Turning plant operations over to the supply chain is a risky business

Having pushed its Taiwanese trading company partner for a site visit to the Chinese manufacturer of its product, says Jim Ridgwick, Shanghai-based manager in Deloitte & Touche LLP's global supply chain practice, “Our client suspected its hosts were hiding the exact location of the manufacturer by taking numerous back roads and potholed dirt tracks—roads that could never handle a...

By Malcolm Wheatley, senior contributing editor June 1, 2008

Having pushed its Taiwanese trading company partner for a site visit to the Chinese manufacturer of its product, says Jim Ridgwick, Shanghai-based manager in Deloitte & Touche LLP ‘s global supply chain practice, “Our client suspected its hosts were hiding the exact location of the manufacturer by taking numerous back roads and potholed dirt tracks—roads that could never handle a fully loaded truck—all in an attempt to disorient them so they could never go back.”

Given a growing crisis in global resources, leading to more assertive nationalism, a backlash against the free flow of labor and capital, and what amounts to a reshuffled world order, some wonder whether the rising tide of globalization is set to recede or at least slow in the next several years.

Diversifying the chain

But for manufacturers—and for product-centric companies that don’t actually make products themselves—the job of managing supply chain risk based on not-long-ago decisions involving very different assumptions continues to grow. And ironically enough, perhaps, it’s only now that the efforts of enterprise application providers to comprehensively address risk in outsourced plant operations are coming fully to light.

For example, within the SAP eco-system, it recently became possible to map an enterprise and supply chain to differentiate between in-house and outsourced business processes. Smaller vendors including Centric Software and Mitrix have introduced solutions for inventory management within totally outsourced manufacturing and supply chain operations.

Unlike the unnamed manufacturer working with Deloitte, North Canton, Ohio-based Diebold believes it has a handle on supply chain risk. The company—a manufacturer of ATMs and security systems—uses procurement capabilities resident in a solution from Ariba Software to enhance its supply chain diversification.

“To mitigate risk, the first thing is to understand what those risks are,” says Michael Rager, Diebold VP for indirect procurement. “Ariba’s spend analytics capability lets us see those items we source from a single supplier, a single geographic region, or from areas of known vulnerability to threats like earthquakes and typhoons.”

Does that seem a bit over the top? Not according to Patrick Lemoine, a former McKinsey consultant and current director of supply chain applications strategy at ILOG , a vendor of supply chain optimization engines that last year acquired LogicTools for applications that include scenario planning solutions for reducing supply chain risk.

“There’s a tendency to think that risks are lower than they are, and that disasters won’t strike—but they do,” observes Lemoine.

Pointing to the 2003 fire that badly damaged the wafer fab at Philips Semiconductors ‘ manufacturing facility in Caen, France—the sole source of supply for certain components that were manufactured there—he draws a stark distinction between companies like Nokia , which deftly dealt with the interruption in supply, and competitors like Ericsson , which fared less well.

Seeking to avoid just such exposure to a single source of supply, Diebold is leveraging a combination of Ariba capabilities—ranging from spend analytics to sourcing tools and Ariba Buyer itself—to spread its spend more widely.

“A lot of our more strategic components are now being bought regionally,” says Rager. “It might be from the same supplier, but it’s from multiple locations, rather than just one.”

Worries by the bushel

In aiming to reduce supply chain risk, manufacturers are vulnerable to a wider set of threats than mere supply interruptions. As Mattel ‘s high-profile 2007 product recalls highlighted, quality problems bring in their wake not just the direct costs of remediation, but the risk of lingering damage to reputation that can take years to dissipate.

Almost as worrisome is the threat of intellectual property theft, as contract manufacturers have either stolen proprietary design data or operated “third shifts” using manufacturing capacity for illicit output destined for the grey market.

“The tough realities of global business—coupled to consumer pressure and retailer liability—are collectively forcing manufacturers to improve compliance processes throughout the supply chain to meet the expectations of customers, regulators and retailers,” notes Phil Friedman, VP for consumer and life science industries at enterprise software provider QAD . “Ultimately, the responsibility lies with manufacturers to account for where each product is coming from, and ensure that it meets the required standards.”

Pre-contract audits, supplier certification schemes, and vigilant monitoring all help, of course. But the opacity of business relationships in parts of the developing world—where, almost by definition, the use of contract manufacturing will be most fruitful— sometimes renders such approaches problematic.

