Does Location Matter? Supply Chain Disruptions In Sparse Transportation Networks

Title: Does location matter? Supply chain disruptions in sparse transportation networks Author: Jan Husdal Møreforsking Molde AS Britv 4, 6411 Molde, Norway Tel: +47 71214289 / +47 91248023 Email: [email protected] Web: www.mfm.no Submission date: 1 August 2008 Revision date: 21 October 2008 Word count: 5637, incl. abstract and excl. 6 figures

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ABSTRACT Disruptions of the supply chain are of particular interest in countries or regions with sparse transportation networks. Here, the supply chain can not be structured freely, but is limited by constraints, and with only a few transportation modes and links available between communities, they become extremely vulnerable, since in a worst-case scenario no suitable alternative exists for deliveries to or from communities. Thus, the structure or design of the supply chain, along with the organization and preparedness become important factors in determining if a company has a favorable or an unfavorable location. The question then arises, are businesses located in regions with sparse transportation networks more prone to supply chain disruptions than businesses located in more favorable locations? Does a sparse transportation network constrain the supply chain setup, such that it is more vulnerable and more likely to be disrupted? This paper serves as a conceptual gateway for further research into supply chain disruptions in sparse transportation networks, and develops a new framework for the categorization of supply chains, based on the number of links and modes available in the transportation network. Sparse transportation networks can be categorized as constrained supply chains with an unfavorable supply chain setup. Within the constrained supply chain framework, a company can address its locational disadvantage by either redesigning the supply chain towards a better structure, in order to gain better location, or by redesigning the supply chain towards a better organization, in order to gain better preparedness.

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INTRODUCTION Transportation networks like freeways and interstate highways are the main backbone of modern society and play an important role in supply chains. Consequently then, the reliability of the transportation network or the reliability of supply chains is thus a decisive factor not only in terms of market outreach and competition, but also in terms of continuity, to ensure a 24/7 operation of the community we live in. Any threat to the reliability of the transportation network constitutes a vulnerable spot, a weakness in the supply chain. This vulnerability of the transportation network as part of the supply chain is of particular interest in countries or regions with sparsely populated areas, and hence, a sparse transportation network. Typically traits of such regions are few transportation mode options and/or few transportation link options for each transportation mode, for example maybe only one railway line and two roads, no port, no airport. It should not come as a surprise then that the nature of sparse transportation networks, and thus sparse supply chains, makes them vulnerable to many different kinds of internal and external risks. With only a few transportation modes and links available between population centers, these population centers become extremely vulnerable to any disruption in the transportation system or supply chain, since in a possible worst-case scenario no suitable alternative exists for deliveries to or from these communities. From the community is as important as to the community, since the supply chain goes both ways, meaning that no goods or supplies can come in and no manufactured goods or supplies to companies in other locations can leave. Few will question that the sender, the recipient, the freight hauler, or society at large, experience additional costs when goods or people cannot reach their destinations in time or in space. A non-functioning, or at best, badly-functioning link will impose costs on the user in terms of loss of time, additional operation costs or other costs as a result of delays and diversions. Transporters of perishable goods will also experience a loss of value. The question then arises, are businesses located in regions with sparse transportation networks in fact more prone to supply chain disruptions than businesses located in transportation-wise more favorable locations? Does the sparse transportation network influence the setup of the supply chain? Does a sparse transportation network in fact constrain the supply chain setup, such that it deviates from the ideal and thus is more vulnerable and more likely to be disrupted? This paper will not attempt to answer these questions but synthesize some of the recent literature on supply chain risk and apply it in a transportation vulnerability setting, and point towards some potentially interesting alleys for future research. As supply chains grow more and more complex and intertwined, special consideration should be given to the notion in (1) that “should systemic financial risk lead to a serious deterioration in the world economy, the prospects for collaborative (risk) mitigation may be reversed on several fronts simultaneously as attention turns to more immediate concerns.” This could imply that supply chain disruptions are likely to increase in the near future, as companies are struggling to keep themselves and governments are struggling to keep the national economies afloat, thus jeopardizing collaborative efforts in supply chain risk management, which at present may seem less important than the immediate economic concerns.

TRANSPORTATION NETWORK VULNERABILITY AND SPARSE TRANSPORTATION NETWORKS The vulnerability of transportation networks is a subject that has received increased interest within the academic community in recent years (2)(3)(4)(5)(6), and has been the topic of several international conferences, most notably Taking up the invitation in (5) to bring out and recognize the vulnerability in the road transportation system as a meeting point for all the different strands of transportation reliability research and other issues (p.127), the focal point of this paper is to look at the importance of transportation networks from a supply chain perspective, and how companies my overcome the disadvantages of unfavourable locations.

