Riding Out Global Challenges

Good supply chain risk management considers both procurement and sales and marketing perspectives.

Take RAE Systems (Sunnyvale, Calif.), for example. The company, which manufactures products that measure atmospheric contaminants, sells three product categories with significantly different price

points. Its disposable products are $25/box, its instruments are $2,500, and its systems run about $25,000. Bob Durstenfeld, director of marketing, has his hands full not only with the long-term challenges of the three product lines, but with medium-term challenges of the economy and a couple of short-term challenges.

"This is an unusual market, both in terms of the economy and in terms of buying patterns," he explains. "The forecasts we once used, which were based on seasonality, no longer have relevance. The key is having inventory to match forecast." As a result, he emphasizes the need for manufacturing to be more nimble in responding to marketing's new understandings of shifts in product preferences and volumes. This, obviously, requires similar flexibility from procurement.

"The world is a different place, so you need contingency plans that include inventory management and shipping," he explains. "We had a plan in place to deal with the changes caused by the war in Iraq, but we did not have one in place to address the challenges of SARS, which, for us, were significant. We had to rethink where that inventory was and what to do with it."

Basic strategies

Sometimes risks occur because a company is pursuing opportunities such as just in time (JIT) deliveries or supplier-managed inventory.

"One example of JIT program risk is that you generally reduce your inventories," explains Tim Underhill, president of Underhill & Associates (Tulsa, Okla.) However, with lower inventories, a company runs a number of risks, including downtime, having to pull inventory in at higher freight costs, or paying higher prices from other suppliers who can deliver faster.

One solution for JIT program risk is to create contingency plans with suppliers. Underhill recalls working with a utility company that was in process of allowing one of its suppliers to manage its inventory. The company's big risk was what it called the "hundred year storm." The company actually experienced a storm of great magnitude, resulting in twice as many customers out of power as at any other time in the utility's history. The storm had gone from Minnesota, through Wisconsin, and into Michigan. While most other utilities in the region were still struggling to get customers hooked up four weeks later, this utility was able to get all of its customers back on power within two weeks. "The reason was that it had a contingency plan in place that outlined what suppliers were expected to do in the event of such a storm," explains Underhill. The utility arranged to have suppliers load up trucks filled with material heading from the East Coast to the storm area. Each truck had two drivers, so they wouldn't have to stop. "Again, this was all planned in advance," he notes.

Another solution, which can be effective in supplier-managed inventory programs, is to require certain levels of critical parts to be in place at the company's own location, as well as requiring that the supplier carry certain levels.

Underhill also emphasizes the importance of creating a team of stakeholders—those who would be affected by a shortage of material. This can include production, maintenance, engineering, distribution, etc. "Get them involved in identifying the concerns they have, then get input on possible solutions," he suggests.

Randy Berry, partner, Supply Chain Management Service Line, for Accenture (San Ramon, Calif.) cites some effective strategies for anticipating and mitigating supply chain risks. First, he says, make sure procurement and suppliers are involved up front in product design in order to maximize the flexibility of design, allowing multiple options in terms of sources. "Create a portfolio approach to supplier arrangements within a given component or assembly category in terms of tradeoffs of inventory liability and availability of products, etc.," he continues. Evaluate supplier capabilities in terms of overall capacity and geographical contingencies that may be available within that supplier's organization, such as being able to shift production or having multiple sources of production.

In dealing with contract manufacturers, it's important to identify what their roles will be in the sourcing process. If some sourcing requirements are the contract manufacturer's responsibility, a company needs to work with them in assessing risk and making sure they also have contingency plans in place.

"We also see companies creating effective supplier development initiatives," continues Berry. "One high-tech manufacturer we know contends that, for every head it adds to its supplier development capability, it adds $300,000 or more per year in savings from an overall total sourcing cost standpoint."

Berry emphasizes the importance of selecting the appropriate technology and tools to facilitate communication throughout the supply chain. "We think it is important to have general communication connectivity across the multiple partners in the supply chain," he explains. This involves creating supplier relationship management strategies, such as collaborative design, etc. It also involves good e-sourcing tools, such as reverse auctions and leveraging the Web to conduct negotiations and transactions. "Consider new opportunities for communications such as videoconferencing to replace face-to-face meetings," he adds.

Risk management in action

One company that has developed an effective supply chain risk management program is Johnson & Johnson (New Brunswick, N.J.). Affiliates run their own businesses and manage their own supply chains. "However, we work with the affiliates on strategic initiatives," explains Craig Lozak, global commodity manager. Lozak handles strategic sourcing for direct materials in manufacturing, including consumer products, pharmaceuticals, and medical devices. "One strategic initiative is continuity of supply."

