While diversifying supply chains to minimize risk has always been considered a sound business practice, a new paper out of Stanford Graduate School of Business is questioning that premise.
The new thinking is that multisourcing is a great way to mitigate a firm’s disruption risk — unless everybody else is doing the same thing. If that happens, and it does, the risks of industry-wide disruptions are actually higher than they would be otherwise, according to Kostas Bimpikis, author Multi-Sourcing and Miscoordination in Supply Chain Networks.
The problem at hand is that most firms have a limited understanding of and control over the decisions of their suppliers. Using multisourcing as a risk-mitigating strategy results in overlapping supply chain networks for rival firms. Consequently, the likelihood of industry-wide disruptive events becomes increasingly higher, argue Bimpikis, in a paper with Douglas Fearing at the University of Texas and Alireza Tahbaz-Salehi at Columbia University
This scenario became apparent after Japan’s tsunami and earthquake in 2011. As Automobile News reported, the disaster badly damaged the company that supplies 40% of the electronic chips used in cars. In yet another case, a year later, car makers were disrupted because an explosion at a German factory knocked out production of a specialty chemical that’s used in fabrics, brake parts, and even fuel tanks.
Bottlenecks like those suggest a blinkered understanding of what happens in a networked economy, the authors argue. What begins as an effort to diversify and reduce risk ends up creating overlap in the procurement channels available to an industry and consequently higher systemic risk. In a highly networked world, problems at a single obscure electronics company can cause havoc for a big swath of the industry.
“Firms are becoming increasingly aware that they operate in a networked, global economy,” Bimpikis says. “This realization unveils a host of important issues related to the interplay of the firms’ profit-maximizing incentives and their positions in the supply chain structure.
Companies are beginning to realize that it is not only important to know whom they are doing business with but also who else is doing business with them."
“Advances in information technology have made it easier for firms to delegate many of their core functions to third parties,” Bimpikis says. “Obviously, this has tremendous benefits, as companies can focus on what distinguishes them from their competition. But the flip side is that more delegation leads to longer and more decentralized supply chain networks, and there are all sorts of risks associated with that trend.”