risk management models for supply chain outsourcing

Risk Management Models forSupply Chain Outsourcing

David L. OlsonUniversity of Nebraska

FAIM 2008 Conference, University of Skövde

Risk & Business

• Taking risk is fundamental to doing business– Insurance• Lloyd’s of London

– Hedging• Risk exchange swaps• Derivatives/options• Catastrophe equity puts (cat-e-puts)

– ERM seeks to rationally manage these risks• Be a Risk Shaper


Enterprise Risk Management Definition

• Systematic, integrated approach– Manage all risks facing organization

• External– Economic (market - price, demand change)– Financial (insurance, currency exchange)– Political/Legal– Technological– Demographic

• Internal– Human error– Fraud– Systems failure– Disrupted production

• Means to anticipate, measure, control risk


Supply Chain Perspective of ERM• Historical vertical integration– Standard Oil, US Steel, Alcoa– Traditional military

• Control all aspects of the supply chain• Contemporary– Cooperative effort

• Common standards• High competition• Specialization

– Internet• Service oriented architecture


Supply Chain Problems• Land Rover– Key supplier insolvent, laid off 1000

• Dole 1998– Hurricane Mitch hit banana plantations

• Ford– 9/11/2001 suspended air delivery, closed 5 plants

• 1997 Indonesian Rupiah devalued 50%– Blocked out of US supply chains– Jakarta public transport reduced operations, high repair

parts– Li & Fung shifted production from Indonesia to other Asian

sources


More Problems

• Taiwan earthquake 1999– Dell & Apple supply chains short components a few

weeks• Apple had shortages• Dell avoided problems through price incentives on

alternatives

• Philips semiconductor plant in New Mexico burnt 2000– Ericsson lost sales revenue– Nokia had designed modular components, obtained

alternative chips


Supply Chain Risk Sources

• Giunipero, Aly Eltantawy [2004]– Political events– Product availability– Distance from source– Industry capacity– Demand fluctuation– Technology change– Labor market change– Financial instability– Management turnover


Robust StrategiesTang [2006]

• Postponement – standardization, commonality, modular design

• Strategic stock – safety stock for strategic items only

• Flexible supply base – avoid sole sourcing

• Economic supply incentives – subsidize key items, such as flu vaccine

• Flexible transportation – multi-carrier systems, alliances

• Dynamic pricing & promotion – yield management

• Dynamic assortment planning – influence demand

• Silent product rollover – slow product introduction - Zara


Supply Chain Risks & OutsourcingRISK Elaboration ImpactAccounting Risk of ruin HighAsset investment Asset utilization Increase risk to coreCountry risk Most innovative supplier may be in risky

countryCompetitive risk Need to

differentiateOutsource products available to competitors

Customer risk Product obsolescence

Low quality drives out customers;Outsourcing reduces risk of obsolescence

Downside risk Risk of failure Can replace outsource vendors

Financial risk Financial market risk Core less threatened by outsourced vendor failure

Interaction Communication, coordination

Outsourced vendors more independent;Can impose IT requirements


ContinuedRISK Elaboration ImpactLegal risk Litigation exposure Risk shifted to outsourcing vendor

Product risk Product technical complexity

Core needs to assure outsourcing vendor competent

Regulatory risk Outsourcing vendors assume local risk

Reputation risk Customer confidence

Higher to core, as customers hold them responsible

Shared risk Outsourcing allows access to market of vendors

Supplier risk Smaller organizations have greater risk

Supply disruption

If outsourcing vendor fails, have alternatives


Early Supplier InvolvementRisk to Core

• Vertical cooperation – design & concept– Reduce development time– Better product quality– Improved costs– RISKS: sequencing, shortages, incapable suppliers

• ROLLS ROYCE Aerospace– New product development 3-4 years– ESI 1999– SUPPLY COST REDUCTION:

• Reduced threat of excessive costs, easier to handle changes• Reduced legal liabilities, fewer quality problems• Less supplier capacity constraints, shorter development time


Vendor RiskRisk to Suppliers

• Disintermediation – US gas stations• Motokov UK Ltd. – European importer/distributor in agricultural market, tires– Selected by Italian agricultural machinery manufacturer

Landini to market Zetor tractors• For 3 ½ years, exclusive UK distributor• Then Landini formed an internal distributor

– Tires • Mid-1990s dropped Matador Tyres for a Czech tire company• 1995 Czech company went under, back to Matador• 2002 Matador dumped Motokov

