This chapter states the core theoretical aspects that are linked to this master thesis report. It covers chapters on identifying supply chain risks and the associated risk mitigation strategies that can be used to reduce the negative effect of the supply chain risks.
Identifying supply chain risks
Identifying, defining and classifying ideas are often needed for a research in order to create better understanding (Oke & Gopalakrishnan, 2009). Researchers have used different ways to explain and classify the concept of supply chain risks. (For example, see Chopra & Sodhi, 2004; Kaku & Kamrad, 2011; Norrman & Jansson, 2004; Svensson, 2002; Zsidisin and Ellram, 1999; Zsidisin et al., 2004; Tang & Tomlin, 2009) and consequently many frameworks have been developed by the researchers. However, there is no clear agreement on which type of the framework best captures the supply chain risks (Oke & Gopalakrishnan, 2009). The tables in the appendix A, B, and C summarize prior researches in determining supply chain risks and clearly show the diversity of supply chain risks identification and categorization ways used by the researchers. According to Sodhi and Tang (2012), the supply chain risk categorization methods employed by researchers are suitable to address a set of different supply chain issues. For example, Tang and Tomlin (2008) discuss the major type of supply chain risks that occur regularly, Chopra and Sodhi (2004) classify and lists supply chain risks based on the drivers of the risks, Kaku and Kamrad (2011) presents a supply chain matrix classifying supply chain risks based on two major dimensions (Internal vs. external events and high-frequency, low- impact events vs. low-frequency, high-impact events).
After reviewing the framework by different researchers, this thesis adopts the template of Chopra & Sodhi (2004) to follow in this study. While adopting this model, this thesis considers that the model by Chopra & Sodhi (2004) best enables to answer the research questions raised in this paper as it deals the supply chain risks more specifically by considering the drivers of the supply chain risks. Besides, the categorization by Chopra & Sodhi (2004) empowers to position the associated mitigation strategies for each category of supply chain risks (to answer research question two) as compared to for example the categorization of supply chain risks by Kaku and Kamrad (2011). However, in order to make it more comprehensive a modification is made to it by considering the work of other researchers including Kaku and Kamrad (2011), Speckman and Davis (2004) and Tang and Tomlin (2008). The following table is the adopted model and will be used throughout this research while identifying, supply chain risks and reviewing risk mitigation strategies that can be used in order to lessen the effect of the risks while relocating a production system in a foreign market.
Supply risk refers to the happening of occurrences linked with inbound supply (Zsidisin, 2006). Due to various reasons suppliers can be unable to deliver the material or service on time leaving the firm to serious procurement problems (Zsidisin, 2002). This difficulty in purchasing will disturb the other manufacturing operations of the firm consequently affecting the end customer. Different factors amplify the existence of the supply risks. For example, the location of the firm (how far it is from the suppliers?), buyer demographics (statistics on customers’
availability) (Mitchell, 1995), availability of raw materials, type of supplier (Steele & Court, 1996), supply conditions (monopoly or oligopoly), and complexity of the supply chain (Kraljic, 1983).
Moreover, the rise of the supply risk is also linked with the difficulty of finding an adequate reliable supplier in the new market. As Kralji (1983) and Steele and Court (1996) uncovers the amount and the availability of supplier will determine the features of the supply risk. Traditionally it was common that companies had many suppliers for a product to insure that the best price is discounted and the procurement risk distributed across the many suppliers. However, the cost of dealing with many suppliers allow firms to depend on one (single sourcing) or two (double sourcing) suppliers which make firms to rely on these sources only consequently increase the supply risk (Tang & Tomlin, 2008).
Risk linked with the supply can also increase in a foreign market due to the globalization of the supply chain which creates complexity of the supply chain by allowing increased participants and diminish response to changes favoring for supply disruptions and amplified uncertainties (Hallikas et al., 2005; Wagner and Bode, 2006).
According to Tang and Tomllin (2008), supply risk embraces risks linked with supply cost, supply quality, and supply commitment.
Every organization depends on its supplier for goods and services. The cost of material from a supplier is more than 50% of the total sales of a firm, thus supply costs are very determinable for the success of a company (Tang, 1999). In order to keep the supply cost as minimum as possible, buyers force their suppliers through bargaining and switch to another, when the supplier cost does not match their need (Tang, 1999). To keep this bargaining power Porter (1980) considers the importance of sourcing from many suppliers, undergoing short term contracts with suppliers, and keeping the information of other suppliers (e.g., in terms of cost, sales, product type etc.). Firms can also get a considerable amount of cost saving by appropriately selecting a supplier (Degraeve & Roodhooft, 2006). Thus, it’s important for firms to view the risks associated with the cost of a supply while relocating a production system in order to reduce costs and stay competitive in the global market.
It’s not only enough to consider a supplier with reasonable cost, besides quality aspects of a supplier is very fundamental for the success of an organization (Okes Westcott, 2011). A supplier with low cost but ignoring quality aspects will cause serious problems in manufacturing including delays, interruption in production, and allowing production of substandard products where by affecting the overall performance of the supply chain (Okes & Westcott, 2011). In today’s global market, there is a severe competition which indicates the need of maintaining quality for firms to stay profitable (Persson & Olhager, 2002). Thus, firms require to consider the availability of a supply quality while relocating. As Okes &
Westcott (2011) reveals there is always an inherent risk to the firms through procuring goods from suppliers in terms of quality.
Commitment is very crucial in any type of business relationships. It is defined as “An implicit or explicit pledge of relational continuity between exchange partners” (Dwyer et al., 1987, p. 19). It encompasses the willingness of business partners to scarify their short term business benefits for the sake of maintaining long-term business relationships, developing trust and partnership arrangements (Anderson Weitz, 1989; Morgan & Hunt, 1994). A supply commitment is a fundamental aspect for firms to improve the quality of their outputs by reducing the variations in inputs (Okes & Westcott, 2011; Batt and Wilson, 2000). Moreover, it renders other advantages such as better information flow (Batt and Wilson, 2000), and improved performance of the supply chain (Gyau & Spiller, 2008; Kalwani & Narayandas, 1995). The need to consider the availability of a reliable supplier is undeniable for the success of an organization (Steele & court, 1996).
Demand risks are risks due to the undetermined nature of consumer demand in the market (Tang & Tomlin, 2008). It relates to variations in the flow of information and products between the company and the market. (The Decision Makers´ Direct, 2011). Demand risk is one of the supply chain risks companies are facing by relocating their production in a foreign market (Liu & Nagurney, 2011). According to the report by The Economist Intelligence Unit (2009), 500 executives of global companies listed demand risk as a top risk factor which needs to be considered when relocating.
Firms will incur loss if the demand is higher or lower than the actual consumer demand. In case if the demand is higher than the actual consumer demand it’s unnecessary cost to the firm (e.g., excess inventory) and when the demand forecast is lower than the actual consumer demand it’s again a cost to the firm in terms of lost sales (Sodhi, 2005; Kopczak & Lee, 1993). Thus an appropriate demand management strategy is required by firms to handle risk associated with demand.
Tang and Tomllin (2008) explain the main source of demand risk as demand uncertainty.
Demand is always uncertain (Blackhurst & Wu, 2009). This unpredictable nature of demand is considered affecting manufacturing firms (cf. Wilding, 1998). When there is uncertainty, there will be an inherent risk which affects firm’s decisions. Van der Vorst & Beulens (2002) explains the existence of uncertainties with questions like, what will be the actual customer demand? Will the supplier deliver the goods? And will the supplier deliver with the required quality? Decisions made through these uncertainties will affect the performance of the firms. “The more uncertainty related to a process, the more waste there will be in the process” Persson (1995 p. 14). Firms need to consider the existence of demand uncertainties and develop strategies to cope with to reduce wastes and make better decisions which improve their performance (Mason-Jones & Towill, 1998).
