Topics: Importance of Supply Chain Risk Management Supply Chain Risk and Drivers Mitigation Strategies Decision Trees in the Risk Management Process

Supply Chain Risks and Drivers Understanding the types and interconnectedness of supply chain risks enables you to select risk-reduction strategies

Supply Chain Risks and Drivers (cont.) High capacity utilization Inflexibility of supply source Poor quality or yield at supply source Excessive handling due to change in transportation modes Disruptions Delays Systems risk Forecast risk Intellectual property risk Procurement risk Receivables risk Inventory risk Capacity risk Natural disaster Labor dispute Supplier bankruptcy War and terrorism Dependency upon a single supply source Exchange rates Percentage of key components from a single source Industry wide capacity utilization Long- vs. short-term contracts Information infrastructure breakdown Extensive system networking E-commerce Product obsolescence Holding costs Demand/supply uncertainty Organizations must understand risk categories and their risk drivers to effectively manage risk Vertical integration of supply chain Global outsourcing and markets Number of customers Financial strength of customers Cost of capacity Capacity flexibility Inaccurate forecasts Bullwhip effect

Job Aid: Supply Chain Risks Refer to Module 8, Lesson 3, Job Aid 1 CME130_M8_L3_JA1_SCR_Categories_FINAL.docx

Interconnected Supply Chain Risks 3F O R C A S T R O C U E M N T 4R E 5C I V A B L S A P C I Y 6S Y S T E M 7I V N T O R Y

Analysis of Supply Chain Risks and Their Drivers Identifying risks most likely to disrupt a supply chain helps to mitigate such risks

Question and Answer Drivers to “Systems Risk” include extensive system networking, information infrastructure breakdown, and _______________. Demand and supply uncertainty E-commerce Long lead times Exchange rates

Question and Answer “Disruptions” to a supply chain include supplier bankruptcy, war and terrorism, labor disputes, and _______________. Demand and supply uncertainty Inventory holding costs Long lead times Natural disasters

Question and Answer What must organizations understand first before they attempt to mitigate a supply chain risk? Bullwhip effect Drivers of the risk Inventory management Supply and demand

MITIGATION STRATEGIES Lesson Topics: Importance of Supply Chain Risk Management Supply Chain Risk and Drivers Mitigation Strategies Decision Trees in the Risk Management Process

Mitigation Strategies There is not a “one-size- fits-all” strategy for protecting supply chains Managers need to know which mitigating strategy works best for each specific risk

Job Aid: Supply Chain Mitigation Strategies Refer to Module 8, Lesson 3, Job Aid 2 CME130_M8_L3_JA2_MitigationStrategies_FINAL.docx

Mitigation Strategies for Delays Combine inventory with different transport modes Example: Dell Maintain flexible capacity in plants Example: Toyota Balance capacity and inventory Example: Cisco

Mitigation Strategies for Disruptions Stockpile inventory For products with low holding cost and no obsolescence Redundant suppliers Not every supplier will be disrupted at the same time Use for products with high holding costs and high obsolescence

Mitigation Strategies for Systems Risk Robust back-up systems Well-designed recovery systems Cyber warfare is no longer a threat for businesses… it’s a reality

Mitigation Strategies for Forecast Risk Use the bullwhip effect mitigation strategies Selectively hold inventory Example: Commodities Build responsive production and delivery capacity CPFR VMI EDI Milk Runs Vendor Managed Inventory Electronic Data Interchange Collaborative Planning Forecasting and Replenishment

Mitigation Strategies for Intellectual Property Risk Bring (or keep) some production in house If not, keep it under direct control Examples: Cisco, Sharp Limit the flow of intellectual property into countries with weak legal protections

Mitigation Strategies for Procurement Risk For exchange rate risks: Balance cost with revenue For mitigating price increases by suppliers: Sign long-term contracts Redundant suppliers

Mitigation Strategies for Receivables Risk Filter customers and suppliers for credit worthiness Spread the risk across more customers Example: McMaster-Carr

Mitigation Strategies for Inventory Risk Pool inventory Example: Nordstrom Component commonality Example: Paint industry Postpone or delay Example: Benetton

Mitigation Strategies for Capacity Risk Make existing capacity more “flexible” Use same capacity for a variety of products Example Toyota

