Skip to content

Managing Supply Chain Risk

May 2, 2011

On the blog ‘husdal.com’, there is an interesting article related to supply chain risk. It highlights a book written some 10 years ago, Acts of God or Acts of Man, which questions why people apparently ignore known hazards when deciding how and where to site or build key infrastructure.

The book observes that modern society is generally well aware of the potential for disasters when it builds in areas subject to earthquakes or flooding or volcanic activity. Yet not only does it choose to continue siting cities, factories, power plants etc. in such areas, it also chooses not to improve design to take account of such risks.

I suspect there are a number of answers as to why this happens. In part, as the author points out, catastrophic events in any particular region are relatively rare, so there is doubtless a degree of risk acceptance, based on an assessment ‘it won’t happen in my lifetime’. Today, there is probably a further factor, which is the belief that people will be protected from the consequences of their decision. They have faith that somehow new technologies will arrive that will make their surroundings safe; or that government would not put them there if it was really dangerous.

As for those governments, they see cheap land, or local politicians push for development, or entrepreneurs see opportunities  – and all of them know they will never be held to account. As for safer designs, there are several reasons that doesn’t happen. One, it would be acknowledging the risk and might lead to more questions about the wisdom of building in the first place. Second, it would cost more money and third, it would take more time – and all for a risk that probably won’t occur during my period of control.

So catastrophic risk is no different from other forms of risk. We base decisions on probabilities and we hope for the best. After all, another way that these high risk locations would be avoided (or safety practices would change) would be if the buyers of goods and services stopped buying from such regions. Why are they so willing to put such risks into their supply chain? The answer, of course, is because of relative cost or convenience. Humanity tends to deal in realities, not possibilities. And it is generally reluctant to pay extra to safeguard against those possibilities until the economic case for doing so becomes overwhelming.

I guess the book might just as well ask why the buyers of goods or services similarly ignore such perils

4 Comments
  1. Hi Tim and thanks for sharing your thoughts on my post. Just to set the record straight, it’s not a book, just a paper I am referring to.

    Anyway, I think you raised some interesting issues related to how we manage (or rather: decide not to manage) the risks that are around us. We seem to choose to live the risk rather than wanting to pay the price of avoiding or mitigating what we could mitigate.

    Which brings to mind some of the images of the Japanese tsunami, where some coastal towns obviously had build tsunami walls, except they weren’t high enough. That said, if they hadn’t had the walls in the first place, things would have been much worse.

    • Jan, thanks for your comment – and apologies for reading your original article too fast amd missing the fact that it was a paper, not a book!

      The issues you raise seem to permeate risk management generally. My focus is contracts, and it is an area where management regularly makes choices that appear to defy economic wisdom. For example, they insist on risk-averse negotiating behavior that has been shown to sub-optimise deal outcomes … but they still do it, just in case (so in fact almost a reversal of the situation you mention; here, when risk avoidance seems easy and relatively cost-fre, they adopt it – even though the result is negative). On the other hand, it has also been shown that better management of contracts can increase their performance and add to bottom line results. But getting that improvement will require some investment – in tools or in people. And they would rather accept failed contracts or disappointing results than make that (relatively small) investment.

      The common denominator is that the risks are relatively hard to quantify and therefore the benefits are difficult to predict. So we tend to wait until disaster strikes and THEN we make the investment that would have mitiagted or avoided it ….. Essentially, we wait to pay our insurance premium until we have suffered the losses that it might have covered. Curious economic logic.

  2. John Tracy permalink

    Jan, Tim, Enjoyed the article and the comments. My view is the biggest challenge in managing against a catastrophic risk is cost. For example, dual sourcing, having multiple production locations and other ways to manage against a catastrophic risk all have a cost impact. It means that you have to qualify multiple sources or locations. It means that you have to split production volumes which many times has a cost impact on the purchase price. Even if you had multiple sources qualified and were only using one, you can’t turn the spigot on and immediately get product unless you have the alternative source carrying inventory and that’s another cost. In my opinion the risk has only increased with outsourcing as outsource suppliers are not going to carry inventory on their own because that would be a cost to them and in most cases
    they would be excused from performance with the catastrophic loss being a force majeure. Some risks can clearly be managed through various contract terms but those also have a cost and won’t provide for an immediate recovery.
    Many companies purchase insurance to cover business interruption as a result of a catastrophic loss but that may protect against financial loss but it won’t protect you against the loss of the customer or the loss of any annuity business you would get from the sale. My opinion is the best sourcing or contracting groups can do is identify the potential risks and any alternative that may be available to help manage them and let the business decide if they want to make the investments to manage against the risk or take the lower cost option and “roll the dice”

Trackbacks & Pingbacks

  1. Blog Review: Commitment Matters • Supply Chain Risk – Business Continuity – Transport Vulnerability

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: