MIT GLOBAL SCALE Risk Initiative September 30, 2009

1. MIT GLOBAL SCALE Risk Initiative September 30, 2009 Bruce C. Arntzen, Ph.D. MIT Center for Transportation & Logistics 77 Mass Ave, E40-365, Cambridge, MA  02129 W: 617-252-6965   M: 978-793-1411 email: barntzen@MIT.edu

2. Contents: • Overview of Supply Chain Risks • Examples of Supply Chain Risk Event • Global SCALE Risk Initiative • Phase 1. Broad Survey of Regional Experiences and Attitudes • Phase 2. Challenges of Multinational SCRM • Phase 3. Quantitative Analysis of Multinational SCRM Opportunities SCRM = Supply Chain Risk Management

3. What is a Risk? • “Risk” is distinguished by several key characteristics: • Sudden occurrence • More suddenly than expected • Examples of Sudden: • 1) Global Warming in 30 years 2) Sales Drop in 2 months • 3) Earthquakes last 20 seconds • Unexpected occurrence • Unplanned Occurrence - firm not ready to deal with it • Severity Exceeded what was expected • Significant negative outcome • No Harm, no Risk • Examples of Negative Outcomes: • 1) Personal injury 2) Property Damage • 3) Loss of market share 4) Loss of profits • 5) Loss of brand integrity

4. Supply Chain Risk Hierarchy • Risk Hierarchy (Highest Level) : • Poor Performance Due to Internal Business Practices • Poor Financial Performance • Poor Customer Performance • Loss of Control • SC Interruptions Due to External Factors • Supply Chain Interruption • Difficult Business Climate Poor Performance due to Internal Business Practices SC Interruptions due to External Factors Supply Chain Risks Unexpected Poor Financial Performance Unexpected Poor Customer Performance Unexpected Difficult Business Climate Loss of Control Sudden Supply Chain Interruption

5. Risks Along the Supply Chain Poor Product Quality Limited Production Capacity Poor Purchasing Process Supplier Failure Bad Supplier Contracts Costs too High Manuf. Process Failure Poor Measuring Spike in Labor Costs Excess Inventory Forecasting through Production Capacity Planning Supply Planning Purchasing Supplier Mgt Production Customer’s Plans S&OP Raw Material Positioning Finished Goods Positioning Sales Forecast Demand Planning Inbound Transport Poor Forecasting Process Out of FG Stock Spike in Energy Costs Sudden Drop in Demand Out of Raw Stock Poor Material Planning Limited Supplier Capacity Poor Quality Raw Matls Spike in Raw Material Costs

6. Types of SC Risks (Internal) Poor Performance due to Internal Business Practices Side 1: Internal Unexpected Poor Financial Performance Unexpected Poor Customer Performance Loss of Control Poor Asset Mgt Poor Profits Poor Product Quality Poor Delivery Technology & Systems People Costs too High Excess Inventory Out of Raw Stock Excessive A/R Sales Too Low Out of FG Stock Abuse of A/P Poor Distribution Process Prices Too Low

7. Types of SC Risks (External) SC Interruptions due to External Factors Side 2: External Supply Chain Interruption Difficult Business Climate Mother Nature Health & Environment Crime & Terror Economic & Financial Political & Social List of External SC Risk Factors were Adapted from Marsh, Gary Lynch

