Preparing for the Black Swan
Risk Mitigation and Planning for Procurement and
the Supply Chain
ISM Risk Management
August 20, 2012
Rob Handfield, PhD
Co-Director, Supply Chain Resource Cooperative
Bank of America University Distinguished Professor of SCM
1
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
3
4
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
5
Global Economic Woes Foreseeable for Some Time to Com
Unemployment
stuck at 8-9%,
contagion in
Europe, home
values below
market, banks
are mired in
regulatory
firefighting.
Uncertainty,
low demand,
and excess
supply has
postponed
expansion
and hiring,
job markets
recovery will
take years.
Commodity
prices are
likely to rise
on trend,
while the
dollar will
weaken and
housing will
remain flat
for a number
of years
Economic
recovery
estimates
have been
scaled back to
2013 under a
positive
scenario
Multiple mixed signals
emanating from global markets
makes forecasting & strategic
planning for 2013 and beyond
extremely challenging
Global Risks are Frequently Generating
Supply Chain Disruptions
Caterpillar
Tornado
Oxford MS
Tsunami
Indian
Ocean
Fallujah
Offensive
2005
SARS
Outbreak
Sadr City
Bombings
Hurricane
Katrina
2006
Mumbai
Attacks
Iceland
volcano
Healthcare
H1N1
Outbreak
Global
Recession
2007
2008
Hurricane
Katrina
Chinas
stimulus
package
2009
Surge in
Afghanistan
2010
Japanese
Earthquake
French
Strikes
Thai
Floods
2011
Toyota
Accelerator
Recalls
Business Failures: Bear Stearns,
Lehman Brothers, TARP,
Global Recession
6
Libyan Crisis
2012
Greek
Political
Chaos
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
7
Global Risk Events Overlap and Impacts Compound
Sept 2001 Terrorist
Attacks
Hurricane
Katrina
West Coast Ports
Lockout
SARS/H1N1 Virus
Iceland
Volcano
Conflict in Iraq
AFP – Frederic J. Brown
Dealing with Risks is the Normal Operating State
8
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
• 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
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.
1
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.
2
3
Green, “Loss/Risk Management Notes: Survey: Executives Rank Fire, Disruptions Top Threats,” Best's Review, Sept. 1, 2004
9
“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
New Sources focusing on
new emerging players
Pre-qualification investments can open options.
New players can offer lower cost opportunities,
as evidenced in steel and aluminum
Increase visibility of key
commodities bottom line
impact with ‘rules of thumb’
Understanding how and where commodities
impact and ‘time lag’ to bottom line help
manage exposure
Constant forecasting relying
on market experts for
insight
Ensures proper visibility and data driven
sourcing decisions
Scenarios for building future
options and guiding
decisions
Which scenario is hard to know but impact of
scenarios can be mapped (remember when
gold at $1,000 / oz was insane?)
Understand when ‘rules of
thumb’ break down
Detail Red Flags to watch and transition into
potential new market scenarios when they
appears
Rapid Decisions and Rapid
Implementation
Inactivity is a decision: Procuring
infrastructure will need to facilitate
implementation
11
The track record on predicting
Black Swan events is not good….
October, 2007: “The problems in credit markets have been severe, and while the first
phase is now over, we are still waiting to see exactly how the consequences will play
out…..At this point, we expect global growth to slow in 2008, but remain at a buoyant
pace. - IMF
December, 2007: “The economists project, on average, that the economy will grow 2.1%
from the fourth quarter of 2007 to the end of 2008, vs. 2.6% in 2007. Only two of the
forecasters [out of 54 in total] expect a recession.” - Business Week annual survey of
business forecasters.
March, 2008: “I have great, great confidence in our capital markets and in our financial
institutions. Our financial institutions, banks and investment banks are strong. Our capital
markets are resilient. They’re efficient. They’re flexible. - Henry Paulson. US Treasury
July 15, 2008: “We can have confidence in the long-term foundation of our economy….I
think the system basically is sound. I truly do.” - George W. Bush, President
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Statistical Regularity ≠ Predictability
Sigma (“”) is a measure…
SIGMA
1.0
2.0
3.0
4.0
5.0
6.0
DPMO *
691,462
308,538
66,807
6,210
233
3.4
YIELD
30.8538%
69.1462%
93.3193%
99.3790%
99.9767%
99.9997%
* EPMO = Events per million opportunities
6 variation
6
= 3.4 events per
Million Opportunities
5
4
Unpredictable
events
3
2
Variation
1
Expectation
• 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 ?
13
Source: Mykridakis, Hogarth and Gaba, “Why Forecasts Fail”, MIT Sloan Mgmt Rev., Winter 2010.
Six Common Executive Mistakes in Trying
to Manage Uncertain Events
Instead, focus on:
Common Mistakes
1.
2.
3.
4.
5.
6.
