Strategic Risk from Supply Chain Disruptions

Supply chain disruptions can lead to both tactical (loss of short term sales) and strategic (loss of long term market share) consequences. In this paper, we model the impact of regional supply disruptions on competing supply chains. We describe generic strategies that consist of two stages: (i) preparation, which involves investment prior to a disruption in dedicated backup capacity and/or measures that facilitate quick detection of a problem, and (ii) response, which involves post-disruption purchase of shared (non-dedicated) backup capacity for a component whose availability has been compromised. Using expected loss of profit due to lack of preparedness as a measure of risk, we characterize the conditions that pose the greatest risk and suggest ways to reduce the risk exposure. This analysis reveals that a dominant firm in the market should focus primarily on protecting its market share, while a weaker firm should focus on being ready to take advantage of a supply disruption to gain market share. We distinguish between preparedness activities related to monitoring and detection as systemic preparation, which affects many components simultaneously, and preparedness activities related to securing extra dedicated backup capacity as targeted preparation, which affects only a specific component. We characterize conditions that affect the optimal ratio of investment in these two types of preparation and conclude that larger firms should use targeted preparation defensively, while smaller firms should use it offensively. Finally, we discuss how firms can use both long term information (e.g., estimates of the likelihood of disruptions) and real-time information (e.g., severity of disruption after it occurs) as part of their preparedness strategy.