Supply Chain Risk: Acts of God and Acts of Man
These characteristics of more variable markets affect sourcing decisions.
The first two articles in this series showed that source selection and supply chain operations are important factors in defining a supply management strategy to mediate supply chain risk. They fit closely with the focus of this article--Acts of God and Acts of Man.
An important consideration in all business is predictability, both on demand and supply sides. These two areas are, in fact, tied together tightly, since alignment between supply and demand is necessary for effective order fulfillment—having product available to sell when a customer wants to purchase. (At some point in the future, I’ll write an article comparing various strategies and processes of marketing and supply management. I suspect you’ll be surprised at the similarity.)
Manufacturers forecast demand and, depending on the market, do so with either minimal error—which supports predictability—or too much error, which does not. When demand is not predictable, manufacturers can achieve acceptable customer fill rates through build-to-demand capability; pre-built inventory, or a combination of some level of both.
To compensate for overly optimistic forecasts, manufacturers can attempt to increase demand through marketing programs. These efforts utilize both financial and manpower resources and should be considered waste. In other words, regardless of forecast accuracy, they are only needed if a manufacturer is unable to build-to-demand. The further a manufacturer is from having this capability, the higher the risk of manufacturers—and suppliers—being left holding a bag of pre-built inventory. This usually has a significant negative impact on financial results, affecting not only a current year financials but also the profitability in succeeding years, since, in effect, much of that following year’s pre-built inventory would have already been built—to boot, way ahead of demand!
In the case of under-optimistic forecasts, manufacturers and suppliers can satisfy demand only through one of the three above cited options. It is rare that through any of them all demand will be satisfied, which in essence means a manufacturer is either leaving money on the table and/or incurring waste. The point, then, is to minimize waste and maximize sales by building what the market is buying. This requires at least some level of building to demand. From this perspective, build-to-demand capability should be seen as the lean end-game.
The above discussion also applies to all members of an OEM’s supply chain. When forecasts are accurate, longer supply chains associated with low-wage overseas countries may represent the best sourcing business case. On the other hand, when forecasts typically have significant error—which usually implies that market demand is variable—a sound sourcing business case calls for agile and flexible suppliers. This means that OEM sourcing decisions should take into account the demand characteristics of the markets for their products. I haven’t seen many OEM’s consider this in selecting suppliers.
How does this relate to either Acts of God and/or Acts of Man? They both affect sourcing decisions and/or order fulfillment, as I will describe below.
Acts of God
Acts of God are well-understood. They are occurrences such as tornados, earthquakes, typhoons, and flooding, as well as (as we well know) debilitating or even deadly viruses. Depending on severity and extent of impact, they can have a significant negative effect on supplier operations and shipments.
There are generally three primary options in dealing with Acts of God. First, you can consciously select sources located in areas of lower risk. For instance, if you source where logistics doesn’t include sea travel, you won’t the risk of typhoons. Similarly, if you source in Tornado Alley, your risk of tornados is heightened.
Second, you can moderate risk by dual sourcing. In this case, you’d probably want to source in different geographical areas to limit the chance that both suppliers will be affected by the same Actof God, such as an earthquake.
Or third, you can provide firefighting support to suppliers in aiding them to get their production back up and running. To be most effective, this should take the form of a pre-planned Plan B.
You will probably find the need to exercise each of these approaches depending on the situation.
What are fundamental truisms of Acts of God? First, the longer a sourced part’s exposure—both in manufacturing and logistics—the higher risk that it will be impacted by an Act of God. This is another reason to focus on reduction of “true” lead-times as the primarily driver of supply chain waste.
Second, sooner or later you will have to deal with an Act of God. Over my career, I’ve had to deal and interact with many longer-term supply management personnel from other OEMs, and the vast majority have had to respond to Acts of God. In fact, over beers, many of the favorite stories we’ve shared concerned how we were able—or not—to react effectively to them.
Thirdly, you can’t anticipate every possible type of Act of God.
Acts of Man
Over the last couple of years, Acts of Man have been significantly more prevalent than in recent decades. The first significant such occurrence in my lifetime was the OPEC oil embargo in the late 1970s. It significantly impacted the price and availability of the largest byproduct of oil, gasoline. You may remember or have heard of long lines of cars at pumps, and there being limits on the amount of gas an individual driver could buy. That event also led to the implementation of a national 55 mph speed limit in an effort to reduce fuel consumption. Its impact on industry was devastating.
It is interesting to compare that embargo to a more recent Act of Man. Namely the spat between the Russian Federation and Saudi Arabia, in which both countries flooded the market with oil in an attempt to gain market share. Even before COVID 19’s negative impact on manufacturing—and consequently oil prices—the competition between Russia and the Saudis had reduced oil prices to levels that haven’t been seen in decades. A price in fact, which was well below the cost of extracting oil in the United States. Talk about lack of predictability in demand.
The most visible Act of Man today is the U.S. imposition of tariffs on foreign goods. It’s not my purpose here to discuss the merits and risks associated with tariffs--I’ve done enough of that over the last year in previous columns. Rather, it is to point out that tariffs can have a significantly negative impact on supply chain predictability. This in turn, can result in higher governmental costs in the form of subsidies to individual industries; lead to price increases in the shorter term and inflation in the medium- to longer- term; and domestic manufacturers themselves either not being able to satisfy market demand and/or see their markets dry up.
One doesn’t have to look too far to confirm the above. For instance, when our country imposed tariffs of Chinese goods, China responded tit-for-tat by imposing their own tariffs on imports of U.S. soybeans. This made them non-competitive compared to other world sources. China had been our primary customer. As a result, the government has pumped over $60 billion dollars in subsidies to farmers to help support the agriculture industry.
Similarly, our government lifted tariffs on a variety of goods from China in the weeks before Christmas 2019 to ensure that our children would have the toys they wanted under their Christmas trees—no kidding. Again, this was to ensure both adequate availability and to not force parents to face higher prices on those toys that were available. It will be interesting to see what happens in the upcoming Christmas season.
The point here is that tariffs negatively affect market demand and order fulfillment consistency. Some of these negative consequences are unanticipated and add waste / cost to the entire supply chain.
Some people say that the Chinese are paying for additional domestic costs through the tariffs. I don’t understand this, since it is the domestic importers who have to deal with the tariffs. And the tariffs go to the government, not U.S. consumers or industries. And as I think we can all agree, our government isn’t very efficient in distributing subsidies to impacted industries.
The point of this whole column is that the more likely Acts of God and Acts of Man—usually based on past experience—should be taken into account when making sourcing decisions. Over the last generation, at least from my perspective, such consideration seems to have taken a back seat as OEMs have prioritized low piece-price as their primary sourcing criteria.
If you are a regular reader of my columns, you should understand that while in some cases this makes sense, in most it doesn’t. World-class manufacturers such as Toyota understand that in variable markets –these days more are variable—the lowest overall cost strategy is to manufacture and source in the markets you serve.
Or perhaps you think Toyota has it all wrong.