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In (5), the argument is made that studies of transportation network reliability to a large extent only seek to quantify the probability and to some degree the extent of failure, disregarding the potential for successfully handling the effects of failure, since obviously, vulnerability only then becomes a true vulnerability if the effects of failure indeed result in severe consequences. A methodology used in (6) identifies the most vulnerable road links by means of an accessibility index that have the greatest socio-economic impact. Transferred to supply chain management this could mean that links with the greatest socio-economic impact also are the most important supply chain links. Similarly it should be possible to assess the vulnerability of transportation-dependent business in relation to their location, and hence, assess the vulnerability of a company’s supply chain at that given location. The issue of sparse transportation networks is well illustrated in the figure below, showing same-scale maps of the road network Norway (the author’s home country) and Europe, taken from an online route planner. Lack of details and missing road links aside, it is clear that Central Europe enjoys a much better denser road network than the Scandinavian countries, and Norway in particular, and hence has many more rerouting options in case of disruptions. Thus, supply chain (road) disruptions will have potentially more severe implications in Scandinavia than in the rest of Europe.

FIGURE 1 The sparse road network in Norway and Sweden compared to the dense road network in Central Europe. (Source: viamichelin.com) A supply chain that is subject to a sparse transportation network can not be set up freely, but is limited by constraints, mainly transportation mode choice (air, sea, rail, road) and transportation link choice within each mode. Taking both modes and links into consideration, transportation networks or supply chains can be divided into four principal types of networks or supply chains: Free, Directed, Limited and Constrained. Figure 2 illustrates this division.

FIGURE 2 Four categories of networks or supply chains, based on the number of modes (rail, sea, air, road) and number of links within the modes that are available. In a free supply chain there are little or no constraints as to transportation modes and there is a dense transportation network with many possible links. In a directed supply chain there are many

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possible links, but few modes, thus directing the supply chain towards a certain mode or set of modes. In a limited supply chain there are many mode choices but few links, which creates an overall limited setup. In a constrained supply chain there are few choices as to mode and/or links and in worst case the supply chain is locked to one mode and very few, or maybe, only one link.

SUPPLY CHAIN RISK MANAGEMENT AND BUSINESS CONTINUITY MANAGEMENT From a broad perspective, a supply chain is not a chain, but an interwoven network consisting of suppliers, manufacturers, distributors, retailers and end-customers, where three kinds of flows take place: material (items or goods), financial (money) and information (documents and records). In popular terms this is often referred to as “boxes, bucks and bytes”. Supply chain disruptions often focus on a disruption in the first flow (material), but a disruption with crippling effects can essentially occur in any of these flows. Supply Chain Management (SCM) , formerly known as logistics, is not a new science, but it is only in the last decade or so that supply chain vulnerability and supply chain risk management has gained attention (7),(8),(9),(10). An excellent overview, linking supply chain management with risk management is given in (11). Globalization is a major reason why. Sparked by global outsourcing and offshoring, different industrial sectors in different supply chains are becoming increasingly vulnerable to disruption, dislocation, total breakdown or simply failure to deliver according to requirements (12),(13)(14). Supply Chain Risk Management (SCRM) has evolved from SCM and is a relatively new field. Nonetheless, it has many similarities with the already established field of Business Continuity Management (BCM). BCM is an interdisciplinary science and concerned with how an organization will recover and restore partially or completely interrupted critical function(s) within a predetermined time after a disaster or extended disruption. With lean and cost-effective supply chains stretched around the globe, it is easy to see how a supply chain disruption situation quickly can develop into a business continuity situation. The now classic textbook example of Nokia versus Ericsson in the Albuquerque plant fire incident shows how proactive and reactive supply chain risk management can make or break a company’s existence (15)(16). In a sparse transportation network setting, this author contends that a well-handled supply chain or transportation network disruption can translate into business continuity, while an ill-handled supply chain or transportation network disruption can translate into business dis-continuity. That is why SCRM can and should draw upon BCM for advice. The business continuity perspective is important, since it illustrates an important point made in a report (1), stating that even a relatively small supply chain disruption caused by a localized event may have consequences across the global economic system. The supply chain is an essential function in every organization, and when disrupted, there can be serious consequences not just for one single organization.

