Study: No link between supplier expenditures and risk

A new study from the Massachusetts Institute of Technology (MIT) contradicts the commonly held belief that the suppliers that pose the greatest degree of supply chain risk are those that receive the biggest annual payments from manufacturers. The study found no correlation between the total amount of money a manufacturer spends with a supplier and the financial loss from a supply disruption involving that supplier. Professors David Simchi-Levi of MIT, William Schmidt of Cornell University, and Yehua Wei of Duke University conducted the research.

The three academics studied Ford Motor Company's supply chain. Their quantitative analysis found that the suppliers whose disruption or failure would inflict the greatest blow to Ford's profits are those that provide the manufacturer with relatively low-cost components. "This explains why risk in a complex supply chain network often remains hidden," said Simchi-Levi in an article about the study in the MIT News newsletter. "The risk occurs in unexpected locations and components of a manufacturer's supply network."

Traditional methods of identifying the suppliers and events that pose the highest risk require knowing two things: the probability that a specific type of risk event will occur, and the magnitude of the problems that would ensue. Because a company's mitigation choices—maintaining more inventory or an alternative supply source—are the same regardless of the type of problem that occurs, Simchi-Levi reasoned, a more effective model of supply chain risk should calculate the impact of a supply disruption on a company's operation.

Simchi-Levi built a model that incorporated bill-of-material information and mapped each part or material to the appropriate Ford facilities and product lines. The model also considered multiple tiers of supplier relationships, supplier recovery time, and operational and financial impact.

As researchers removed individual nodes from the supply network, the model determined how to reallocate inventory, identify alternatives, and predict the associated financial impact. When applied to Ford's multitier supply network, the model predicted that a short-term disruption at 61 percent of the automaker's Tier 1 suppliers would not result in a profit loss. But a disruption among just 2 percent of Ford's suppliers would have a large impact on profits—even though each of those suppliers provides Ford with inexpensive components.

The researchers discuss their findings in "From Superstorms to Factory Fires: Managing Unpredictable Supply-Chain Disruptions," in the January/February issue of Harvard Business Review.