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Transcript of 1 Preparing for the Black Swan Risk Mitigation and Planning for Procurement and the Supply Chain ISM...
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Preparing for the Black Swan Risk Mitigation and Planning for Procurement and
the Supply ChainISM Risk Management
August 20, 2012
Rob Handfield, PhDCo-Director, Supply Chain Resource Cooperative
Bank of America University Distinguished Professor of SCM
Introductions…Rob Handfield, PhD• Bank of America University
Distinguished Professor of Supply Chain Management, NC State University
• Director, Supply Chain Resource Cooperative – top 3 MBA SCM programs in the US
• Adjunct Professor, Manchester Business School
Research and consulting supply risk projects with different industries including:
• Bank of America• Biogen Idec• Boston Scientific• BP• Cardinal Health• Chevron • ConocoPhillips • Duke Energyr• General Motors• GlaxoSmithKline• Honda• Northrupp Grumman• LyondellBasel• Spectra Energy• Shell
Current Partner Companies
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Agenda
• The Global Market Picture• Why think about Complex Adaptive Systems?• Issues Facing Industry Executives in this context
– Commodity Volatility– Global Footprint and Regulatory Challenges– Supplier Risk– Talent management– Global footprint
• Building an Agile Organization
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Global Economic Woes Foreseeable for Some Time to Come
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Multiple mixed signalsemanating from global markets makes forecasting & strategic planning for 2013 and beyond
extremely challenging
Global Risks are Frequently Generating
Supply Chain Disruptions
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2005 2006 2007 2008 2009 2010
Caterpillar
TornadoOxford
MS
H1N1 Outbreak
Global Recessio
n
Iceland volcanoHealthca
re
FallujahOffensiv
e
Sadr CityBombing
s Mumbai Attacks
Japanese Earthquak
e
TsunamiIndian Ocean
Business Failures: Bear Stearns, Lehman Brothers,
TARP,
Global Recession
HurricaneKatrina
Surge inAfghanista
n
ToyotaAccelerato
rRecalls
SARSOutbreak
Libyan Crisis
Greek Politic
al Chaos
Chinas stimulus package
French Strikes
Hurricane Katrina
20122011
Thai Floods
Agenda
• “Black Swan” Events• Common Errors in Forecasting and Risk Mgmt• Approaches for Reducing Impact of Unplanned
Events• Case Study: Pandemic Scenario Planning
Survey Results
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Global Risk Events Overlap and Impacts Compound
Dealing with Risks is the Normal Operating State
AFP – Frederic J. Brown
Sept 2001 Terrorist Attacks
Conflict in Iraq
Hurricane Katrina
SARS/H1N1 Virus
West Coast Ports Lockout
Iceland Volcano
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• Cost of supply chain “glitches” – average of 10.28% decrease in shareholder value at time of announcement, with share price recovery (if firm does recover…) in roughly 60 trading days.1
• Cost of crises – sharp initial decrease of almost 8%, with full share price recovery (if firm does recover…) in roughly 50 trading days. 2
• 69% of CFOs, Treasurers & Risk Managers at Global 1000 companies in North America & Europe view fires/explosions and supply chain disruptions as leading threats to top revenue sources.3
1 Hendricks and Singhal, “The effect of supply chain glitches on shareholder wealth,” Journal of Operations Management, Vol 21, 2003, pp. 501-522. Supply chain glitches include parts shortages, order changes by customers, production problems, product launch problems, quality problems, engineering changes, weather-related problems, capacity and equipment problems, IT system problems, etc.2 Knight and Pretty, “The impact of catastrophes on shareholder value,” The Oxford Executive Research Briefings, 22 pages. Crises include Johnson & Johnson Tylenol product tampering, Union Carbide Bhopal gas leak incident, Pan Am Lockerbie plane crash, Occidental Piper Alpha Oil Platform explosion, Exxon Valdez oil spill, Perrier Benzene contamination, etc. 3 Green, “Loss/Risk Management Notes: Survey: Executives Rank Fire, Disruptions Top Threats,” Best's Review, Sept. 1, 2004
Why Should Companies Manage Supply Chain Risks Like Other Risks?