THE COST OF SUPPLY CHAIN DISRUPTIONS Interestingly, a study about how Norwegian businesses adapt to transportation disruptions (17) reported that road transportation is the mode of transportation that is that most flexible in case of supply chain disruptions. This should indicate that businesses relying heavily on road transportation in a constrained supply chain setup may be less vulnerable than businesses where the supply chain is shouldered upon other modes of transport, like rail or sea. Regardless of the inherent flexibility of road transport to change routes quickly, sparse networks are more likely than dense networks to be ridden with bottlenecks (18) that can cause severe delays or disruptions. In (19) a point is made that the typical socio-economic impact of road network disruptions in Western Norway varies greatly, depending on a) the traffic volume, b) the actual possibilities of rerouting traffic and c) the composition of the traffic that uses the impacted road. The

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study comprised 7 of the most avalanche-prone Norwegian counties with a total population of 1.7 million and a total road length of 38,000 kilometers (23,000 miles). Over a five-year period, 20012006, the average number of registered incidents was 136 incidents per year, with an average closure time of 16 hours per incident. The average hourly socio-economic cost was calculated to be $4,000 per incident, varying between mere $400 and as much as $16,000 per hour, depending on the three factors mentioned above. What should be noted here is that these are generalized costs, which do not take into account the actual and individual losses that are incurred by travelers, freight haulers or businesses at either end of the supply chain. Any disruption has a certain cost associated with it, and granted, passive acceptance of the disruption risk and passive acceptance of the disruption costs may be the common choice among many companies. Preparing for potential disruptions by investing in countermeasures may on the other hand lower the cost of disruptions. Several authors have addressed the issue of finding the optimal trade-off between supply chain security, vulnerability and cost. Both in (20), and later in (21), this trade-off approach is used within the framework of security management related to electronic business. Another very similar approach can be seen in (22) and (23) in determining the optimal value for investing in supply chain security. The actual cost of disruption or cost of recovering from a disruption will depend on the mitigative pre-emptive actions and the contingent recovery actions. The higher the mitigation costs, the lesser the economical impact of disruptions. However, there is the danger of “over insuring” against disruptions (24), and SCRM is concerned with balancing risk and reward.

ROBUSTNESS, FLEXIBILITY AND RESILIENCE In recent years, several “buzzwords” have been linked to supply chain risk and vulnerability in various ways, among which are robustness, flexibility, and resilience. Agility is another term that has emerged, and albeit not equal to, in the context of this paper, it will be considered to imply the same as flexibility. An overview of these terms as they relate to the vulnerability of a production system is provided in (25): Robustness is the ability to accommodate any uncertain future events or unexpected developments such that the initially desired future state can still be reached. Flexibility is the ability to defer, abandon, expand, or contract any investment towards the desired goal. Resilience is the ability of a system to return to its original state or move to a new desirable state after being disturbed. Flexibility, robustness and resilience are different sides of the same coin, yet at the same time distinctively different animals. Flexibility is the inherent capability to modify a current direction to accommodate and successfully adapt to changes in the environment, whereas robustness refers to the ability to endure such changes without adapting. Resilience, in essence, is the ability to survive these changes despite severe impact. In (26) the focus is on security and resilience by upholding flexibility and redundancy as two methods with the greatest potential to create resilience. Flexibility can here be seen as a contingency action (actions taken in the event of a disruption) and redundancy can be seen as a mitigation action (actions taken in advance of a disruption, hence incurring a cost regardless of disruption), akin to the distinction between contingency and mitigation in (27), which also identified a third “action”: Passive acceptance of the disruption risk and disruption, which more often than not appears to be the default strategy, even when it is not appropriate. Robustness, flexibility, and resilience stand out as three strategies or approaches towards supply chain disruptions. These three terms are distinctively different and which strategy that works best would depend not only on the supply chain in question as a whole, but also which part of the supply chain that may be vulnerable. A best-practice supply chain is likely to encompass all three, making it robust, flexible and resilient at the same time. There is a distinct notion of severity in these definitions, and in a business setting, the ability to survive (resilience) is likely to be much more important than the ability to quickly regain stability (robustness) or the ability to divert (flexibility).

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THE IMPACT OF SUPPLY CHAIN DISRUPTIONS The notion of supply chain resilience (28) is important when considering the impact of supply chain disruptions on supply chain performance and the time it takes to recover from a disruption. In both (25) and (29) a disruption profile is used to illustrate the incremental impacts and corresponding recovery activities, showing that recovery time and long term impacts are a function of resilience.