8. Risk Classification Scheme Supply Chain Risk Poor Performance due to Internal Business Practices SC Interruptions due to External Factors Supply Chain Interruption Difficult Business Climate Unexpected Poor Financial Performance Unexpected Poor Customer Performance Loss of Control Technology & Systems People Mother Nature Health & Environ ment Crime & Terror Economic & Financial Political & Social Poor Asset Mgt Poor Profits Poor Product Quality Poor Delivery Economic Recession Regulatory Change Poor Process Control Terrorism Sabotage Poor Measuring Software Failure Security Violations Hurricane Tornado Fires & Explosion Excess Inventory Excessive A/R Abuse of A/P Currency Devaluation Gov’t Policy Change Product Tampering Loss of Data Executive Misdeeds Earthquake Disease & Infestations Poor Monitoring Poor Quality Raw Matls Labor Dispute Civil Unrest Workplace Violence System Overload Key Resignations Flood Mudslide Contamination & Leaks Sudden Drop in Demand Sloppy Invoicing Slow Payment of Suppliers Costs Too High Prices Too Low Interest Rate Surge Tax Law Change Kidnap & Extortion Hardware Failure Inexperience Incompetence Extreme\ Heat/Cold Transport Accidents Bad T’s & C’s Poor Forecasting Process Tighter Supplier Terms Currency Inconvert- ability Counterfeiting & Piracy Wildfires Facility Collapse Escape of IP Project Mgt Failure Sales Too Low Sloppy Fulfillment Design Change Spike in Raw Material Costs Hit Credit Limit Sudden Asset Deval. Weak Collections Spike in Energy Costs Poor Purchasing Process New Competing Product Out of Raw Stock Poor Distn Process Out of FG Stock Drop in Credit Rating Spike in Labor Costs Risks Causes New Competitors Bad Supplier Contracts Bad Product Quality Poor Material Planning Limited Supplier Capacity Poor Forecasting Manuf. Process Failure Sloppy Fulfillment Lack of SC Visibility Spike in Health Care Costs Sudden Oversupply Poor Forecasting Supplier Failure Abuse of A/P Limited Production Capacity Unpredictable Transportation B.Arntzen, 2008 Spike in Pension Costs

9. Contents: • Overview of Supply Chain Risks • Examples of Supply Chain Risk Event • Global SCALE Risk Initiative • Phase 1. Broad Survey of Regional Experiences and Attitudes • Phase 2. Challenges of Multinational SCRM • Phase 3. Quantitative Analysis of Multinational SCRM Opportunities SCRM = Supply Chain Risk Management

10. Ford and Firestone 1/2 • The Background • Firestone plant in Decatur, IL used a new pelletized rubber process that reduced tread adhesion • Shoulder design contributed to cracking, tread separation • Explorers on Ranger chassis had a high center of gravity • Ford recommended 30psi instead of 36psi for smooth ride • The Event • Underinflated tires heated up, cracked the shoulder, and caused tread separation due to lower adhesion • Taller SUVs rolled more easily when blowouts occurred • 148 deaths in US, 525 injuries Source: Yossi Sheffi, “The Resilient Enterprise”, MIT Press, 2005

11. Ford and Firestone 2/2 • The Result • Repeated denials that anything was wrong • Each side blamed the other side • Eventual recall of about 20 million tires at cost of $3 billion • Ford sales down 11%, Firestone down 15% • Both brands severely damaged, loss of public trust • The Learnings • Must test products exactly how customers will use them • Slow Response and False Denials forfeit consumer trust • Fast, Honest, Pro-Active Response is best in the long run since it protects Brand Integrity Source: Yossi Sheffi, “The Resilient Enterprise”, MIT Press, 2005

12. Tylenol 1/2 • The Background • 1982 J&J had a 37% share of the non-prescription pain reliever market • Many off-the-shelf drugs including Tylenol were sold in Capsule form • The Event • Someone replaced the Tylenol with Cyanide in several pill bottles • In September 1982 seven people died in the Chicago area from taking Tylenol Capsules • J&J share dropped 8%, it’s Market Cap dropped 7% Source: Yossi Sheffi, “The Resilient Enterprise”, MIT Press, 2005

13. Tylenol 2/2 • The Result • J&J immediately recalled 31 million bottles of Tylenol • Capsules were replaced by Caplets - harder to tamper with • Tamper-proof packaging was introduced – 3 seals • J&J held Tylenol off the market for a month • Reintroduced Tylenol with lots of advertising • After 6 months, J&J had regained its market share. • The Learnings • Fast, Decisive, Pro-Active response builds customer trust • Leverage, advertise that Tylenol is now safer than others • Competitors now had to match J&J for product safety Source: Yossi Sheffi, “The Resilient Enterprise”, MIT Press, 2005

