A Rule for Risk

Supply Chain Frontiers issue #19. Read all articles in this issue. 

As the sudden decline in the fortunes of airline JetBlue show, even companies that are riding high can be jolted by an unexpected business disruption. New research at the MIT Center for Transportation & Logistics aims to define risk metrics that will forewarn companies and investors of operational flaws that could unseat even the most well-regarded supply chains.

JetBlue Airways hit the skids this February, when a major snow storm forced it to cancel more than 1,000 flights and disrupt the travel plans of over 100,000 passengers. JetBlue’s reputation took a nose dive, and some $200 million was wiped off its market capitalization.

Why was the airline’s fall from grace so dramatic? Analysts, investors and even JetBlue’s own management were unaware of the risks it was facing. The likelihood of a service meltdown was not reflected in analysts’ reports and probably not in its stock price. Reflecting operational risk in a company’s valuation is difficult, because there is no metric that can be used to measure (and therefore assess and manage) this type of risk. 

Similarly, even though an international supply chain is vulnerable to disruptions, and interruptions to product flows can undermine a company’s long-term viability, quantifying these risks is difficult. Yet recovering from adversity is a capability that has become critically important in today’s risk-prone business environment. For example, in his book The Resilient Enterprise (MIT Press, 2005), Professor Yossi Sheffi, director of MIT-CTL, shows that resilient companies tend to bounce back quickly from supply chain disruptions. 

The goal of the new CTL research project is to explore different approaches to creating and calculating supply chain risk metrics. By comparing distinct sets of metrics - the relative advantages and disadvantages and relevant case-studies whenever applicable - a framework for measuring supply chain risk is being developed.

Initially, the project involves five distinct but complementary avenues of research.

•    Existing risk frameworks are being revisited to identify their applicability to supply chains. This includes the frameworks used in the accounting, engineering, insurance, and manufacturing industries.    •    Using data provided by several companies participating in the project, a database of disruptions and supply chain characteristics is being constructed.  The database will support the development of econometric models to determine the relative importance of a variety of factors such as inventory levels, the number of suppliers involved, the availability of alternative parts, lead time, and the company’s competitive position. The damage from actual disruptions also will be factored into the analysis.    •    The research will assess the advantages and disadvantages as well as the main challenges of using insider information to measure supply chain risks. For example, a distribution manager might have intimate knowledge of a supplier that is not available to senior management.    •    Various models of supply chain characteristics are being developed. These models will be used to understand the effect of disruptions under multiple supply chain structures and configurations. The work will generate key metrics modeled on the different environments.    •    Finally, a set of case studies documenting the value and limitations of supply chain risk metrics is an integral part of the work.   Efforts are also under way to develop a robust methodology to “roll up” risks at the supplier level, through the bill-of-materials, to the OEM and customers such as retailers.    This is an extract from a forthcoming article in the April 2007 issue of Supply Chain Strategy. For more information on CTL’s supply chain risk metrics research contact CTL Research Associate Edgar Blanco.