Shareholder Value Impact Is About the Same Magnitude and Duration for Supply Chain Risk Events and Traditional Crises
“Black Swan Events”
An event with three attributes:1.An outlier, that lies outside the realm of
regular expectations, because nothing in the past can convincingly point to its possibility.
2.It carries an extreme impact.3.In spite of its outlier status, human nature
makes us concoct explanations for its occurrence after the fact making it explainable and predictable.
Source: Nassim Taleb, New York Times, April 22, 2007.10
Strategies for Managing Commodity Volatility
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The track record on predicting Black Swan events is not good….
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Sigma (“”) is a measure…
Statistical Regularity ≠ Predictability
* EPMO = Events per million opportunities
• Variation in commuting time by subway can be modeled by bell curve with almost all values falling within 3 std. deviations•BUT – what is the probability of being hit by a coconut under a palm tree while on vacation? (“coconut uncertainty”)•How to forecast an event that is 20 ? 30 ?
Expectation
Unpredictable events
Variation
6 variation= 3.4 events per
Million OpportunitiesSIGMA DPMO * YIELD
1.0 691,462 30.8538%
2.0 308,538 69.1462%
3.0 66,807 93.3193%
4.0 6,210 99.3790%
5.0 233 99.9767%
6.0 3.4 99.9997%
SIGMA DPMO * YIELD
1.0 691,462 30.8538%
2.0 308,538 69.1462%
3.0 66,807 93.3193%
4.0 6,210 99.3790%
5.0 233 99.9767%
6.0 3.4 99.9997%
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2
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Source: Mykridakis, Hogarth and Gaba, “Why Forecasts Fail”, MIT Sloan Mgmt Rev., Winter 2010.
Six Common Executive Mistakes in Trying to Manage Uncertain Events
Common Mistakes1. Thinking you can manage risk by
predicting extreme events.2. Convincing your team that
studying the past will help manage risk.
3. Not listening to good advice about what you shouldn’t do.
4. Assuming risk can be measured by standard deviations.
5. Confusing mathematical equivalency with psychological equivalency.
6. Focusing on being lean without considering the importance of redundancy.
Instead, focus on:1. Gauging how your company will be affected, and
how your supply chain partners will be impacted.
2. Recognizing there are no “typical” failures or successes, as global randomness is inherently unstructured in nature.
3. Thinking of risk mgmt in terms of preservation of profits and retention of shareholder value.
4. Avoid underestimating the size of the class of rare events that can impact supply chain.
5. Looking at multiple measures of risk from multiple perspectives, not just the best case scenario which increases risk appetite.
6. Avoiding leverage, and identifying strategic redundancies in the supply chain that are critical in the event of something going wrong. Source: Taleb, Goldstein, and Spitznagel, The Six Mistakes Executives Make in Risk Management,
Harvard Business Review, October, 2009.14
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Three key elements of supply chain disruption management
Disruption Discovery
Disruption Recovery
Supply Chain Redesign
Supply Market Intelligence Enables Supply Chain Risk Mitigation
• Disruption Discovery– What type of detection and
intelligence does a firm need to detect disruptions?
• Disruption Recovery– Once the disruption is discovered,
how does a firm effectively recover from a disruption?
• Supply Chain Redesign– How can a company strategically
re-design its supply chain over time to become more resilient and avoid or easily mitigate future disruptions?
16Time
Imp
act
of
Dis
rup
tion
($
, C
ust
om
er
Acc
ou
nt,
Ma
rke
t sh
are
)
DISRUPTIONDiscovery(A) Recovery (A)
Impact(A)
Discovery(B) Recovery (B)
Impact (B)
Disruption Discoveryand Recovery time (B)
Disruption Discoveryand Recovery time (A)
Disruption A
mplifiers
(Glo
balization and Com
plexity)
Visibility Systems
Excess Resources
The key is planning, NOT forecasting. The ability to respond is a function of how well your organization has considered and planned for the worst case scenario.