First step identifies critical suppliers. Next, the team conducts a supplier process vitality check, covering six categories:

• Operations. This includes process operations, process capabilities, and stability of operations. It also includes emergency preparedness—the supplier's ability to maintain operations in the event of disaster. Some questions the team asks: Does the supplier have dual site manufacturing capability? If not, do they have a joint venture or partnership with another supplier? How is the supplier prepared to deal with catastrophic events? "For example, if the supplier is a mold shop, we want to know if the molds are secured in a safe area, if the CAD/CAM programs are stored off-site in a secure area, and so on," reports Lozak.

• Quality. This addresses the assurance of quality and conformance to the company's specifications using process excellence tools such as Six Sigma.

• Financial vitality. This looks at how dependable the company is financially.

• Engineering/technical expertise. "This includes depth of technical support the supplier offers," notes Lozak. It also addresses engineering support related to manufacturability and information technology (IT).

• Dependability and conformance to delivery schedule.

• Strategy and leadership , which involves top-down management vision, mission, commitment, and support on where the supplier is headed and how it is tracking in relation to those issues.

"While we can get some of this information indirectly, it is very important to get the majority of it through site visits," emphasizes Lozak. By monitoring performance in these areas, Johnson & Johnson assures itself of addressing supply chain risk and minimizing potential disruptions.

Another company with an active supply chain risk management program is Teradyne Inc. (Boston, Mass.). "The area where we really focus is pre-crisis risk management," explains Jack Lanzoni, vice president of supply line management. "Over the years, we have created a risk assessment process for new product development, because we have a very long development cycle." The process identifies design sourcing decisions early on that can affect the company's ability to hit product cost target, time-to-market window, ability to ramp up production, and reliability. The company looks at the elements of risk in technology, supplier, and parts selection. It also looks at environmental, technological, and performance factors that may cause risk.

Teradyne tracks risk using a color-coding system. Green means "Don't worry. Be happy." Yellow means that there is some element of risk, but the company sees a solution on the horizon. "If we don't do too much, the risk will probably go away on its own," Lanzoni explains. Orange means there is a risk that requires a mitigation plan to ensure the company meets its goal. Example: "We may have a printed circuit board where the estimate says we will miss our cost target," notes Lanzoni. "We may create a plan to take the material content of the assembly offshore to a low-cost region. This puts us on track to hit the cost target." Once the plan is in place, the color shifts from orange to yellow. Red identifies a risk where a problem has been identified, but no mitigation plan or risk avoidance plan has been developed.

Because up to 70% or 80% of a system's cost is designed in, Lanzoni says, "We identify contingencies early in product design and try to create a product sourcing plan that becomes a roadmap that anticipates and creates mitigation plans for every risk we can determine. We have risk mitigation or elimination plans for all of the items we identify as having risk."

Lanzoni explains how the process has evolved over the years. In the early days, before Teradyne instituted its process, engineering focused on functionality and not cost. This led to a somewhat adversarial relationship between engineering and the supply line organization. "We wanted earlier involvement, but engineering was trying to prevent this for fear that our programs might inhibit their ability to make schedule and hit their functionality requirements," explains Lanzoni.

The company had a material cost curve that came down about 40% from its high point, but was still another 30% away from hitting the material cost target. "After we conducted a cost analysis, we found that the process was never designed to meet the cost that would have given us the desired ROI," he notes.

During the second phase, which was dubbed Revolutionizing Product Design (RPD), the supply line organization was able to get earlier involvement, but often still after the technology selection was made. "We created a plan that showed us being able to hit the cost target at about the 350th unit," Lanzoni says. Strategies assisting in this included changing suppliers, using multisourcing, moving to low-cost regions, changing manufacturing methods, etc.

Learning from this, Teradyne moved on to a third phase, where it decided it needed even earlier supply line management involvement—during the time when technology selections are being made. This provided a common objective of cost owned jointly by engineering and the supply line organization. In fact, the engineering manager and Lanzoni co-chair weekly review meetings. "This earlier involvement with engineering has now enabled us to hit the target at the 50th unit," he adds.

The team, which consists of representatives from supply line management, engineering, manufacturing, finance and marketing, sets a material cost target that is based on achieving a certain cost of goods sold (COGS), which is based on what the company anticipates the average selling price to be for the life of the product. "If we are in a situation like we are today where the market is driving average selling prices lower than we had planned, then our material cost targets change at the same time," explains Lanzoni. "Our target is not necessarily to hit materials cost numbers, but to hit a direct COGS percentage. This keeps our measurements and activities very dynamic."

The company is still moving forward in its efforts to manage supply chain risk. To date, risk assessment has been driven primarily by the components that go into a design. "With our latest project, we are moving away from commodity management and toward solution management," he reports. "We are now reinventing the supply line organization to be solution-focused." This means that, rather than focusing on specific commodities, the organization is focused on the solutions certain commodities provide. "This will allow us to align ourselves with engineering, because this is the way they think about product design."