Process risks are risks of loss due to a manufacturing process or internal operations of a firm (Tang & Tomlin, 2008). For example, schedule instability/revising the production plan, is the common instability of firms in their internal operation which happens mainly due to external issues with buyer and supplier interrelationships (Pujawan & Smart, 2011). It has been viewed that companies have had been implementing different strategies and philosophies to reduce inventory (for example, Just in time inventory and total quality management) (Celley et al., 1986; Norris et al., 1994), to eliminate waste, bring continuous improvement and improved efficiency (Lummus and Duclos-Wilson, 1992; Orth et al., 1990; Suzaki, 1987). Yet, firms are seen unstable in their internal operations (Svensson, 2003; Tang & Tomlin, 2008). Disturbance in the internal operation of firms will disrupt the supply chain leading to failure to conform customer requirements (Sodhi & Tang, 2012).
According to Tang and Tomlin (2008), process risks include risks associated with quality, time and capacity risks associated with inbound and outbound logistics and internal operations of an organization.
Quality can be defined as meeting or exceeding customers’ expectations (Grönroos, 1983; Parasuraman et al., 1985), conformance to requirements (Crosby, 1979) and fitness for use (Juran & Gryna, 1988). Thus, quality risk is the risk of loss due to defective products. Different operations of a firm such as problems in designs, wrong operations/processes, machine breakdowns, can affect the quality of a product (Kaku & Kamrad, 2011), consequently, disturbing the supply chain and the end customer (Sodhi & Tang, 2012). Quality is “the single most important force leading to the economic growth of companies in international markets” (Feigenbaum, 1982 p. 22). Therefore the need to consider and manage risks associated with quality is very fundamental for firms who relocate their production in a foreign market.
In the global market meeting order time is very fundamental to meet the need of customers (Lederer & Li, 1997). Answering orders in the minimum time enable firms to stay competitive. Many authors have explained the negative effect of delays in a supply chain causing disruption and inefficiency (e.g., see Spekman & Davis, 2004; Chopra & Sodhi, 2004; Mason-Jones&Towill, 1999; Yeo & Ning, 2002). By Offshoring a manufacturing, firms could face delay risk (Schoenherr et al., 2008; Chopra& Sodhi, 2004). The main source of delays in a supply chain often includes lack of supplier flexibility, quality problems of materials, logistics failures and time spent for checking while border crossing (Chopra & Sodhi, 2004). Spekman & Davis (2004) demonstrate the effect of delays of bulk chemicals due to flooding in the Midwest causing the factory to cease operation.
Capacity risk is risk of loss due to less supply than demand (Chopra& Sodhi, 2004). When firms have lower capacity and are unable to meet a demand there is an opportunity cost (Pindyck, 1986). At the same time, building excess capacity and underutilizing it is also a huge financial loss for the firm (Pindyck, 1986; Chopra& Sodhi, 2004). “A firm’s capacity choice is optimal when the value of the marginal unit of capacity is just equal to the total cost of that unit” (Pindyck, 1986 p. 2). In times of bankruptcy, firms will usually focus on reducing inventory which heightens the capacity risk (Cable, 2010). Recession also makes suppliers highly vulnerable and unable to deliver their promises to different firms (Szuster, 2010). This consequently makes firms to not produce the required goods and services as required by the end customers, leaving the supply chain disturbed. Assessing the financial situation of suppliers is very important for firms who relocate their production system as their business operations are highly dependent on the capacity of their suppliers (Offshoring Research and Consulting, 2012).
1.2 Objectives of the research
2.1 The Research process
2.2 Exploratory research
2.3 Qualitative method
2.4 Data Collection
2.5 Data Analysis
3. Theoretical Background
3.1 Identifying supply chain risks
3.2 Supply chain risk mitigation strategies
4.1 Results from literature review .
4.2 Results from the interviews
5.1 Analysis of the Interviews
5.2 A Framework developed for managing supply chain risks while relocating a production system in a foreign market
6. Conclusions and discussions
7. Suggestions for future research
8.1 Journals, books and other publications
8.2 Web -References
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Supply Chain Risks Associated With Relocating a Production System in a Foreign Market