On the Value of Mitigation and Contingency Strategies for Managing Supply Chain Disruption Risks

Instructor: Professor Muh-Cheng Wu Presented by: Mao, Seikveng

Brian Tomlin

Kenan-Flagler Business School,

University of North Carolina at Chapel Hill.

IEM DepartmentSeminar I

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Management Science, Vol. 52, No. 5, May 2006

Presentation Outline① Abstract

② Introduction

③ Optimal Strategy and Conclusion

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Brian Tomlin:Associate Prof. of Operations, Technology & Innovation Management at UNC, and

Benjamin Cone Scholar

Reliable Supplier (R)(Expensive)

Reliable Supplier (R)(Expensive)

Unreliable Supplier (U)

(Cheap)

Unreliable Supplier (U)

(Cheap)

FirmSingle-Product Setting

FirmSingle-Product Setting

SuppliersDual-Sourcing

SuppliersDual-Sourcing

OptimalDisruption-Management

Strategy

OptimalDisruption-Management

Strategy

Disruption-Management Strategy (DMS)

Disruption-Management Strategy (DMS)

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ConditionsConditions

In 2000, fire at Philips Semiconductor Plant

Hurricane Mitch at Central America in1998 affected the banana field

Earthquake in Taiwan in 1999 affected PC’s components plant

Nokia Ericsson Chiquita Dole Dell Apple

• Lost all of supply from Philips• But Suffered little financial impact

• $400 million potential loss• 14% of shares is tumble

• Lost significant supply• Increases revenue 4% in the 4th quarter.

• Lost 70% of regional supplier • Decline revenues 4%• Over $100 million loss

• Respond to disruption risk more effectively, by changing the demand

• Less ability to cope with disruption risk, • More supply constrain

Alternative suppliers

No backup suppliers

Alternative banana field

No alternative

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Why does firm think about supplier’s Disruption Risk?

Why does firm think about supplier’s Disruption Risk?

Disruption Risks: may arise from natural disasters, strikes, economic disruptions, or terrorists

Mitigation Vs. Contingency: act in advance Vs. act only in the event of disruption

Volume Flexibility: the amount of extra capacity and the speed which it becomes available

Uptime Vs. Downtime: time in which a machine is actually operational. Vs. the machine is no longer operational, because of repairs or maintenance.

Disruption Length: period of disruption

Key Terms

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Disruption-Management Strategy (DMS)

Strategy Description

Passive AcceptanceSource exclusively from the U and carries no inventory. The firm passively accepts the disruption risk.

Financial Mitigation Purchase business interruption insurance

Inventory MitigationThe firm sources exclusively form the U but carries some inventories to mitigate disruption

Sourcing Mitigation The firm source exclusively from R

Contingency ReroutingSources exclusively from U when that supplier is up. The firm carries no inventory, but it reroutes to the R during disruption.

Inventory Mitigation & Contingency Rerouting

Sources exclusively from the U when that supplier is up. The firm carries some inventory to mitigate disruption, but during a disruption it may also reroute production to the R.

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Conditions of Strategy

Firm’s Attitude to Ward Risk(Level of Risk Tolerance)

Risk Aversion Zero risk

Risk Neutral Constant risk

Risk Seeking High risk

Supplier’s Characteristics

Percentage Uptime(reliability of supplier) Impacts on frequency and level at mitigation

and contingency costs.Disruption Length

Supplier’s CapacityPlays an important role through its effect on supplier’s recovery time in the aftermath of a disruption.

Volume Flexibility(extra capacity)

Enables contingent rerouting to an element of firm’s strategy, and can significantly reduce the cost.

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1a- R has no volume flexibility and U has infinite capacity, a risk neutral firm uses single DMS:

1- passive acceptance (U)

2- mitigation by carrying inventory (U),

3- mitigation by single source from the R, optimal only when disruption long, otherwise 2 is optimal

1b- Mixed mitigation (2+3) optimal if the firm is risk averse or if U has finite capacity (cannot recover during disruption period)

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Optimal DMS

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2- When R has volume flexibility firm can reroute

a- Contingent rerouting is often the component of optimal DMS, and significant cost reducing

b- In the idea, rare disruptions would favor for contingency tactic, as the costs are incurred only in the event of disruption.

c- However, the finding suggests that sourcing mitigation (1a3) often become optimal as disruption become less frequent.

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Optimal DMS

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• Percentage up time and the nature of the disruption are the key determinants of the optimal strategy

• Firms that passively accept the risk of disruption leave themselves open to the danger of severe financial and market-share loss

• Advance information provides the right tactics to solve disruption risk and encourages for future research

• The model of volume flexibility provide a foundation for further research into the benefits of volume flexibility in context other than disruption risk

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Conclusion

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Thanks for Your Time Value!

Q & A!