So we started to look at other ways to assess risk and found Dr. David Simchi-Levi of MIT. Dr. Simchi-Levi has developed what he calls a Risk Exposure Index™
Dr Simchi-Levi takes the approach of understanding the nature of various risks, quantifying the supply chain risk and finally by addressing these risks through supplier segmentation. Risks range from the controllable execution problems or "known-unknown" to the uncontrollable natural disasters called "unknown-unknown" (which he refers to as "black swans").
Make a risk list. Starting from the top, list the unknown-unknown and uncontrollable (natural disasters, pirates, etc.). Then at the bottom put your controllable risks (forecasting accuracy, execution problems, etc.). Rank the remaining risks as best you can in between. See illustration from his book.
He assumes controllable risks (day-to-day operations such as maintaining inventory and backup plans) can be anticipated. Based on past experiences, some of these are controllable. HE DOES NOT ASSUME that "black swans" are so rare and unexpected that there is not much that can be done. While they are hard to forecast, he assumes there will be some over a given period and that they will increase with the complexity of the business.
Here is a simplified walk-through of how Dr. Simchi-Levi assesses risk:
- Identify each critical node for each business unit, product line, geographical region (the most critical products)
- Calculate the "Time-To-Recovery" (TTR) for each node (TTR is how long it takes to recover after a disruption)
- Now use the TTR and calculate lost sales. This is the Financial Impact (FI)
- Now aggregate these to obtain the Risk Exposure Index™ for each value chain.
- So now you have your priorities for a mitigation plan! Segment your suppliers. Focus on the underlying source components and determine the critical dependency and associated strategy for each component. See illustration from his book.
- Now is the time to examine different strategies for identified suppliers and components. There are many strategies that can be used to reduce risk: Alternative suppliers; production flexibility in the plants; flexibility in sourcing; adding inventory.
Want to see more? Dr. Simchi-Levi has published a book called Operations Rules and has produced a videocast which talks about how to quantify the cost of "unknown unknown" supply chain risks. By the way, Dr. Simchi-Levi is an advocate of Supply Chain Control Towers.