The key is planning, NOT forecasting. The ability to respond is a function of how well your organization has considered and planned for the worst case scenario.
Disruption Discovery and Recovery
A process for supply chain continuity planning
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Challenge your team to identify not the EVENTS, but the major areas impacted internally or in your supply
chain
Exercise: Think of recent “near misses” or disruption that resulted in a major business impact…..
Examples• Iceland volcano• Storms or weather• Supplier mergers or
acquisitions• Bank failures• HSSE near misses?
Post-mortem lessons learned?• Inventory positioning?• Contract reviews and re-
negotiations?• Dual sourcing agreements?• IT systems redundancy?• Others?...• What are the implications
for WHO should be on a supply chain continuity team?
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Begin by classifying internal enterprise functions that would disrupt operations or limit growth…
Enterprise &Supply ChainBusinessCritical?(bottleneck,Single source,Etc.)
Likely to be impacted?(Direct impact or proximity to threat)
High
High
Low
Ware-house
Call Center
Logistics
FieldSupply
RetailAssociates
Janitorial
SalesAgents
IT Systems.
OperationsPurchasing
Acct.Payable
HealthProviders
CafeteriaBenefits
Maint-enance
FacilitiesHVAC
Software
CustomerBilling
Legal
High likelihood, high impactHigh Opportunity, Low-Hanging Fruit
Security
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Identify critical assets/parties in the supply chain that would be impacted…
Enterprise &Supply ChainBusinessCritical?
Likely to be impacted?(Physical proximity or directly dependent on resource)
High
High
Low
DirectMaterials
Call Center
ThirdPartyLogistics
FieldSupply
Distrib.
Janitorial
FieldSupport
IT Maint.
EnergyIT Systems
Insurance
ContractMfg.
FoodServicesOffice
Supplies
ContractResearch Facilities
Maint.
Billing
LabServices
Legal
High likelihood, high impactHigh Opportunity, Low-Hanging Fruit
Security
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Impact
Ris
kStep 2:
Initial Impact Assessment
(Decision Tree)
IncludedH/M or L
Step 3:Supplier Risk Assessment
1 Performance 2 Supply Chain3 Financial4 HR5 Continuity6 Relationship
Excluded (L)
HighOr
MediumStep 4:
(H/L, M/M and M/H)Scorecard, Auditing
Step 4:(H/H and H/M)
Mitigation Strategy
Classify each party/relative to risk and impact, and establish mitigation requirements
Step 1:Generate/Validate
Initial Critical Supply Chain List
L
L
M
M
H
H
Mitigation Strategy, Scorecard
Mitigation Strategy, Scorecard
Scorecard, Auditing
Scorecard, Auditing
Scorecard, Auditing
No Action
These steps represent a supplier risk management
strategy.
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PerformancePerformance
CAUSES (Categories of Predictive Measures)
DisruptionEVENTS
CONSEQUENCES (Impacts)
Human ResourcesHuman Resources
Supply Chain DisruptionSupply Chain Disruption
Financial HealthFinancial Health
EnvironmentalEnvironmental
RelationshipRelationship
Quality, Delivery, Service ProblemsQuality, Delivery, Service Problems
Supplier Union Strike,Ownership Change, Workforce Disruption
Supplier Union Strike,Ownership Change, Workforce Disruption
Supplier LockedTier II StoppageSupplier LockedTier II Stoppage
Supplier Bankruptcy (or financial distress)Supplier Bankruptcy (or financial distress)
Disasters (Weather, Earthquake, Terrorists)Disasters (Weather, Earthquake, Terrorists)
Misalignment of InterestsMisalignment of Interests
Finished Goods Shipments Stopped Finished Goods Shipments Stopped
Locate and Ramp Up Back up SupplierLocate and Ramp Up Back up Supplier
Emergency Buy and ShipmentsEmergency Buy and Shipments
ReputationReputation
Market Share LossMarket Share Loss
EFFECTSRevenueLosses and Recovery Expenses
OTHERIMPACTSForgoneIncome
Emergency Rework and Rushed FG Shipments
Emergency Rework and Rushed FG Shipments
Recall for Quality IssuesRecall for Quality Issues
Sudden Loss of Supplier Sudden Loss of Supplier
Predicting failure points and potential impacts requires structured brainstorming with SME’s…
Copyright© 2006 Supply Chain Redesign, LLC
Su
pp
lie
r A
ttri
bu
tes
Sit
ua
tio
na
l F
ac
tors
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Strategically redundant assets and plans are required for high risk high impact elements with
business case identified
Develop Potential Mitigation Strategies
· Improved coordination· Increased inventory· New source· Product redesign
Who?