FIGURE 3 A typical disruption profile, adapted from (21), (27) and (28)

An almost identical figure is used in (30) in describing the business continuity planning methodology, where the time that elapses from when an incident occurs until normal operations are resumed is called maximum tolerable disruption or maximum tolerable outage. The disruption profile in (29) thus becomes a statement, while the profile in (30) becomes an objective. A good illustration of where the susceptibility to disruption (and hence, the resilience and ability to recover) is a determining variable in the strength of a supply chain can be seen in a report from the New Zealand research initiative “Resilient Organisations” (31). Here, resilience is a 3-fold construct, depending on 1) keystone vulnerabilities, 2) situation awareness and 3) adaptive capacity. The adaptive capacity becomes particular important in recovering from a disruption. In a supply chain this could be viewed as the the inter- and intra-organizational “preparedness” (or worst case, “unpreparedness”). It is the preparedness then that determines the actual impact of supply chain disruptions. However, supply chain resilience is not only a function of organizational preparedness, it is also a function of supply chain design.

DO SUPPLY CHAIN CHARACTERISTICS MATTER? The notion that supply chain characteristics play a major role in supply chain disruptions is greatly underscored in (32), where the severity of supply chain disruptions is related to supply chain design characteristics (supply chain density, supply chain complexity and node criticality) and supply chain mitigation capabilities (recovery capability and warning capability). In brief: supply chain structure and supply chain organization. It is argued that supply chain disruptions and the associated operational and financial costs should be viewed as a normal more than an abnormal occurrence. However, there are specific factors that contribute to or dampen the severity of such disruptions. These factors are presented in the form of 6 propositions: Firstly, proposition 1 to 3, an unplanned event that disrupts a supply chain is more likely have a severe impact if the supply chain structure is 1) dense or 2) complex or 3) contains critical nodes or bottlenecks. Secondly, proposition 4 and 5, an unplanned event that disrupts a supply chain is less likely have a severe impact if the supply chain 4) has proactive or reactive recovery capabilities or 5) warning capabilities, as in

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detection and dissemination of critical information. Thirdly, proposition 6, combining the previous 5 propositions, an unplanned event disrupting a supply chain that is dense, complex and with many critical nodes is less likely to be severe if there is a capability to quickly detect and disseminate information about the event and thus respond and correct in a proactive or reactive manner. Taking this proposition into sparse transportation networks, it may very well be that the structure or design of the supply chain in a sparse transportation network is already pre-determined, given and constrained by the transportation network, and thus, not chosen by the companies in the supply chain. In other words, proposition 3 holds, leaving proposition 4 and 5 (and 6) as the key attack points for lessening the impact of supply chain disruptions.

A MODEL FOR ANALYZING LOCATION-SPECIFIC SUPPLY CHAIN VULNERABILITY A typical supply chain consists of a company with incoming raw materials from an upstream supplier and outgoing products to a downstream customer, as seen in the figure below. On one side the supply chain is subject to certain potential disruptions, which act as risks. On the other side the supply chain has certain characteristics, which make up the supply chain vulnerability. The list categories of supply chain risks varies within the supply chain risk literature, but predominantly a division of five is usually applied: 1) supply-side risk, 2) operational risks, 3) decision risks, 4) demand-side risks and 5) external risks (33). In terms of supply chain vulnerability and within the realm of this particular research, the correct categorization of risks is not the issue at hand; what is at hand is the degree of supply chain vulnerability, i.e. how the supply chain characteristics influence whether or whether not potential disruptions may or may not impact the supply chain. Applying the notions in (32), the supply chain characteristics are divided into 1) structural (or locational) and 2) organizational characteristics, respectively. The figure below illustrates how the vulnerability of supply chain is determined by its structural and organizational characteristics.

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FIGURE 4 The relationship between risk, vulnerability, supply chain disruptions and supply chain characteristics

The term “location” refers to not only a physical location, but also to a sequential location within the supply chain. The term “organizational” refers first and foremost to which management and information structures that are in place. These two elements, structural and organizational, determine the degree of adaptability or capacity of the company to deal with or handle disruptions that might occur. The term “location” is furthermore used to mark the notion that the structure of the supply chain in a sparse transportation network is constrained by the transportation network. In terms of location, suppliers (or customers) can be clustered together in a dense formation or not, the supply chain may be complex with or without interdependencies, or it may be characterized by critical nodes, through which every item in the chain has to pass. The organizations within the supply chain may or may not be equipped with an adaptive capacity or preparedness, and in addition, there may or may not be established a protocol of system wide sharing of information on events within the chain. Although in most cases the structure and organization of a supply chain are not haphazardly put together, the degree of order and focus in supply chain structure and supply chain organization will vary from company to company. It can be said that the level of structural or organizational disorder that is present in a company’s supply chain equals the cost the company is willing to face vis-à-vis potential supply chain disruptions, while the level of organizational or structural order is the premium the company is willing to pay to insure itself against potential supply chain disruptions. The figure below takes the notion of supply chain structure and organization in (32) and adds a new perspective: supply chain categories, as described earlier

