Can there be such a thing as too much supply diversification? A new paper on global supply chains suggests that manufacturers that try to reduce their risk by diversifying their suppliers may in fact be increasing their entire industry's risk of disruption.
That somewhat counterintuitive insight is developed in a new paper co-authored by Kostas Bimpikis at Stanford Graduate School of Business, and it may have implications for more than just manufacturing.
In a nutshell: 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.
It's standard practice for automobile manufacturers, for example, to have more than one supplier for critical components. That sounds like it makes sense. If something bad happens at the one company that supplies headlights for Lexus, the disruption could shut down production for the entire line of cars.
But Bimpikis, in a paper with Douglas Fearing at the University of Texas and Alireza Tahbaz-Salehi at Columbia University, argues that the problem 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.
That 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.
To Bimpikis, Fearing, and Tahbaz-Salehi, bottlenecks like those suggest a blinkered understanding of what happens in a networked economy. 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." They 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.
The broader lesson is that multisourcing in a networked environment is a double-edged sword: It provides great power to cut costs and diversify risk, but it can also have significant adverse effects.
"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."
The recent security breach at Target Corp. provides an excellent illustration of this point: Computer hackers managed to steal data on more than 40 million customers, a revelation that hurt sales at the height of last year's holiday buying season. It turned out that the hackers cracked into Target's system in part by going through its supplier for heating and ventilation services. In a world where almost every company is tied electronically to scores of other organizations, increased connectivity brings increased exposure to risks.
Kostas Bimpikis is Assistant Professor of Operations, Information and Technology at Stanford Graduate School of Business. Much of his research focuses on the study of complex networks.