What?
Additional Resources Required to Implement?
Analysis of Potential High Risk Product/
Supplier
Implement Risk Mitigation Strategy
Management Identify
Resources and Implement
Supply Chain Analyst
· Basic information from procurement, mfg. engr., quality
· Key risk drivers
Supply Chain Analyst
Mitigation recommended?
Supply Chain Analyst, MEs, Procurement, Quality as needed
YES
NO
Supply Chain Analyst
· Coordinate/perform activities as needed
We need to re-think current contracting behaviors and recognize risk as a shared component of the relationship….upfront
collaboration can solve many problems that occur later on…
Critical Elements of ContractingWhere do managers spend time in contract negotiation?
25Source: T. Cummins, Commitment Matters, June 2009.
“Classical law views cooperation as being ‘of little interest’ and external to the contract. In part, this is because it assumes a common base of presumed rules by the parties.” – Ian McNeil, 1969
Case Example: Pandemic Exercise
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“While pandemics have happened several times in the past, never before have we had all of the tools of today. Never before have we possessed the wealth of knowledge on the problem and the ability to prepare. The challenge is immense, but so is our will to protect and preserve.” Michael Levitt, Department of Health and Human Services, Pandemic Planning Update II, July 2006.
Pandemic “Dogma”1. Only H1, H2 and H3 viruses could infect humans, H5, H7, and H9 subtypes jumped
from birds to infect people (Incorrect)2. Pandemic viruses emerge from Asia, the cradle of flu viruses (H1N1 originated in
Mexico)3. Pandemics are triggered by antigenic shifts or small mutations which resulted in
the H1N1 virus. (Actually, almost everyone alive has antibodies to H1 viruses).4. Emerging pandemics can be extinguished with quick use of antiviral drugs (this
virus spread before anyone had time to distribute) antiviral drugs)5. Pandemics are easy to spot and occur during flu season (this one started in the off-
season)6. Governments can quickly respond to a pandemic virus once it is spotted (The WHO
took many weeks to actually raise the level of infection to a level that required emergency actions)
7. People will clamor for pandemic vaccine (Many people resisted taking the vaccine in 2009).
8. Vaccine would be ready in time (the length of the spread of the vaccine made it difficult to plan release of vaccines and distribution was problematic).
27Source: Branswell, Helen, Nov 4, 2009, “Flu dogma being rewritten by a strange virus no one pegged to trigger a pandemic”, The Canadian Press.
How well prepared are companies for a pandemic?
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Number of organizations
Create governanceteam
Identify critical resources
Ancillary workforce
Plan for scenarios
Determine Impact on Financials
IT SystemBackup
Emergency Communications
Implement Drill / Exercise
SC Risk Impacts
RedundantResources Training
Best Case: Financial Services Pandemic Plan
29Source: Deepwater Horizon Accident Investigation Report, BP, September 8, 2010, Executive Summary.
Parting ThoughtsBlack Swan events have always been part of our economic climate; only recently have we begun to recognize that uncertainty is part of our fabric, and that successful firms are those who don’t rely on forecasts, but instead plan for uncertainty and exploit their relative position when surprises occur.
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