Without knowing the actual factory that is making a product, claims Friedman, there is a major risk associated with substandard social and environmental compliance that could cause irreparable damage to a company’s reputation.

If it’s at the point where you don’t even know where your manufacturing partner is to be found, says Deloitte & Touche’s Ridgwick, “there is no evidence that your quality requirements have been adequately cascaded down the chain to the point of production. There is no assurance that they are being understood, respected, or adhered to.”

That’s one reason why Ariba recently bolstered the resources invested in its Global Sourcing Organization, notes Pat Furey, senior category manager. “We can help our customers find suppliers anywhere in the world, but we realize more people are needed on the ground to identify and qualify suppliers, and auditing them to ensure they meet quality and reliability standards Ariba users want,” he says.

Validation isn’t just appropriate to start a supply chain relationship. While about 90 percent of audits Ariba carries out for clients are pre-contract, says Furey, the remaining 10 percent are ongoing audits—a proportion that is growing. “If you’re not doing some sort of ongoing monitoring of suppliers, and the quality of what they are shipping, you’re opening yourself up to risk.”

A noticeable shift

Furey say the perception that China is a riskier option than was first appreciated has prompted a growing number of manufacturers using Ariba to opt for sources of supply closer to home.

“Mexico has really come on in the last year or so,” Furey notes. “It’s seen as a safer option, and with better logistics. You can get an engineer to Monterrey, Mexico, a lot quicker than you can get that engineer to Shanghai—with the added benefit that the peso-dollar rate has basically stayed flat, while the Chinese renminbi has appreciated 20 percent.”

A supply chain association survey recently found 69 percent of brand owners now have less control over at least five key supply chain processes, including order processing, analyzing and managing risk, inventory liability, and forecast sharing.

The Wall Street Journal agreed in a recent article on globalization, stating, “As some U.S. corporations relocate operations from lower-cost spots in Asia, Mexico—which has a free-trade pact with the U.S.—has seen a surge in foreign investment, up 21 percent last year to $23.2 billion.”

Distance indeed adds an inevitable dimension of complexity—and that with complexity comes risk.

“Dependency on complex, global supply networks has increased the potential value—and risk—associated with transportation and logistics processes,” says Peter Scott, a VP with supply chain collaboration and business process integration specialist Exostar . “Many manufacturers are taking a more active role in logistics—including consolidating with one primary third-party logistics provider or investing in visibility capabilities such as tracking a container’s progress through international customs.”

Models for management

Manufacturers are turning to specialist supply chain applications to first model, and then manage, that risk—using network modeling tools from vendors such as Oracle and LogicTools/ILOG.

Steps taken to mitigate risk not only ensure viability as an ongoing business, but also deliver to the bottom line.

“By building a network model of the entire supply chain—from raw materials right through to manufacturing and onward shipment to the customer—you are not just developing a realistic picture of total landed costs in the supply chain, but also building up a picture of where the risks lie,” says Jeff Karrenbauer, president of Manassas, Va.-based INSIGHT , a software and consulting firm specializing in strategic supply chain management issues.

“To the extent that this suggests backing away from overreliance on long-distance offshoring, the result is reduced risk and improved responsiveness,” Karrenbauer adds.

Montreal-based apparel manufacturer Gildan Activewear credits Oracle’s Strategic Network Optimization tool with helping the 16,000-employee business—which will sell about 500 million shirts this year—with reducing some of the less obvious risks inherent in a fashion-centric supply embracing 14 manufacturing operations spread across Honduras, Nicaragua, the Dominican Republic, and Haiti.

“Risk is the dark side of Lean,” explains Jon Chorley, Oracle VP of supply chain product strategy. “Supply chains hedge against risk by holding more inventory, and having available accelerated transportation options. If you have aggressive lean policies, you need clear visibility to risk and tools to plan and deploy those hedges effectively.”

At Gildan, use of the Oracle modeling tool led to both reduced inventory obsolescence and reduced transportation cost through better inventory deployment, says Alexander Sbaite, company director of supply chain planning—as well as improving improved on-time shipment rates and inventory turns that lead to increased sales and margins.

Regardless of how globalization rolls out in the future, the capabilities that manufacturers and product-centric companies are taking today should serve them well in the future. Steps taken to mitigate risk not only ensure viability as an ongoing business, but also deliver to the bottom line.

The lesson is clear. Risks remain risks—but protection has a payoff.