The Billion-Dollar Mistake in Supply Chains

Most companies estimate a loss of over 10% of revenue from supply chain disruptions in the past year alone. This loss is costing companies billions of dollars in revenue, damage to their brand image, and millions of potential customers. While many overlook its impact on the market, the supply chain is also an important aspect to company success, and is manageable, predictable, and optimizable. Many companies will suffer losses if they ignore supply chain optimization completely, opting for traditional strategies to solely maximize profits. However, optimizing a company's supply chain is a delicate balance between costs and resilience.

Two studies shed light on this challenge from complementary angles:

Sunil Chopra and Manmohan S. Sodhi argue that companies should rethink their supply chain design by emphasizing segmentation, regionalization, and an overinvestment in resilience. Meanwhile, a 2021 report by The Economist Intelligence Unit, sponsored by the GEP, surveys hundreds of executives across industries to reveal the real-world costs of disruption, such as revenue losses, brand damage, and shifting attitudes about efficiency. Together, these insights paint a clear picture: the era of “just-in-time” is giving way to an era of “just-in-case.”

What are the costs of disruptions, and what causes the disruptions?

During the COVID-19 pandemic, the cost of consumer goods such as toilet paper or food shot up overnight. This jump was an example of what happens when supply chains are disrupted, spreading fear among consumers. Some impacts of this disruption were the pause on car manufacturing in companies such as Toyota and BMW. Additionally, the fibre-optics industry and memory-chip manufacturing in Wuhan, China, were also negatively impacted, causing a ripple effect through the IT supply chain that caused global harm. According to a survey conducted by the Economist Intelligence Unit, nearly every executive surveyed reported that supply chain operations were impacted by the COVID-19 pandemic, with two-thirds reporting revenue losses of 6% and 20% in the past year. These costs were due to companies needing new suppliers, with a third of companies saying costs have risen. In this note, companies that have not made significant investments in technology to prevent risk have spent more to recover, which is why efficiency in the supply chain often fails.

Why Efficiency Fails and Resilience Works

While efficient supply chains focus on improving a company's financial performance, this often leads to a fragile structure. One example is outsourcing to low-cost locations. Although margins could be increased, resulting in more profits, it leaves supply chains vulnerable to disruptions, such as increased tariffs, natural disasters, and political instability. The risks in supply chain disruptions can be categorized into two different groups: 

1. Recurrent risks are regular, often predictable risks that occur over time and can typically be managed with established procedures and buffers.

   1. Demand Fluctuation

   2. Supply Delays

   3. Labor Shortages

2. Disruptive risks are rare, unpredictable, and high-impact events that can significantly affect operations and require strategic contingency planning.

   1. Natural Disasters

   2. Geopolitical Conflict

   3. Cyberattacks

To optimize supply chains, a common technique is segmenting them, which reduces the impact of both risks.

Segmenting The Supply Chain

Rather than having one factory produce everything, by segmenting, a business can tailor operations to the needs of each product type. This way, companies reduce costs, improve responsiveness, and minimize risks from disruptions.

For products with high volume and low uncertainty, decentralization or multiple production locations near consumers can help reduce transportation costs. Another benefit is that if one region fails, another can take its place.	For products with low volume and high uncertainty, such as niche fashion items or custom machine parts, the supply should be centralized. This way, companies can save space and costs.
Example: Amazon stores high-demand items, such as phone chargers, in many regional warehouses, allowing them to be delivered quickly and remain operational if one warehouse goes offline.	Example: Amazon tends to hold onto its less popular, slow-moving items more centrally compared to the different warehouses for popular items.

This specialization, based on the items' needs, doesn’t hinder efficiency either and minimizes risks. For example, assume a disruptive risk happens, such as a natural disaster. A segmented supply chain can quickly adapt to it, since popular items have multiple sourcing locations, while less popular items are not as in demand. A short production halt for low-demand items causes less operational impact. To counteract recurrent risks such as demand fluctuations, a segmented supply chain should adapt over time. Some products may lose demand, while other products increase. By adapting to the demand for the product, supply chains will remain effective. For instance, a tech company might produce a new smartwatch in one factory at launch, but once sales pick up and stabilize, it sets up multiple production lines in different countries to scale and serve the global market.

The Oil Tanker Analogy

This image illustrates how early oil tankers prioritized efficiency with large, shared cargo holds. This method prioritized efficiency over resilience. While they could carry more oil, they were prone to capsizing when liquid shifted. Similarly, supply chains designed purely for efficiency, without risk containment, can fail catastrophically when disrupted. By adding more compartments in tankers, similar to segmentation in supply chains, it offers a balance between efficiency and resilience.

Conclusion

As global supply chains face growing uncertainty, stemming from both geopolitical instability and unpredictable shocks, companies can no longer rely solely on efficiency to drive performance. The COVID-19 pandemic exposed the weaknesses of traditional supply chain models, prompting businesses to reassess their risk management strategies. By segmenting supply chains based on product characteristics and regionalizing operations, Amazon has shown that it’s possible to strike a smart balance between cost and resilience.

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Sources:

• Chopra, Sunil, and Manmohan S. Sodhi. Reducing the Risk of Supply Chain Disruptions (PDF)

• Economist Intelligence Unit. The Business Costs of Supply Chain Disruption (PDF)