The fallout from the Covid-19 pandemic and related disruptions, like shortages of both labor and products, tested companies throughout 2022. In such an uncertain environment, resilience attracted much attention, yet the task of building and sustaining resilient supply chains remains extremely challenging for many companies.
There are various reasons why resilience-building is far from straightforward, but one of the main ones is that companies struggle to build a solid financial case for such investments. This may seem surprising at a time when steeling supply chains against extreme market volatility is the subject of so much discussion.
However, decades of research at MIT CTL show that the financial hurdles to achieving resilient supply chains are far from new. The problems fall into three key areas: deciding how much resilience is needed, the timing of investments, and quantifying future cash flows, and data issues.
How much resilience do I need?
This question needs to be answered when planning any form of investment in a new capability or service, but arriving at an answer is tricky when the goal is to increase resilience in supply chains.
The problem is that there is no single holistic measure of resilience available today. Two resilience measures in common use are time to recovery (TTR — the time it takes to recreate lost capacity post-disruption) and time to survive (TTS), (how long the firm can continue to meet demand after a capacity loss due to disruption). If TTS is longer than TTR, there will be no disruption to the flow of goods. If TTS is shorter than TTR, there will be a break in the flow of goods equal to the difference between TTS and TTR.
But this measurement approach is seriously flawed. For example, TTR and TTS values need to be ascertained at the supply-chain-node level, which is very difficult — nearly impossible, even.
In the absence of reliable ways to estimate how much resilience is needed, practitioners often fall back on measurements of risk to guide them. An example is measuring supplier-related risks such as financial stability. However, the risk-based approach is not an adequate proxy and does not provide the guidance that companies need.
When and how will the investment pay off?
Estimating both the timing and the amount of the cash flows involved in resilience investments is the second problem area.
Deciding on the timing is irksome, simply because the anticipated disruptions that prompt companies to invest in resilience have not happened yet, and no one knows precisely when they will occur. It is possible to estimate the probability of an event like a natural disaster happening over, say, the next 10 to 20 years. Again, however, this approach falls short of what companies need to effectively evaluate resilience investments. In this case, the net present value (NPV) will vary dramatically depending on whether the disruption occurs in, say, year two versus year 20, complicating efforts to measure the worth of these programs.
Similar unknowns frustrate efforts to quantify the cash flow effects of a disruption. Practitioners do not know for sure how long the theoretical crisis will last, its impact on the organization, and how competitors will respond. Hence, quantifying the cash flow benefits of a resilience measure that enables the company to continue to operate when disaster strikes is fraught with uncertainty.
There are other complications too. For instance, building resilience can be achieved in myriad ways, and each method has its own cost and impact profile. It is not easy to choose which ones will be the most effective in particular situations.
Is the data available?
Accessing the right data is a problem common to many supply chain projects, but is especially challenging when the goal is to evaluate an investment in resilience.
Obtaining high-quality TTR data is often problematic, and the key data required to develop the discounted cash flow, or DCF, of a supply-chain-resilience investment is difficult to access and often inaccurate.
To further complicate things, the data picture is not static. A supplier’s TTR likely changes over time based on the supply and demand dynamics of materials and systems required to restore lost capacities. This variability has been extreme over recent years due to the bullwhip effect (where a customer intentionally over-orders to compensate for supply uncertainty and this practice becomes more exaggerated as one progresses along the supply chain).
Coping mechanisms for right now
Given these hurdles, is building a financial case for investments in resilience a lost cause? More research is needed to help solve the shortcomings described in this article, but in the meantime there are ways to improve resilience case-building.
For example, including other functions such as sales & operations planning and finance in the process provides a more complete picture of future resilience demands. Recognizing that such investment decisions may have a strategic element also helps. Consider, for example, the investment Toyota made in semiconductors after the great Tōhoku earthquake and subsequent tsunami severely disrupted its supply chain in 2011. Recognizing that a semiconductor shortage in the future would likely threaten the franchise, the company made a strategic investment in inventory.
No one knows what crises are in store during 2023, but it is a sure bet that supply chains will be disrupted in some way next year. Leadership teams are understandably leery about sanctioning significant investments in ways to mitigate the impacts of future business interruptions that may or may not happen. However, the alternative — to do nothing or put inadequate resilience measures in place — makes even less sense in today’s uncertain world.
This blog post is based on the Harvard Business Review article “Overcoming the Financial Barriers to Building Resilient Supply Chains.”