Thinking you can manage risk by
predicting extreme events.
Convincing your team that
studying the past will help
manage risk.
Not listening to good advice
about what you shouldn’t do.
Assuming risk can be measured
by standard deviations.
Confusing mathematical
equivalency with psychological
equivalency.
Focusing on being lean without
considering the importance of
redundancy.
1.
2.
3.
4.
5.
6.
Gauging how your company will be affected, and
how your supply chain partners will be impacted.
Recognizing there are no “typical” failures or
successes, as global randomness is inherently
unstructured in nature.
Thinking of risk mgmt in terms of preservation of
profits and retention of shareholder value.
Avoid underestimating the size of the class of
rare events that can impact supply chain.
Looking at multiple measures of risk from
multiple perspectives, not just the best case
scenario which increases risk appetite.
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,
14
Harvard Business Review, October, 2009.
Supply Market Intelligence Enables Supply
Chain Risk Mitigation
Three key elements of supply chain disruption management
•
•
•
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 redesign its supply chain over time to
become more resilient and avoid or
easily mitigate future disruptions?
Disruption
Discovery
Supply Chain
Redesign
Disruption
Recovery
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Impact (B)
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 Amplifiers
(Globalization and Complexity)
Impact of Disruption ($, Customer Account, Market share)
Disruption Discovery and Recovery
Disruption Discovery
and Recovery time (B)
Disruption Discovery
and Recovery time (A)
Excess Resources
Impact(A)
Visibility Systems
Discovery(A)
Recovery (A) Discovery(B)
16
Recovery (B)
Time
A process for supply chain continuity planning
• Establish senior executive support for supply chain risk planning team
• Dedicated cross-functional planning committee with authority to drive
business cases .
Governance
• Criteria: Who will be impacted? Who has knowledge?
Supply Chain
Risk Planning
Strategic
Redundancies
• Identify critical suppliers and employees that would impact operations
and market share in the event of a major disaster (“downside risk”)
• Identify key bottlenecks that would impact capacity in a rapid growth
scenario (“upside risk)
• Develop scenarios and ‘what if’ analyses to stress test supply chain
• Establish requirements for redundant resources at impacted enterprise
supply chain nodes bearing the highest risk
• Develop business case, present to leadership team, and execute
• Defined action plans and education for critical employees and suppliers
Supply Chain • Collaborate with supply chain partners on role plays, drills, simulations,
Education &
etc. on a periodic basis as required.
Training
17
Challenge your team to identify not the EVENTS, but
the major areas impacted internally or in your supply
chain
Pandemic or health threat (of any sort)
• Workforce decreases by 30%....
• Supplier capacity cut in half….
Economic meltdowns (or sudden surge)
• Ability to flex up or down
• Suppliers experiencing financial distress or lack of
access to capital
Terrorist Cyber Attack / Travel Shutdown
• Systems compromised
• Logistics network shut down
• Travel restrictions to critical regions
18
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 renegotiations?
• Dual sourcing agreements?
• IT systems redundancy?
• Others?...
• What are the implications
for WHO should be on a
supply chain continuity
team?
19
Begin by classifying internal enterprise functions
that would disrupt operations or limit growth…
High
High Opportunity, Low-Hanging Fruit
High likelihood, high impact
Purchasing
Field
Supply
Call
Center
Enterprise &
Supply Chain
Business
Critical?
(bottleneck,
Single source,
Etc.)
Operations
Security
Logistics
IT
Systems.
Warehouse
Facilities
HVAC
Janitorial
Health
Providers
Customer
Billing
Benefits
Low
Retail
Associates
Software
Maintenance
Sales
Agents
Legal
Acct.
Payable
Cafeteria
Likely to be impacted?
(Direct impact or proximity to threat)
High
20
Identify critical assets/parties in the supply chain that
would be impacted…
High
High Opportunity, Low-Hanging Fruit
High likelihood, high impact
IT Systems
Call
Center
Field
Contract Supply
Mfg.
Billing
Enterprise &
Supply Chain
Business
Critical?
Contract
Research
IT
Maint.
Direct
Materials
Field
Support
Distrib.
Third
Party
Logistics
Energy
Security
Facilities
Maint.
Lab
Services Janitorial
Legal
Insurance
Office
Supplies
Low
Food
Services
High
Likely to be impacted?
(Physical proximity or directly dependent on resource)
21
Classify each party/relative to risk and impact, and
establish mitigation requirements
Step 1:
Generate/Validate
Initial Critical
Supply Chain List
Risk
Step 2:
Initial Impact
Assessment
(Decision Tree)
Mitigation
Strategy,
Scorecard
Mitigation
Strategy,
Scorecard
M
Scorecard,
Auditing
Scorecard,
Auditing
L
No Action
Scorecard,
Auditing
H
Included
H/M or L
L
Excluded (L)
Step 3:
Supplier Risk Assessment
1
Performance
2
Supply Chain
3
Financial
4
HR
5
Continuity
6
Relationship
22
High
Or
Medium
M
Impact
H
Step 4:
(H/H and H/M)
Mitigation Strategy
These steps represent a
supplier risk management
strategy.
