Monday, June 04, 2007

Supply Chain Risk

CNN reports today on a study by Deloitte Consulting regarding supply chain risk. The title of the Deloitte report is "Supply chain's last straw: A vicious cycle of risk." The consulting firm studied how many firms have prepared (or not prepared) for major supply chain disruptions. They concluded that, "The search for cheaper labor, cheaper raw materials, and cheaper transportation - the quest for efficiency - has forced the focus of companies to switch from revenue growth to cost reduction...Individually, these forces have changed the world in which we live and conduct business. But when combined, these forces can create a perfect storm of risk not seen before in the history of commerce or humankind."

Charles Perrow's theory of complex systems, I believe, can be applied to think about the enhanced risk that firms are assuming with the leaner, more efficient global supply chains of today. According to Perrow, the risk of catastrophic incidents increases when systems are characterized by what he calls "tight coupling." By tight coupling, he means systems that have the following characteristics: time dependent processes, a fairly rigid sequence of activities, one dominant path to achieving the goal, and very little slack. His classic example is that of a nuclear power plant. Its subsystems are tightly coupled (or highly rigid, if you will). One could argue that the efforts to build leaner, more efficient global supply chains have enhanced the level of tight coupling in those systems, and thereby enhanced the risk of a catastrophic failure of some kind.

Take, for example, the issue of slack. Years ago, supply chains tended to have a fair amount of slack - for instance, many firms maintained a fair amount of buffer inventory between various stages of the value chain. Of course, carrying all that inventory proved quite costly. Today, firms have been driving slack out of their supply chains in order to reduce costs. The unfortunate downside of that slack reduction may be an increase in tight coupling - and thus, in systemic risk. Naturally, the solution to the enhanced risk does not lie in adding back tons of waste to the supply chain. Instead, firms must find ways to reduce the rigidity of the system, so that one small error cannot easily cascade into a series of problems that lead to major catastrophe.