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Can technology handle supply chain risk? Today's supply chain technology has a notable lack of risk management tools. Developers need to change this to compete in a global market.

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In a recently conducted AMR survey, 100 user companies listed commodity volatility and prices as their number one supply chain risk. This comes as no surprise when the price of copper has tripled in five years, the price of Zinc has doubled, and that of wheat and soybeans rose by 70 percent in 2007. Futures prices of crude oil, gold, silver, lead, uranium, cattle, cocoa and corn are all at or near records.

Close followers in the rankings were supplier failure risk, logistics services costs and shortages, and environmental risks. All indicate that companies find themselves facing significant risks across their entire supply chains. For a global company managing an extended supply chain, risks in supply, demand, compliance and logistics are always lurking, necessitating a new way of thinking that balances traditional cost efficiency focus with the new goal of risk mitigation.

Some companies are thinking beyond risk mitigation, and are embracing supply chain risks as a potential for a game-changing competitive advantage. For example, HP has embraced environmental risk and positioned its efforts to build a green supply chain as an opportunity to grow its lead and its market share in a low carbon economy.

User companies seeking to build risk-focused organizations that continually make educated bets balancing risks with potential rewards are investigating SCM technologies to assess their ability to support this new business model. Their findings? Traditional SCM technologies with a primary, focus on cost reduction and efficiency are not adequate in supporting global companies in managing and capitalizing on supply chain risks.

Accounting for Risk and Profitability

If you asked operational managers ten years ago to list the reasons why they have invested in SCM technologies, cost efficiencies and improved customer service undoubtedly would have been the top two reasons. Naturally, risk management has always been a driver in SCM technology, selection. SCM tools have indirectly helped minimize risks; be it the risk of obsolescent inventory, customer service failure, or non-value-add transportation costs. But rarely did traditional SCM technologies view supply chain risk as an explicit variable that can be accounted for, quantified, and optimized.

For instance, the primary goal of a tool like factory planning is to optimize the operations of manufacturing plants through better resource allocation and production scheduling. A positive byproduct of factory, planning is the reduction of the risk of failure to fulfill a customer's order or the risk of a plant underutilization or shutdown. Similarly, solutions like demand forecasting and transportation management that focus on supply chain cost efficiencies do mitigate supply chain risks, albeit indirectly.

Companies have long strived to mitigate supply chain risks like supplier failure or commodity price fluctuations by avoiding them altogether. Due to increasing pressures on global supply chains such as low cost country., sourcing and shorter product lifecycles, supply chain risk has increasingly dominated executives' mindshare. Recently, leaders like Samsung have viewed risk as an opportunity that can be leveraged to improve profit and market share. Companies are beginning to realize that they must take a new approach to managing their supply chains: explicitly accounting for risk and making decisions based on the potential costs and value that each risk introduces.

A great example of embracing supply chain risk for growth and profitability comes from Panasonic. In 2004, Panasonic was selling $5,000 plasma TVs and introducing new models every year. High levels of inventory of the older models were chipping away at its profit margins from new models. Demand for plasma TVs was volatile, and there was little collaboration with channel partners to share accurate demand signals. All these factors resulted in the dangerous combination of inventory channel stuffing and out-of-stocks.

In this situation, Panasonic was faced with a myriad of supply chain risks: volatile demand, frequent new model introduction, excess inventory, and lost sales. But these risks also offered a potential upside: improvement in margins, growth in market share and better relations with its top customers like Best Buy. Panasonic realized that many risks can be mitigated with closer collaboration with its channel partners, so the company worked with them to develop annual budget plans and demand shaping events based on seasonality and promotion analysis, and together analyzed POS data to better position their products. Panasonic has reaped stellar benefits, including double-digit improvements in forecast error and in-stock rates combined with a significant reduction in required on-hand inventory.

How SCM Technologies Can Help

As risk permeates every supply chain function, risk management logic must permeate every supply chain management solution. This means that every SCM technology must be retooled to explicit[y manage the opportunity and threat that a supply chain risk presents. To do that, traditional SCM tools must change their focus:

* Deterministic modeling to stochastic modeling: Gone are the days when deterministic modeling was acceptable to solve supply chain problems. Using a demand forecasting tool to generate a one number forecast and planning your supply chain accordingly is too simplistic to be credible. To account for risks associated with the range of supply and demand uncertainties, SCM technologies must rely on stochastic modeling. With stochastic modeling, a tool like inventory optimization weighs the threats and opportunities associated with each risk in demand forecasting and supplier lead times to generate the most profitable inventory recommendation.

* Localized standalone solutions to end-to-end process solutions. Solving a problem like sourcing in isolation will likely generate additional risks in other areas, such as logistics or demand fulfillment. To manage risk, solutions need to quantify the total risk associated with an end-to-end process like procure-to-pay or order-to-cash. Finding the "optimal" routing plan for a distribution network might fail to see the upside in accepting the risk of idle transportation resources, as a calculated bet to meet potential demand from a key client.

* Direct costs to expected value and opportunity costs. To simplify supply chains, many technologies focus on direct costs: minimizing working capital or minimizing sourcing spend. With a risk focus, the technologies take into account the expected financial impact and the opportunity costs associated with each decision. For instance, while minimizing inventory, the company must contrast the cost savings with the expected reduction in ability to meet the key customer's fluctuating demand. Making the inventory decision has to be based on a risk/reward analysis of the risk in carrying excess inventory and obsolescence with the potential of market share growth.

Without organizational alignment, education and process redefinition, technology cannot drive the fundamental mind shift that companies must embrace to manage supply chain risk. When--and only when--a company has establish the organizational and process foundation, it should assess if its current SCM tools have the right approach to managing risk, even if they are not deployed in that capacity. For example, can the simulation functionality in the implemented network design tool be used to quantify risk? For more traditional SCM tools, companies should work with their SCM vendors to find out their plans for revamping their solutions to explicitly manage risk.

Which brings us to the vendor side. For all vendors, "risk management" should not be a mere marketing message. Determine if this is a pain point you'd like to solve. For those vendors who believe that they can immediately help companies manage their supply chain risks, clearly explain how your solutions have been deployed in that capacity and present users with actual success stories. For vendors who believe that their tools have the potential to manage supply chain risk, allocate development dollars to achieve the necessary functional enhancements. All SCM vendors must realize that risk will continue to take center stage.

Noha Tohamy (ntohamy@amrresearch.com) is a research director at AMR Research.
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Title Annotation:TEChNOLOGY
Author:Tohamy, Noha
Publication:Supply Chain Management Review
Article Type:Industry overview
Date:May 1, 2008
Words:1270
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