Will your backup supplier be there when you need them?

Will your backup supplier be there when you need them?

Multi-sourcing is a common risk mitigation strategy, but just because you have a relationship with a second supplier doesn’t guarantee supply in the event of a disruption.  In my experience, people put a lot of confidence in the fact that they have a backup supplier. A sort of, “oh we have a backup supplier so we’ll be fine”, attitude prevails.  However, as discussed below, this confidence may be misplaced.  This is not to say that having multiple suppliers is not a valid risk management strategy – it absolutely reduces risk in the case of a primary supplier failure.  But there are also scenarios where additional suppliers are unlikely to be of any value, and it’s important to be aware of (and appropriately mitigate) these risks.

In August of 1997, members of the International Brotherhood of Teamsters struck United Parcel Service (UPS) for fifteen days.  At that time there were three providers of overnight parcel service: UPS, Federal Express, and Airborne (since absorbed by DHL).  In response to the strike at UPS, FedEx chose to protect service levels in their network and limited customers to a 10% increase over their historical shipment volume.  Consequently, even those customers that had a dual sourcing arrangement in place were impacted to the extent they had volume with UPS.  The simple fact was that there was not enough excess capacity in the overnight parcel network to absorb a disruption of either of the major players.

A more recent example is the 2016 Hanjin bankruptcy.  When Hanjin failed, their customers were clearly the most severely impacted.  However, all container shippers were ultimately impacted as the failure of Hanjin left the industry as a whole short on capacity resulting in delayed shipments and price hikes.  Price increases were a long lasting impact as they were needed to restore the balance between capacity and demand.

These brief case studies offer some important lessons to supply chain practitioners:

Key Lesson #1: A backup supplier is only an effective strategy to the extent that the backup supplier or suppliers have capacity to absorb the required increase in volume.  This is a basic truth, but in my experience, it is often overlooked in practice.

Corollary #1A: When industry capacity is concentrated in a few suppliers, the disruption of any one of those suppliers can result in negative impacts for all customers of that industry – not just the customers of the disrupted supplier. 

In the case of the UPS strike, FedEx protected its customers and its brand from service impacts by capping shipments.  However, when Hanjin failed, there were no such protections as former Hanjin customers overwhelmed the remaining capacity.  All ocean shippers experienced disruptions, not just those that had used Hanjin. The imbalance between capacity and demand created by the loss of a major supplier led to shipment delays and price increases across the industry.

Key Lesson #2: When a supply market is disrupted, the effectiveness of a mitigation strategy depends on the actions of other customers and suppliers in the market space. 

When developing strategies to mitigate potential supply chain disruptions, it’s best to approach the problem with a little bit of Game Theory.  In other words, consider how other customers of the disrupted supplier will respond.  What strategies are they likely to put in place?  How will potential backup suppliers respond to the disruption of a competitor?  Does this information suggest a different approach? In the case of the UPS strike, if your company was the only one to implement a backup arrangement with FedEx, that strategy would have worked brilliantly.  The problem was that every other company had the same idea.  Knowing in advance how FedEx might respond (i.e., by capping shipment volumes) would have provided another indication that this strategy was not likely to be effective.

So, can a backup supplier be an effective strategy?  Yes, in situations where the supplier’s industry is highly fragmented such that the loss of any one player does not disrupt the overall balance between capacity and demand.  And yes, when the risk that you are looking to mitigate is narrowly defined (e.g., quality issues for a product produced only for your firm) so as not to trigger a simultaneous response by other firms.  The use of a backup supplier can also be effective in combination with other strategies provided that the capacity limitations of the backup are well understood.  However, if the potential backup does not have the capacity to absorb the additional volume associated with the potential event or disruption – based on the expected actions of all parties affected by the disruption – then other strategies need to be considered.