Mitigation Strategy Benefits Mitigating supply chain risk: Improves traceability and visibility Lowers costs Increases operational efficiency Improves customer satisfaction Closer compliance to regulations Creates a climate of continuous improvement

What strategy can an organization use to mitigate forecast risk? Question and Answer What strategy can an organization use to mitigate forecast risk? Use redundant suppliers Bullwhip effect strategies Sign long-term contracts Spread the risk across more customers

Question and Answer What strategy can an organization use to mitigate intellectual property risk? Keep some production in-house Sign long-term contracts Stockpile inventories Use redundant suppliers

Question and Answer Mary received bad news from a supplier. The firm cannot meet its next three shipments because the firm’s main vendor is insolvent. What mitigating strategy should the firm have used first before contracting with the vendor? Credit worthiness Redundant suppliers Stockpile inventory

Exercise: Mitigating a Supply Chain Risk Small Group Exercise Find a partner or work in a trio Refer to Module 8, Lesson 3, Exercise 1 CME130_M8_L3_E1_Exercise_FINAL.docx Read directions on: Mitigating a Supply Chain Risk Complete the activity; be prepared to share your responses Time allowed: 20 minutes

DECISION TREES IN THE RISK management PROCESS Lesson Topics: Importance of Supply Chain Risk Management Supply Chain Risk and Drivers Mitigation Strategies Decision Trees in the Risk Management Process

Decision Trees in the Risk Management Process Tool for course of action decision-making Helps for choosing options involving high costs and risks Provides structure for alternatives and outcomes Finds numerical values for alternatives Provides picture of risks and rewards for each course of action Outcome 1.1 25% likely Outcome 1.2 70% likely Outcome 1 20% likely Risk B $30,000 implication Outcome 1.3 5% likely Outcome 2 80% likely Risk A $10,000 implication

The 3-Step Process for Decision Tree Analysis Identify the problem Assess the likelihood and magnitude of impact Use a decision criterion to model the process of choice

Identify the Problem: The Objectives Requirement Overall Goals Tradeoffs Metrics Evaluate Progress

Nodes and Branches A diagram of nodes and connecting branches: Decision nodes: these are strategies = Chance events: chance or uncertainty determines outcomes =

Example: Two Vendor Decision Class Activity Refer to Module 8, Lesson 3, Scenario 2 CME130_M8_L3_S2_Scenario_FINAL.docx Read directions on: Which Vendor to Choose Complete the activity as a class

Scenario Analysis: Draw the Decision Tree Vendor B Vendor A Decision trees need room to grow! Start all the way on the left side of the paper Root node

Chance Outcomes and Endpoints Early On Time Late Delivery Chance node Vendor B Vendor A Endpoint

Analyze the Risk $75,000 $50,000 $25,000 $90,000 $30,000 Proposed Price $45,000 Expected Price $56,000 .1 .6 .3 .4 Probability Delivery Vendor B Vendor A Early On Time Late .1 x $75,000 = $7,500 .3 x $90,000 = $27,000 .3 x $25,000 = $7,500 .6 x $50,000 = $30,000 .3 x $30,000 = $9,000 .4 x $50,000 = $20,000

Why use a decision tree to analyze a problem? Question and Answer Why use a decision tree to analyze a problem? Helps in making good choices for decisions involving high costs and risks Complements gut instinct for spur- of-the-moment decision-making Helps in analyzing probabilities for just the minor problems Since consequences are not known, decision trees really don’t help

Question and Answer Which step in decision tree process looks at the problem in relation to the organization’s overall goals? Identify the problem Assess the likelihood and magnitude of Impact Use a decision criterion to model the process of choice

Summary Having completed this lesson, you should now be able to: Discuss the importance of conducting risk management activities on a supply chain Identify the nine types of supply chain risks and their drivers Determine the types of actions to take for eliminating, reducing or mitigating supply chain risks Analyze a risk to a project using a decision tree

Summary (cont.) Your ability to apply the principles of risk management and collaborative engagement is vital to effectively executing your job responsibilities and to protecting our national supply chain.

Module 8 Wrap Up Activity Refer to the Module 8 Wrap up Activity As a team, answer the questions in the Module 8 Wrap Up Activity File Each team must answer all the questions. Each Team must be prepared to present their answers. You have the remaining time as directed by the instructor to complete this activity.