14. Contents: • Overview of Supply Chain Risks • Examples of Supply Chain Risk Event • Global SCALE Risk Initiative • Phase 1. Broad Survey of Regional Experiences and Attitudes • Phase 2. Challenges of Multinational SCRM • Phase 3. Quantitative Analysis of Multinational SCRM Opportunities SCRM = Supply Chain Risk Management

15. MIT Global SCALE Network China MLA India Africa Today: MIT, ZLC, CLI Soon: MLA Future: China, India, Africa

16. Contents: • Overview of Supply Chain Risks • Examples of Supply Chain Risk Event • Global SCALE Risk Initiative • Phase 1. Broad Survey of Regional Experiences and Attitudes • Phase 2. Challenges of Multinational SCRM • Phase 3. Quantitative Analysis of Multinational SCRM Opportunities SCRM = Supply Chain Risk Management

17. Survey Overview • Observation: • Supply Chain Risk Management (SCRM) for multinational supply chains is even more challenging than for local supply chains. • Questions: • Are experiences relating to supply chain risks different in different regions, cultures, settings, or industries? • Are attitudes toward supply chain risks different in different regions, cultures, settings, or industries? • What factors can explain these differences?

18. Survey Design Survey covers both: SCRM Behaviors Potential Explanatory Factors • SC Risk Attitudes • Prevention vs. Recovery • Central vs. Regional control • Risk Tolerance • SC Risk Experiences • Frequency of Internal Causes • Frequency of External Causes • Frequency of Failure Modes • Unique SC Risks • SC Risk Management • Most important SC Risks • Role of Risk Manager • Effectiveness of Risk Mgt • Effectiveness of Business Continuity Plan • Personal • Age, Gender, Education • Work Experience, Job Level • Work and Childhood Settings • Regional / Cultural • Country & Nationality • Languages spoken at home & work • Company / Industrial • Size of Company – this site and worldwide • Position in overall supply chain • Industry type

19. Questions: Attitudes

20. Questions: Risk Tolerance

21. Questions: Risk Frequency – Internal Events

22. Questions: Risk Frequency – External Events

23. Questions: Failure Modes

24. Questions: Important & Unique Risks

25. Questions: SC Risk Mgmt

26. Questions: You, Your Company

27. Survey Teams MIT Global SCALE Centers Affiliated Researchers EUR N AMER CHINA INDIA L AMER AFRICA

28. Contents: • Overview of Supply Chain Risks • Examples of Supply Chain Risk Event • Global SCALE Risk Initiative • Phase 1. Broad Survey of Regional Experiences and Attitudes • Phase 2. Challenges of Multinational SCRM • Phase 3. Quantitative Analysis of Multinational SCRM Opportunities SCRM = Supply Chain Risk Management

29. Hypothesis: Mismatches • Based on Phase 1 we have identified different attitudes and behaviors toward SCRM. • Across Multinational supply chains there are significant mismatches in SC Risk management behavior including: • Awareness of risks (Risk? What risk?) • Prioritization of risks (what’s more important) • Risk Tolerance & sense of urgency • Desire & Ability to Prevent Risks (before they happen) • Ability to React to Disasters (after they happen)

30. Attitudinal Mismatches • Awareness/Prioritization Mismatch: Example • HQ is worried about Risks 1, 2, and 3. • Remote Supplier is not concerned with those risks. • Remote Supplier is worried about risks 4, 5, and 6. • HQ not aware of risks 4, 5, and 6. • Each party is frustrated by the other’s lack of concern for the “most important” risks. • 2. Tolerance Mismatch: Example • Both HQ and a Remote Supplier are aware of a risk • HQ worries enormously about it. • Remote Supplier does not seem too concerned. • This mismatch generates tension and angst.

