Since the 1980s, supply chain managers have found themselves performing a high-wire act between the forces of globalization and risk. Trade liberalization, quicker communication, cheaper transportation, and the prevalence of human capital in developing economies have enabled businesses to outsource “non-core” functions to the lowest bidder while investing capital in “core” functions. The hopes for such actions, of course, are to minimize expenses, explode the top line, and offer healthy returns for shareholders. Companies such as Pentalift Equipment are able to take advantage of these hopes by offering the latest loading dock equipment to companies looking to gain an edge. However, such actions in this brave new business world expose companies to supply chain disruption risks so complex and subtle that many managers continue to remain unaware of their existence.
Nevertheless, managers have little choice in whether to pursue a global strategy. Competitive pressures, consumer demands, and investor expectation force management’s hand. Yet, management retains an important capacity: to uncover, prioritize, and mitigate supply chain disruption risks. In theory, management should be vigilant and always lookout for danger; oftentimes in practice, many managers wait until it’s too late.
So what’s at stake? Lots. Let’s imagine a nightmare scenario. I’m the Head of Logistics at Flash, a specialty fashion apparel retailer. Flash targets trendy low-to-middle class consumers in the United States and sells its apparel in Flash Stores nationwide. Because of the anemic economic conditions, many consumers have become thriftier with designer purchases. Flash’s target market has tripled over the past 5 years, yet new forecasts expect the market to plateau over the next 3 years. New competing discount lines from the largest global apparel companies have put significant pressure on Flash to lower its prices. At the same time, investors expect Flash to continue its double-digit growth. I have cut expenses by practicing lean inventory management, outsourcing manufacturing to textile factories in Thailand, and use a Vietnamese shipping company.
With no warning, an earthquake hits Southeast Asia. Many Thai roads, factories, and warehouses are demolished. A subsequent tsunami renders the fleet of Vietnamese vessels inoperable. Not only has Flash lost its manufacturing capabilities, it can’t even access inventories sitting on docks. All the while, inventories residing in Flash’s domestic warehouses deplete within 30 days.
What happens in 30 days? Obviously, the company cannot make sales. Revenue plummets. Our customers look at our direct competitors for trendy apparel. Flash immediately loses market share. In order to salvage the bottom line as much as possible, Flash lays off all hourly wage employees in its retail stores and non-essential salaried employees in its corporate office. Why pay workers when there’s nothing to sell? Even if Flash bounces back from this disruption, employee morale will be low. Many of our best employees will go elsewhere (presumably, to our competitors).
With hat-in-hand, Flash’s CEO will approach the capital markets to ask for a line of credit. Up until now, Flash has had an impeccable credit rating, but the severity of this crisis has diminished its credibility to outside investors. Flash’s shareholders are livid that their equity has been wiped out and no longer stand behind management. Both sides are calling for senior leadership, including myself, to resign (which I soon provide). If Flash can secure its credit line, it will be spending capital to hastily make up ground. In this haste, the deployment of capital is ripe for error and waste.
Regardless of what path Flash assumes, it will have alienate its own employees, stockholders, customers, and outside investors and done serious damage to its brand. What makes this a real tragedy is that had I understood the geographic risk and had I diversified my supply chain away from Southeast Asia, this might have been avoidable.
While my example may be considered hyperbolic, even the most minor supply chain disruptions can compound into negative long-lasting effects. A 2005 study by Kevin B. Hendricks and Vinod R. Singhal analyzed 800 companies that announced a supply chain disruption between 1989 and 2000. They found that in the three years following the announcement, companies experienced 33-to-40-percent lower stock returns relative to their industry peers. This finding was not exclusive to any one industry. Furthermore, for the two years post-announcement, changes in operating income, sales, total costs, and inventories remained below pre-announcement levels (Hendricks, 2005).
About the Author:
Jeremy Thompson is a shipping and logistics expert from Toronto, Ontario.
Hendricks, K. B. (2005). An Empirical Analysis of the Effect of Supply Chain Disruptions on Long-Run Stock Price Performance and Equity Risk of the Firm. Production and Operations Management, 35 – 52.