Lessons from the Ongoing Pandemic: Strategic Sourcing in a Changed World
Wednesday, April 8, 2020
By: Anant Mishra
I teach a graduate-level course on strategic sourcing in supply chains and much of the discussion often focuses on comparison of sourcing alternatives for firms in times of change and uncertainty. Needless to say, there is a lot to talk about at this time.
The ongoing COVID-19 pandemic and the major global supply chain disruptions it continues to cause have brought considerable scrutiny to sourcing decisions. The crisis is raising fundamental questions about whether firms are approaching such decisions in as comprehensive a manner as they think and exposing the myopic nature of the current, preferred way sourcing decisions are made.
More can be done by both sourcing managers and supply chain academia as we figure out how to make sourcing decisions that make a supply chain more resilient in moments of crisis. Specifically, firms should consider going from a “just-in-time” mindset to also planning for “just-in-case” scenarios. I will outline a few ways to do that but first, let’s cover what most companies are doing today.
The Common, Current Approach
As a company considers the pros and cons of sourcing decisions (e.g., in-house sourcing versus onshoring versus offshoring) as well as the benefits associated with sourcing from locations where clusters of suppliers are located closer to each other—a phenomenon often referred to as “agglomeration”—a key decision tool employed in practice is the total cost of ownership (TCO) approach. TCO plays a critical role in deciding whom to source from and where to source from.
Borrowed from management accounting, TCO essentially compares the total costs (i.e., the sum of manufacturing, inspection, inventory, transportation, taxes, warranty, and scrap costs) associated with a supplier at one location to another supplier at a different location. This approach is a vast improvement over the more traditional costing approach used decades earlier. In the traditional costing approach, component manufacturing prices, influenced heavily by labor costs at a supplier’s location, served as the primary influencers of sourcing decisions. Numerous cases and articles have been written highlighting the benefits of the TCO approach in sourcing decisions and why sourcing managers should pay attention to this approach.
Now, how can supply chains become more resilient?
1. Use TCO Approach as a Starting Point Only
Let me be clear: the TCO approach itself is not at fault. What is, however, more questionable is the focus on TCO approach as an indicator of the effectiveness of one sourcing strategy versus another. The comprehensive nature of the cost calculations associated with the TCO approach often creates an exaggerated sense of rigor associated with the approach. This occurs because while the TCO can account for potential fluctuations in labor costs, transportation, tariffs, and taxes over a time horizon, no amount of rigor in cost analysis can account for sudden shocks or crisis scenarios that may fundamentally challenge the cost assumptions associated with a sourcing strategy. While this is an implicit limitation of the TCO approach, often it seems to be lost in the presence of detailed cost calculations, blinding the sourcing function to not consider crisis scenarios. Bennis and O’Toole refer to this false sense of rigor associated with hard analysis as providing an “aura of quantification” that can lull decision makers into ignoring important variables that are not included in such analysis.
Therefore, rather than using the TCO approach as an endpoint in finalizing sourcing decisions, firms should view the TCO approach as simply a starting point to collect and document cost data about various sourcing strategies. Costs will always be an important part of the decision making and continued sustainability for firms. Hence, the TCO approach cannot be ignored, but it cannot be overstated!
2. Assess Your Agility Around Production Shifting
Production shifting refers to a firm’s focus on assessing where, and to what extent, can the firm move its production capacity from one supplier to another when a disruption occurs. While it may be hard for firms to move entire production capacities from one or a few suppliers to alternative suppliers during crises, such analyses can also ensure that a firm’s supply chain does not halt altogether during crises. This approach to reallocating production capacities during emergency scenarios is not new – electricity power grids, which power our daily lives and are essential to national security, often use privately-owned diesel generators as backups in many developed nations to manage local failures and buy the time necessary to repair and redevelop existing power grids.
3. Diversify Sourcing Risks Geographically
While considering production shifting possibilities is an important consideration, it doesn't help if alternative suppliers are also located in the same region. Competing suppliers in a supply chain often have the tendency to agglomerate (i.e., locate closer to one another) to take advantage of a nearby port facility, a large available labor pool, or technology spillovers. However, the proximity to one another also increases the risks of entire supply chains shutting down because of a common problem. For example, Wuhan province (the epicenter of the Covid-19 outbreak) is a major supply base for the consumer-electronics industry. Buyers’ firms are therefore not shielded from a supply chain disruption when they have alternative suppliers in the same region.
While the costs of qualifying multiple alternative suppliers across different geographical locations, and the managerial attention required in doing so are not trivial for a firm, they make a firm’s supply chain resilient in moments of crisis. As a part of geographical diversification of their supply base, firms could also consider developing and nurturing suppliers located close to their home base through smaller orders to reduce difficulties in switching production in moments of crisis.
4. Conduct "Disruption Games" and Simulations for Your Supply Chain
Countries conduct war-games to stay in a state of preparedness. States do drills to test their readiness for tornados. Firms crash test automobiles using simulations. And more recently, Bill Gates has called for countries and policymakers to conduct "germ games" to test their ability to respond to pandemic-scenarios.
These activities and calls for action raise the possibility that firms with complex and globally distributed supply chains should also test the resiliency of their supply chains and sourcing decisions by engaging in disruption games or simulations for their supply chains. Such games that involve executive personnel from the supply chain and sourcing function within a firm along with its lead suppliers can help both sides to first and foremost visualize disruption scenarios, and then, plan for alternative ways where production can be redirected, raw materials can be procured and logistics can be re-routed. In addition, such games can help firms and suppliers identify gaps in decision making that lie within their current organizational structures to respect efficiently and effectively in moments of crisis.
The last two months have demonstrated the unprecedented scale and scope of disruptions caused by the COVID-19 pandemic to global supply chains across a whole range of industries. While the unprecedented nature of the disruptions has exposed the limitations of existing sourcing decisions that may be driven mostly from a TCO standpoint, it presents opportunities for the sourcing function to radically rethink how decisions are made and how the function can better respond to future crises. For sourcing managers and supply chain academia, this crisis is a learning opportunity too great to waste.
Associate Professor, Supply Chain and Operations
Carlson School of Management
Anant Mishra is an Associate Professor in the Supply Chain and Operations (SCO) Department at the Carlson School of Management, University of Minnesota. His current research and teaching interests derive from contemporary issues in the areas of global sourcing, innovation, public sector operations and project management.