31. Phase 2 Approach • In-depth interviews of real supply chain partners (from different regions, industries, cultures) • Determine if attitudinal mismatches exist • Document these mismatches • Determine the impact on SCRM • What steps can remove the mismatches & impacts? Supplier  Manufacturer  Distributor  Customer

32. Contents: • Overview of Supply Chain Risks • Examples of Supply Chain Risk Event • Global SCALE Risk Initiative • Phase 1. Broad Survey of Regional Experiences and Attitudes • Phase 2. Challenges of Multinational SCRM • Phase 3. Quantitative Analysis of Multinational SCRM Opportunities SCRM = Supply Chain Risk Management

33. Hypothesis: Misallocation • Based on Phase 1 & 2 we have identified different attitudes and behaviors toward SCRM and mismatches across regional boundaries. • Because of these, corporate efforts (and resources) to reduce supply chain risks are not allocated optimally. • Two types of misallocations: • Uneven mitigation • Non-Optimal allocation

34. Uneven Mitigation • Uneven Mitigation (Parallel Nodes) Corporate risk mitigation resources are unevenly applied across multinational supply chains. • Example: • Locations A and B each supply a critical component for the manufacture of finished goods at Factory C. • Location A applies enough resources (inventory, process controls, manpower, and mgt attention) to achieve 99% on-time delivery. • Location B applies only enough resources to achieve 80% on-time delivery. • The cost of achieving predictability is non-linear, rising quickly at higher rates of predictability. • Factory C needs both components equally. • Factory C’s maximum delivery predictability is limited to 79% and even that is achieved at a 7% cost premium compared to having both suppliers be 90% predictable. • A better solution may have been to transfer some of the resources used by Location A to Location B.

35. Uneven Mitigation BTO Component A 99% On-Time Delivery Overall predictability = 79% Location A Customer Factory Overall Cost = $340 Location B BTO Component B 80% On-Time Delivery BTO Component A 90% On-Time Delivery Overall predictability = 81% Location A Customer Factory Overall Cost = $317 Location B BTO Component B 90% On-Time Delivery Having one supplier much more predictable than another is an expensive way to achieve overall predictability.

36. Non-Optimal Allocation Non-Optimal Allocation: The costs to mitigate risks are not the same for different members of a multinational supply chain. An optimal risk mitigation strategy may be achieved by investing more in some location and less in others. Example: an ounce of preventions is worth a pound of cure. Location 1 is an upstream producer of electronic component A, 90% are good, 10% are defective. Location 1 randomly tests 25% of its output at a cost of $25 each. Total inspection cost = $14K Location 2 uses 2000 good units of A annually in building larger assemblies. To detect and replace a defective A at location 2 costs $600 in testing and repair labor. Currently, Location 2 spends $100K annually to find and replace defective unit A in their assemblies. Total spend by both parties is $114K, which is more than double the optimal cost for both parties. Instead, Location 1 should test 100% of their units for a cost of $56K. Location 2 can save $58K by paying Location 1 the extra $42K needed for them to do the 100% testing.

37. Non-Optimal Allocation Location 2 Diagnosis cost = $600/unit Location 1 Testing cost = $25/unit 100K Location 2 can subsidize Location 1’s extra testing and still save over 50% Optimal testing and repair costs Current testing and repair costs 56K 14K 0 Location 2 Location 1 Location 2 Location 1

38. $100M $10M Non-Optimal Allocation Example: Two equally important suppliers, both sit on a fault line. Location A  no standards  unprepared for an earthquake Location B  strict standards  overly prepared for an earthquake FAULT LINE Country B Country A Rigorous Earthquake Standards No Earthquake Standards How about spending more on plant A and less on Plant B ?

39. Contents: • Overview of Supply Chain Risks • Examples of Supply Chain Risk Event • Global SCALE Risk Initiative • Phase 1. Broad Survey of Regional Experiences and Attitudes • Phase 2. Challenges of Multinational SCRM • Phase 3. Quantitative Analysis of Multinational SCRM Opportunities SCRM = Supply Chain Risk Management

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