– Zetor Tractors (Czech)• Production halted after dropped Communism


Risk Management Tools

• Simulation (Beneda [2005])– Monte Carlo – Crystal Ball

• Multiple criteria optimization (Dash & Kajiji [2005])– Goal programming - tradeoffs

• SYSTEMS FAILURE METHOD– Information Systems Project Management

• INFORMATION TECHNOLOGY


Monte Carlo SimulationQuoted price

Exchange distribution

Product failure

Organizational failure

Political failure

Expected price

China 0.82 No(1.3,.2) 0.10 0.15 0.05 2.13

Taiwan 1.36 No(1.03,.02) 0.01 0.01 0.10 1.81

Vietnam 0.85 No(1.1,.1) 0.15 0.25 0.05 2.51

Germany 3.20 No(1.05,.02) 0.01 0.02 0.01 3.43

Alabama 2.05 1 0.03 0.20 0.03 2.78


China vendor price distribution


Taiwan vendor price distribution


Simulation OutputMean cost Min cost Prob{failure} Prob{low}

China 2.06 0.54 0.253 0.406

Taiwan 1.84 1.30 0.123 0.103

Vietnam 2.60 0.58 0.410 0.479

Germany 3.43 3.14 0.040 0.003

Alabama 2.05 2.05 0.254 0.009


MCDM j alternatives, I criteria

weights, scores


K

iijij xuwvalue

1

MCDM WeightsCriteria Base 100 Base 10 Best (100) Worst (10) Average

Quality 100 60 0.2299 0.2308 0.23

Experience 90 55 0.2069 0.2115 0.21

Cost 85 50 0.1954 0.1923 0.19

Flexibility 60 40 0.1379 0.1538 0.14

Technical 50 30 0.1149 0.1154 0.11

Exchange 30 15 0.0690 0.0577 0.06

Capital 20 10 0.0460 0.0385 0.06

435 260


ScoresQuality Experience Cost Flexibility Technical Exchange Capital

China Problems 2 years 0.82 High Average High Weak

Taiwan High 17 years 1.36 High High Moderate High

Vietnam Concerns 1 year 0.85 Low Low Moderate Weak

Germany High 5 years 3.20 Low High Moderate High

Alabama good 7 years 2.05 Low High None Average

China 0.20 0.30 1.00 1.00 0.60 0.00 0.20

Taiwan 1.00 1.00 0.50 1.00 1.00 0.50 1.00

Vietnam 0.40 0.10 0.95 0.20 0.20 0.50 0.20

Germany 1.00 0.70 0.00 0.20 1.00 0.50 1.00

Alabama 0.70 0.90 0.30 0.20 1.00 1.00 0.50


ValuesCriteria Weights CHINA TAIWAN VIETNAM GERMANY ALABAMA

Quality 0.23 0.20 1.00 0.40 1.00 0.70

Experience 0.21 0.30 1.00 0.10 0.70 0.90

Cost 0.19 1.00 0.50 0.95 0.00 0.30

Flexibility 0.14 1.00 1.00 0.20 0.20 0.20

Technical 0.11 0.60 1.00 0.20 1.00 1.00

Exchange 0.06 0.00 0.50 0.50 0.50 1.00

Capital 0.06 0.20 1.00 0.20 1.00 0.50

Score 0.52 0.88 0.39 0.61 0.64

Rank 4 1 5 3 2


Balanced ScorecardPerspectives Goals MeasuresFinancial Survive

SucceedProsper

Cash flowSales, growth, incomeIncrease in Market share, ROI

Customer New productsResponsive supplyPreferred suppliersCustomer partnerships

% sales new productsOn-time deliveryShare of key accounts’ purchases# Cooperative engineering efforts

Internal business

Technology capabilityManufacturing experienceDesign productivityNew product innovation

Benchmark vs. competitionCycle time, unit cost, yieldEngineering efficiencyPlanned vs. actual schedule

Innovation & learning

Technology leadershipManufacturing learningProduct focusTime to market

Time to develop next generationProcess time to maturity% products yielding 80% salesNew product innovation vs. competition


Conclusions• Outsourcing provides competitive access– Broader opportunities

• Demonstrate 3 tools– Monte Carlo simulation• Evaluate probabilistic elements

– MCDM• Consider multiple criteria• Select vendor by decision maker preference

– Balanced Scorecard• Measure effectiveness of selected vendor


risk management models for supply chain outsourcing

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