A characteristic of the American economy since the 1970s has been an increasing dependency on supply chains and outsourced partnerships.
First introduced by Booz Allen Hamilton consultant Keith Oliver in 1982, the term supply chain now refers to the full range of processes, outsourcing to subcontractors and use of distributors to produce, sell and support a product or service.
This business model makes economic sense. It allows organizations to focus on their core competencies while outsourcing areas where they lack expertise. While a valuable business model, dependency on outside firms does pose serious risk concerns. Even seemingly minor disruptions among small-scale organizations can cause significant disruptions because of the interconnectedness of businesses. A recent study by the Accenture Consulting organization found that disruptions to supply chain members can have a cascading effect on dependent trading partners and has the potential to seriously impact entire industries. Some of the examples cited include:
- In 2016 Hurricane Sandy closed sea and air ports all along the Eastern Seaboard and severely disrupted trucking. Among other things, this led to the worst fuel shortages since the 1970s and to the bankrupting of many small businesses.
- The 2011 and early 2012 floods that impacted over 1,000 factories in Thailand had a profound effect on the worldwide computer and automotive markets. These factories were responsible for manufacturing around 30% of the world’s hard drives used in computers and cars.
- In addition to the $70 B in damage caused by Hurricane Katrina, the storm’s business impact was felt by thousands of small and mid-size businesses, most of which were members of extended supply chains. Thousands of miles away, transportation links were idled, and food stores and restaurants were unable to secure seafood.
Today, concerns over systemic partner vulnerabilities such as dependence on unstable energy suppliers, the impact of armed conflict on the supply of raw materials, and cyber security concerns plague businesses around the world. Increased targeted hacking of financial institutions has affected the banking and payment industry driving up transactional and insurance costs while raising concern over the inherent security of such networks. The more extended the supply chain, the greater the vulnerability.
The influx of settlers to the New World in the 17th century put enormous pressure on English and French colonial administrators to develop an infrastructure to support these migrants.
Concerned that the local population’s lack or resources would hamper the building of the necessary business framework, European governments created the first North American monopolies. Known as charter companies, they were given exclusive contracts and wide discretion for operations. They were exempt from many legal restrictions. The effect was to squash competition while maximizing profits.
These early organizations were the driving force behind road and bridge building, banking systems, and development of industries such as fishing, agriculture, fur trade, and early manufacturing. Their organizational model was based on vertical integration, where the parent company owns everything from the acquisition of raw materials to the retailing of finished goods. In theory, by controlling all upstream and downstream components the risk of failure of any operating part can be better managed and profits optimized. Many of these colonial creations survived the American Revolution and evolved into some of today’s well-known companies. Embraced by the likes of Andrew Carnegie, John D. Rockefeller, and Henry Ford the principle of vertical integration remained the dominate business model for much of the 20th century.
Managing Vertical Risk
Toward the end of the 19th century the U.S. government moved to curb the abuses associated with monopolies by passing laws such as the Sherman Antitrust Act in 1890. Efforts to control the dominance of markets by one or two companies continues today both in the U.S. and internationally.
While highly vertical firms have many advantages, they face a unique set of business risks in addition to near constant regulatory oversight. Their size and depth of resources represent key advantages, but these same characteristics are impediments to change. Large businesses must deal with complex market goals. Size often limits their market nimbleness, a requirement of contemporary business.
Numerous management risks are associated with going vertical. Since many companies grow by acquisition, successfully merging different businesses takes time and puts a drain on both financial and management resources. Corporate leadership is often ill-prepared to oversee and guide businesses in markets where they are inexperienced.
Vertically integrated companies are often reluctant to embrace new processes since they have invested in optimizing a single set of procedures. These investments face obsolesce if the organization initiates major operational changes. The cost of retooling and retraining may further discourage adopting new procedures causing delays that lead to firms fallings behind competitors. As an example, American made cars were among the last to switch to disc-style brakes because all major U.S. auto manufacturers had large investments in drum-brake producers.
Changing the Business Model
In the latter part of the 20th century, vertical integration began to be replaced by supply chains and horizontal integration.
Also known as extended enterprises, supply chains consist of companies tied together in horizontal networks of interlocking buyer-suppler arrangements. Since the partner companies are free to follow market trends, they stay current and competitive. This allows the prime contractor to focus on their area of expertise while having access to market leading products and services. Properly negotiated contracts provide many of the benefits of vertical integration including preferential purchasing terms and aggressive pricing. These contracts are usually backed by service level agreements (SLAs) or other conditions which help ensure performance.
Horizontal integration has been popular outside the U.S. for many decades. In Japan, the business concept of keiretsu became popular after World War II and replaced zaibatsu (family controlled vertical monopolies) that had previously dominated Japanese business.2 Unlike businesses in the U.S., keiretsu are usually secured by the cross-ownership of stock.
The Next Steps: Value Webs and Public Partnerships
Globalization and everywhere access to products made possible by the Internet, are fueling the next developments in supply chain structure.
A new business model dubbed value chains goes beyond simple buyer-supplier linkages and establishes connections across whole ecosystems of partners and suppliers. As an example, all the coffee growers in a geographical region might exclusively work with a set of packagers who turn have a preferential agreement with a distributor who takes the product to market.
Recently, some businesses have expanded their view of strategic partners. They consider first responders and elements of the public emergency management infrastructure as core components of their emergency support system and factor their response and resources into their crisis management plans. This initiative is commonly referred to as public-private partnership and is a term used within the Federal Emergency Management Agency (FEMA) to refer to this type of initiative.
Managing Supply Chain Risk
Supply chain risk is a subject of active inquiry among many public and private researchers.
Here are ten recommendations for better controlling these risks:
- Conduct multi-stakeholder risk assessments.
- Include your key first tier suppliers in your annual BIA.
- Agree on a common risk management vocabulary.
- Work with key partners to harmonize emergency response plans.
- Adopt and implement the recommendations of resiliency standards.
- Share data on vulnerabilities related to acquisition and support services.
- Jointly agree to mitigation strategies.
- Invite business partners and local first-responders to participate in emergency response table-top exercises and live drills.
- Find ways to improve communications, especially during a crisis.
- Identify alternative sources of products and services that might be compromised by a widescale disruption.
One way to promote resilient third-party chains is to encourage each business partners to join the Ready Rating™ Program. This will provide a common way to measure preparedness and access to tools which will promote better preparedness. Be sure to discuss your rating with partners and explore ways of enhancing rating scores through cooperation. The extended community section of the Ready Rating assessment is particularly relevant to this effort.
Supply chains and value webs will continue to be important business models for the near future. As pointed out by Professor William Verdini, chairman of the Supply Chain Management Department at Arizona State University’s Carey School of Business, “Today, companies don’t compete, supply chains do.”