Robert Kugel's Analyst Perspectives

Disaster, Risk Management and the Lean Supply Chain

Posted by Robert Kugel on May 5, 2011 1:43:54 PM

The earthquake, tsunami and nuclear plant trifecta that devastated Japan has had a negative impact also on companies that embraced the concept of managing a lean supply chain – one that minimizes inventories at each stage. If news accounts are to be believed, there seem to be legions regretting that decision as disruptions caused by the disasters have a ripple impact, hampering manufacturers’ ability to deliver goods worldwide. But although current events are a wake-up call highlighting the risks inherent in a lean supply chain approach, a worse danger is that some companies may overreact, especially those where blame for bad outcomes – not bad decisions – are the focal point of damaging reviews and assessments.

Perhaps some background will help illuminate this point. Adoption of lean supply chains began in the late 1980s as companies started using increasingly powerful information technology to manage their inventories more effectively. Effectiveness, in this case, means handling the trade-offs that are part of decision-making in ways that are consistent with corporate stra­tegy rather than having decisions sha­p­ed by the objectives of any organizational silo. Effectiveness here also means that the decisions ex­plicitly include a dis­ciplined process of identifying, assessing, managing, mitigating and monitoring the associated risks.

For the past month or so I’ve been trying to sort out whether the lean supply chain has proven to be a bad bet or today’s re-examination of leanness is simply a case of people questioning a fundamentally good decision that – at least at the moment – has turned out wrong. It seems to me that the issue isn’t really lean vs. fat but the degree of leanness for specific parts or supplies that provides the optimal trade-off between the costs of holding inventory and the risk of not being able to fulfill orders. That optimal point depends on a company’s specific circumstances, including its risk tolerance. The only rational way to answer how lean or fat a company’s supply chain should be is to apply a combination of objective supply chain risk analytics to what ultimately will be a subjective corporate soul-searching undertaken to determine the proper balance between the company’s appetite for risk and its efficiency. In other words, we recommend applying performance management concepts to optimize an organization’s supply chain profile.

Supply chain performance management means having key performance indicators (KPIs) and key risk indicators (KRIs) that are aligned with each other and with the company’s strategy and objectives so that decision-makers can assess trade-offs intelligently. These indicators are never static. Companies must review them periodically and change them when necessary. The indicators are vital tools for aligning day-to-day business execution across multiple departments (such as purchasing, sales, manufacturing and shipping) and across multiple business units. Defining the metrics that produce the indicators may seem like a straightforward task, but many companies have a difficult time establishing a measurement system that works across multiple departments and setting metrics that are acceptable to all. Having a robust set of supply chain analytics can alleviate this issue; such analytics also are critical to enhancing visibility for managers and executives as I discussed in an earlier blog.

To support their KPIs, companies need a high degree of visibility into their supply chains. “Visibility” is the ability to access relevant information quickly. Thus, “supply chain visibility” is the ability to know the location and status of the physical components, from raw materials to finished goods, as they move from suppliers through the stages of production to delivery to customers. Often, poor visibility is the result of not having transparent data – that is, lacking access to the data collected by a company’s supply chain systems. The data may be in diverse and fragmented systems, and some of it may be in desktop spreadsheets and thus inaccessible for all practical purposes.

Although I believe that the current period of re-examining lean supply chains is simply the natural and rational response to good decisions gone bad, I think it’s also worth considering that the era of you-can’t-be-too-lean may be coming to an end. Some – maybe even most – companies will need to consider strategies for plumping up their supply chains. The recent disaster is occurring against a backdrop of rapidly rising worldwide consumption of primary materials after decades of surplus. It may be that shortages and outages will now be more common than ever. This isn’t a new phenomenon. During the 1970s – even before the first oil embargo – shortages of primary materials became enough of an issue that the United States Securities and Exchange Commission (SEC), as part of its “full disclosure” initiative, instituted a requirement that companies disclose where they had supply chain vulnerabilities. (There even was a shortage of toilet paper – but that’s another story.)

 Going forward, companies need to periodically assess optimal inventory levels, sourcing and siting options in a way that balances the requirements of each part of the business. As my colleague has pointed out, it would be a mistake to believe that your current set of ERP and supply chain management applications alone will be able to provide executives, managers and employees with the intelligence, insight and visibility they need. The current turmoil in worldwide supply chains may be extraordinary, but its lesson for organizations should be that they need to manage their supply chains more nimbly and intelligently.


Robert Kugel – SVP Research

Topics: Performance Management, Sustainability, Human Capital Management, Marketing, Operational Performance Management (OPM), Analytics, Business Analytics, Business Collaboration, Cloud Computing, Governance, Risk & Compliance (GRC), Business Performance Management (BPM), Financial Performance Management (FPM), IT Performance Management (ITPM), Supply Chain, Supply Chain Performance Management (SCPM)

Robert Kugel

Written by Robert Kugel

Rob heads up the CFO and business research focusing on the intersection of information technology with the finance organization and business. The financial performance management (FPM) research agenda includes the application of IT to financial process optimization and collaborative systems; control systems and analytics; and advanced budgeting and planning. Prior to joining Ventana Research he was an equity research analyst at several firms including First Albany Corporation, Morgan Stanley, and Drexel Burnham, and a consultant with McKinsey and Company. Rob was an Institutional Investor All-American Team member and on the Wall Street Journal All-Star list. Rob has experience in aerospace and defense, banking, manufacturing and retail and consumer services. Rob earned his BA in Economics/Finance at Hampshire College, an MBA in Finance/Accounting at Columbia University, and is a CFA charter holder.