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- April 24, 2013 -
Risk Exposure Index Starting to Gain Traction, Change Supply Chain Thinking, David Simchi-Levi Says
Concepts being Adopted by Companies Across the Globe; Focus is Often on Reducing Time to Recovery
by SCDigest Editorial Staff
On a broadcast on our Supply Chain Television Channel in February of 2012, Dr. David Simchi-Levi of MIT and consulting firm OPSrules introduced a new tool for managing supply chain risk, which he called the Risk Exposure Index.
This innovative approach broke some new ground in two ways. First, it provided a better mechanism for companies to quantify their supply chain risks that previous approaches. The traditional methodology usually involved developing a 2 x 2 matrix, with one axis on the likelihood of an event occurring (high or low), and the other the financial impact (high or low). There were sometimes some 3 x 3 version of the same basic approach. Various potential events would then be plotted one of the four quadrants (with those that have a high likelihood of occurring and a large impact obviously receiving the most attention).
The approach often spurs companies to find ways to reduce TTR, and thus the financial impact, just as Toyota is doing through inventory buffers, redundant production facilities and other measures depending on the product category or supplier.
While useful in its way, that methodology didn't really quantify risk, and was not designed to deal with "unknown unknowns," such as the earthquake and tsunamis that devastated Japan in 2011, events which simply can't be predicted.
But the financial impact of those types of events can be calculated, and that is the basis for the Risk Exposure Index (REI). A fundamental concept is time to recovery, or TTR. This measures how long it would take a given node in the supply chain to recover to full volume from a major disruption. It is important to note that this does not necessarily mean full recovery at that specific facility. If volumes for a specific part, for example, could be achieved by adding a second shift at another plant say within a few weeks, that time would be the TTR.
Once the TTR is established, then the financial impact of a disruption at any individual node can be calculated. A summing of those individual impacts then produces a total Risk Exposure Index. Both these numbers then can be used to gauge risk versus investment or process changes to reduce the financial impact.
In an interview this week on our weekly supply chain news broadcast with CSCMP, Simchi-Levi said that already the REI is being accepted and used by a number of companies - and changing the way they are thinking about supply chain risk management. (See full video below).
(Supply Chain Trends and Issues Article - Continued Below)
Simchi-Levi on Risk Exposure Index Progress on This Week's
Supply Chain Video News from the Supply Chain Television Channel and CSCMP
There are a number of companies that now talk openly about TTR, or time to recovery," Simchi-Levi said. "Cisco, for example, has implemented time to recovery across its supply chain to identify and measure risk in its business.
He cited the example of an explosion last year at a factory in Germany of a company called Evonik, which was a major of a nylon chemical called PA12, used as a key ingredient in a number of automotive parts. It took six months for that factory to start producing again, in a disruption that certainly could not have been predicted, causing many months of shortages that impacted auto production and sent prices for PA12 soaring.
"So if you think about time to recovery for this supplier, this component, it's six months. That requires a different way of thinking about risk and managing suppliers than suppliers whose time to recovery is maybe two or three weeks," Simchi-Levi noted.
He said just the effort to collect information on TTR across the supply chain changes a company's approach to risk management. First, such companies realize they don't have this data, and when they do collect the information there are usually some surprises. Second, the approach then often spurs companies to find ways to reduce TTR, and thus the financial impact, just as Toyota is doing through inventory buffers, redundant production facilities and other measures depending on the product category or supplier.
Simchi-Levi said one pharmaceutical company produced the same product at two different factories, and found TTR was much longer at one of the plants due to process differences there that didn't really impact manufacturing costs but did impact recovery time. That company is now standardizing processes to use the one with lower TTR in both plants.
Simchi-Levi said one major automotive company learned some lessons through use of the REI about where risks really lie. Like most companies, the auto OEM believed a dual sourcing strategy would reduce risks. But in the process of doing the TTR analysis, it found that in one case, a key component dual sourced was a major risk, because both tier 1 suppliers were sourcing a key part from the same tier 2 supplier - which had a long TTR. So if there was a problem at that company, the dual sourcing strategy would be for naught. Both tier 1 suppliers would be down for a lengthy time.
On the other hand, a single sourced supplier had a TTR of just three to four days, because it could easily shift production of a part it sold to the OEM to other factories around the globe.
"This is what you discover when you analyze the entire network and model TTR and financial impact," Simchi-Levi says.
It is clear the Risk Exposure Index is changing the industry approach to risk management. Simchi-Levi has additional observations in the video above.
What are your thoughts on the REI? Is a focus on TTR the right way to go, and will this change our thinking about Risk Managemen? Let us know your thoughts at the Feedback section (web form) or button (email) below.