Step 4:
(H/L, M/M and M/H)
Scorecard, Auditing
Predicting failure points and potential impacts
requires structured brainstorming with SME’s…
CAUSES
(Categories of Predictive
Measures)
Relationship
Supplier Attributes
Performance
Human Resources
Supply Chain
Disruption
Situational
Factors
Financial Health
Environmental
Disruption
EVENTS
Misalignment of
Interests
Quality, Delivery,
Service Problems
Supplier Union Strike,
Ownership Change,
Workforce Disruption
Supplier Locked
Tier II Stoppage
Supplier Bankruptcy
(or financial distress)
Disasters (Weather,
Earthquake, Terrorists)
Copyright© 2006 Supply Chain Redesign, LLC
CONSEQUENCES
(Impacts)
Sudden Loss of
Supplier
Finished Goods
Shipments Stopped
Recall for
Quality Issues
Locate and Ramp Up
Back up Supplier
EFFECTS
Revenue
Losses
and
Recovery
Expenses
Emergency Buy
and Shipments
Emergency Rework
and
Rushed FG Shipments
Reputation
Market Share Loss
23
OTHER
IMPACTS
Forgone
Income
Strategically redundant assets and plans are
required for high risk high impact elements with
business case identified
Management
Identify
Resources and
Implement
YES
Analysis of
Potential High
Risk Product/
Supplier
Who?
What?
Supply Chain Analyst
·
·
Develop Potential
Mitigation
Strategies
Mitigation
recommended?
Supply Chain Analyst,
MEs, Procurement,
Quality as needed
Supply Chain Analyst
Basic information from
procurement, mfg.
engr., quality
Key risk drivers
·
·
·
·
Improved coordination
Increased inventory
New source
Product redesign
Additional
Resources
Required to
Implement?
NO
Implement Risk
Mitigation
Strategy
Supply Chain Analyst
·
Coordinate/perform
activities as needed
24
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…
Where do managers spend
Critical Elements of Contracting time in contract negotiation?
Cooperation
Economic
exchange
Planning for the
future
Potential external
sanctions
Social control and
manipulation
Limitation of
Liability
Indemnification
Price / Charge /
Price Changes
Intellectual
Property
Confidential
Information
Data Protection
Service
Levels and
Warranties
Delivery /
Acceptance
Payment
Liquidated
Damages
“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
25
Source: T. Cummins, Commitment Matters, June 2009.
Case Example: Pandemic Exercise
“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.”
26
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 offseason)
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).
Source: Branswell, Helen, Nov 4, 2009, “Flu dogma being rewritten by a strange virus no one pegged
to trigger a pandemic”, The Canadian Press.
27
How well prepared are companies for a pandemic?
60
50
Governance
SC Risk
Impacts
Redundant
Resources
Training
40
Number of
organizations
Completed
30
In Progress
Not Started
20
10
Create
governance
team
0
Implement
Drill /
Exercise
Identify
critical
resources
Ancillary
workforce
Plan for
scenarios
Determine
Impact on
Financials
IT System
Backup
Emergency
Communications
28
Best Case: Financial Services Pandemic Plan
• Pandemic team reports to enterprise business continuity senior executive,
with scope over planning, associate availability, and customer impact
• Includes executives from lines of business, supply management, IT, finance,
Governance
HR, and others as required.
Supply Chain
Risk Planning
Strategic
Redundancies
• Industry-wide pandemic simulation exercise in 2007 led to discoveries of
critical nodes in the supply chain impacted in a pandemic
• Critical categories: Armored vehicles, ATM’s, utilities
• Outsourced IT providers in India also deemed high risk – effects
unknown.
• Recognition that further analysis of supply chain impacts needed
• Establish requirements for stockpiling a number of critical supplies,
including gloves, masks, sanitizer, anti-virals,and hand towels
• IT bandwidth issues identified as an area for redundancy
• Industry action groups reviewed findings of meeting and shared best
practices
Supply Chain • Specific individual roles and functional impacts identified for in-depth
Education &
training as required
Training
S
o
29
Parting Thoughts
Black 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.
Accept
• ….that you’re
operating in an
uncertain world.
• Confront the fact
that many, many
different
possibilities are
plausible.
• Pull together
experts from nontraditional areas
Assess
• …how different
events might
unfold.
• Be willing to gather
and consider more
data and
judgments than
you normally
would.
• Establish the range
of possibility,
then…
Augment
• …the range of
uncertainty that
you are
comfortable with.
• The range of
potential
outcomes is
consistently
underestimated.
• Avoid “futureperfect” thinking.
30