Recurrent versus Disruption Risk

Daniel Dumke — Mon, 18 Jul 2011 13:25:00 +0000

The distinction between disruptions and recurrent / continuous risks is commonly used by researchers and practitioners in supply chain management. But how should the differences be reflected in the supply chain planning process? Is it necessary to differentiate between the risk types here as well?

In 2007 Sunil Chopra et al. analyzed this question in depth.

Disruption vs. continuous risks

For simplicity sake the authors define a disruption as a supplier which does not deliver any product at all. Figure 1 shows an example delivery listing for 20 periods. In periods 4, 7 and 13 nothing has been delivered and so a disruption has happened.

As you can see the overall mean (including the disrupted periods) is 86 with a standard deviation of 39. But the third column highlights an important point: If you leave out the disrupted periods, the mean rises and the standard deviation drops to a third. As a result it should make a difference if a decision maker used one or the other mean / standard deviation to make his decision.

Figure 1: Exemplary Table containing Recurrent and Disruption Risks (Chopra et al., 2007)

Model

To test the effects of a differentiated versus a bundled view the authors develop a model. The focal company has two suppliers, one reliable and one unreliable (at risk of a disruption). The authors then analyze two cases: first, only recurrent risk and second, recurrent and disruption risks. Each with either a decision maker who views the risks bundled together or separately.
Figure 2 has a good graphic to show the implications of the different approaches with disruptions present. In a bundled view the excess order volume (y-axis, to prevent stock-outs) is increasing when the probability of the disruption increases. On the other hand, when the risks are decoupled the decision maker only focusses on the recurrent risk and the excess order even decreases with the probability of a disruption. The disruption risk is then mitigated by contingently using the more reliable supplier.

Figure 2: Comparison of Excess Orders for Decoupled and Non-Decoupled Risks (Chopra et al., 2007)

Implications

The authors conclude that:

Bundling of disruption and recurrent supply uncertainty results in an over (under) utilization of the low cost (reliable) supplier. The extent of over (under) utilization increases as the probability of disruption grows.

Furthermore:

Growth in supply risk from increased disruption probability is best mitigated by increased use of the reliable (though more expensive) supplier and decreased use of the cheaper but less reliable supplier. Growth in supply risk from increased recurrent uncertainty, however, is better served by increased use of the cheaper, though less reliable, supplier.

Conclusion

I liked the article a lot, since it focusses on one simple question: Is it bad to combine different types of risk. The conclusion: There will always be different risk sources or types which, as this article shows, have to be mitigated differently as well.

Reference:

Chopra, S., Reinhardt, G., & Mohan, U. (2007). The importance of decoupling recurrent and disruption risks in a supply chain Naval Research Logistics, 54 (5), 544-555 DOI: 10.1002/nav.20228

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Avoiding Supply Chain Breakdown

Daniel Dumke — Mon, 20 Jun 2011 14:00:00 +0000

This article presents a comprehensive practice oriented framework for managing supply chain disruptions by Sunil Chopra and ManMohan S. Sodhi. The article has been published in the MIT Sloan Management Review in 2004. The framework covers everything from risk analysis to the selection of the risk mitigation strategy.

Risk Categories

Chopra and Sodhi find nine categories for risk in the supply chain context. In figure 1 they contrast the risks with the corresponding risk drivers.

Figure 1: Risk Categories (Chopra and Sodhi, 2004)

Risk mitigation

The above mentioned risks have to be analyzed and if necessary mitigated. Risk mitigation as a process of managerial decision making can be quite cumbersome, since there is no catch-all strategy and some strategies can even increase other risks as a side effect. Figure 2 highlights the effect of selected mitigation strategies on the risk categories.

Figure 2: Effect of Risk Mitigation Strategies (Chopra and Sodhi, 2004)

Cost of risk mitigation

Very often risk mitigation not only comprises a laborious decision process, but also the resulting strategy implementation can mean a huge financial expenditure. Some strategies on the other hand are not only capable of reducing risks but can also increase profitability. Figure 3 highlights the dilemma. The goal should be to jump from the current position “X” to a higher risk-return curve (eg. “A”), instead of moving within the existing decision space.

Figure 3: Trade-off between Risk Reduction and Cost/Reward (Chopra and Sodhi, 2004)

What-if analysis

The authors suggest to use a what-if scenario analysis to assess a companies / supply chains propensity towards certain risks. In the matrix displayed in figure 4 the risk categories are further separated into supplier-related, internal and customer-related parts.

Figure 4: Exploring Scenarios using What-If Analysis (click to enlarge; Chopra and Sodhi, 2004)

Risk and reward

To balance risk versus reward the authors recall three essential relationships:

The cost of risk reduction increase with the level of risk (the higher the risk the higher the cost to mitigate)
Risk pooling reduces the cost to mitigate risks (eg. pooling demands of several customers reduces the cost to mitigate the risk)
The pooling effect is more pronounced when the pooled risks are very high

Depending on the level of risk and the cost of a mitigation reserve the authors suggest four generic strategic approaches to how to mitigate risks under different circumstances (figure 5).

Figure 5: Risk Mitigation Strategies depending on the Level of Risk and the Cost of Risk Mitigation (Chopra and Sodhi, 2004)

Tailored strategies

Finally the authors show examples of risk mitigation strategies and when to use them. The results are shown in figure 6.

Figure 6: Strategies for Risk Mitigation (Chopra and Sodhi, 2004)

Conclusion

I was surprised by the number of topics the authored covered in a single paper. They really tried to cover the whole risk mitigation process, and they succeeded.

Of course, most of the presented results are not really new and not covered in depth, but they make a excellent basis for strategic, business oriented discussions on supply chain risk management.

One drawback though: I did not really understand why exactly those risk categories (figure 1) were chosen. From my point of view the those are not very intuitive since the categories are not exclusive and thus overlap (eg. a disruption can also lead to a delay. Or why is a information infrastructure breakdown a systems risk and not a disruption?). This makes it harder to use the risk categories efficiently. But the categories could easily be replaced by another framework (eg. by Christopher and Peck, 2004)

Reference:

Chopra, S., & Sodhi, M.S. (2004). Managing Risk To Avoid Supply-Chain Breakdown MIT Sloan Management Review, 46 (1), 53-61

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