Posted tagged ‘Supply Chain Risk’

Efficiency can harm Resilience

September 10, 2013

Business people with Financial and Analytical training are schooled in the Improve approach to business management.  With the Improve approach, the business operations are subjected to continual process of looking for ways to get more out of the same resources or to use less resources to get the same results.  The Improve approach can be applied at a micro level, to each separate activity of the business.  It can also be applied at the macro level, where macro planning exercizes such as capital budgeting seek to get better returns for the available amount of capital.  An optimization process is the ultimate objective of an Improve mindset, where optimization seeks to find the best return that can be achieved with the available capital.   


For many situations, the Improve strategy can work well.  But there are situations when the Improve strategy starts to erode Resilience.

You all likely to remember fondly your first big win with an Improve approach.  You came in and quickly identified something that was ripe for a change.  Something where the operations were highly inefficient and you made sure that things changed and a big turnaround happened.  You really felt that you added to company value and to your own reputation. 


 Over time you were able to make many such improvements, on this picture, moving virtually everything on to the efficient frontier. 


Then you felt the need to find more wins.  You were imagining that you could help to completely change the game, to move the possibilities upwards.  Onto a new and more favorable frontier.  But in some cases, what happened instead is that you did change the game, but what you did was not exactly improve efficiency of the system, instead, you started to reduce the amounts of redundant resources of the system.  That improves the expected returns, but often drastically reduces Resilience.  On the picture above, you wanted to move from A* to A++ and instead you moved to A–.  You got the extra return that you wanted but increased the risk and reduced the resilience.  Some of the slack that you removed from the system was really needed, the system becomes very fragile without it.   You were not actually moving to a new more efficient frontier, you were simply adding risk and return. 

A simple example of this is with supply chain risk.  There are two examples of how supply chain choices can look like improvements in efficiency but are at least in part a decrease in resilience.

  • The company had been dealing with 5 suppliers.  Those suppliers had different levels of costs and their competitiveness among them varied quarter by quarter.  You make a long term deal with one supplier to deliver the item at a fixed cost that is lower than what you had ever paid to the most competitive of the 5 suppliers.  The argument was that with the certainty of demand, they could be more efficient and pass along that efficiency to you with the lower price.  However, as many firms who relied upon a single Japanese supplier in 2011, the supply chain was now very sensitive to events that disrupt the single supplier. 
  • The company has been manufacturing a key part to its main product forever.  However, under pressure to win a major contract, the company decides to sub contract the manufacture of that part to a low bidder.  The product is delivered and the sub contracted part fails.  Quite possibly, the savings that the sub contractor was able to deliver was achieved by reduction in expensive quality control.  When you selected the supplier, you were promised a level of quality control that was at least as strenuous as your own processes.  However, you had saved even more money by doing very little monitoring of the actual quality control.  By outsourcing, you had created a risk that the sub would not meet your quality standards and you did not recognize that assurance of those standards was something that you could not afford to outsource.  So the savings were achieved through increase in risk.  Again, not a move to a new frontier, but instead a rightward move along the old frontier to an option that you had all along when you manufactured the part yourself. 

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