FIGURE 5 The severity of supply chain disruptions depend on supply chain structure and organization

The idea in the above figure is similar to (32), but differs from it in several ways: Supply chain disruptions are determined by the supply chain structure (design characteristics) and supply chain organization (mitigation capabilities). The production philosophy is the ideal world, while the transportation network, together with organization and structure make up the real world, in which the supply chain must function. The organization holds the preparedness, while the structure holds the location. Finally, the information flow in the supply chain serves as facilitator towards how supply chain disruptions are handled (warning capabilities). Location and preparedness thus become two important factors in addressing supply chain disruptions.

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OVERCOMING LOCATIONAL DISADVANTAGE If we contend that the supply chain structure represents a company’s location and the supply chain mitigation capabilities or organization represent a company’s preparedness, ideally then, if all contributing positive or negative factors noted in the six propositions in (32) are bolstered or lessened to the full, a company will be both well-located and well-prepared vis-à-vis any form of disruption. Conversely, given a supply chain structure prone to disruption, combined with a lack of organization, a company will be both badly located and badly prepared.

FIGURE 6 The influence of structure and organization on a company’s preparedness and locational favorability

In (32) the severity of supply chain disruptions are linked to a) the supply chain design characteristics and b) the supply chain mitigation capabilities. In other words: the impact of supply chains disruptions depend on a) the structure and b) the organization of the supply chain, where the structure makes up the physical side (a) of the supply chain and the organization makes up the human side (b) of the supply chain. These two parts are complementary in that both are needed for the successful handling of a supply chain disruption, while at the same time, a deficiency in one part can be compensated by the strength of the other part: A badly structured supply chain can be strengthened by making it a well organized supply chain. This is akin to the notion in (31), where the focus is NOT on the vulnerability of systems to failure, but on the ability to manage and minimize the impact of any failures. This is achieved by focusing on organizational preparedness. This implies that firms placed in disadvantageous locations can notably better their supply chain by focusing on improving their supply chain characteristics. Thus, in regions or countries with sparse transportation networks or few transportation mode choices the structure or design of the supply chain becomes an important factor in determining if a company has an advantageous or a disadvantageous location. By re-designing the structure, locational disadvantages can be lessened or entirely eliminated, and a supply chain wise “badly” located company can become “well” located. Conversely, if the structure cannot be improved (or not be improved further), by re-designing the organization, proper training and adding supply chain visibility such that early warnings and early proactive and reactive actions are possible, a company can turn from badly prepared into well prepared. Robustness, flexibility and predominantly resilience will be key components in addressing locational disadvantage. Overcoming locational disadvantage may be of particular interest in a supply chain life cycle perspective (34), where supply chains come into existence and cease to function as business opportunities come and go. A constrained supply chain setting may affect the ability to form new supplier and customer relationships (i.e. supply chains), and thus, this may limit the business opportunities for companies in disadvantageous locations.

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CONCLUSION This paper has made the argument that sparse transportation networks can be viewed as a special case of unfavorable and constrained supply chain setup, with maybe little room for improvement of the supply chain structure itself. Within this framework a company can address its supply chain structure and organization. Locational disadvantage may be overcome by redesigning the supply chain towards a better structure, in order to gain better location, or redesigning its organization, in order to gain better preparedness. The latter may also be the case with favorably located (or supply chain structured) businesses that may have overlooked their preparedness. The implication that should be apparent then is that supply chain structure and organization essential element of supply chain management at the operational, the tactical, and the strategic level, and should not be overlooked. A well-handled supply chain or transportation network disruption can translate into business continuity, while an ill-handled supply chain or transportation network disruption can translate into business dis-continuity.

FUTURE RESEARCH What is still lacking is a full empirical underpinning of the arguments made in this paper. With sparse transportation networks as a departure point, the following questions should be addressed:

1. Does the location reflect a typical supply chain structure? 2. Does the supply chain structure given by the location lead to typical supply chain disruptions? 3. Does the location have bearings on the organizational preparedness for certain disruptions? 4. Does the location lead to typical mitigation and contingency measures? One way of answering these questions could be to 1) survey and sort (a sufficient number of ) companies according to the four supply chain categories mentioned in this paper, in order to verify whether certain geographic locations are likely to have certain supply chain categories. Thereafter 2) investigate which supply chain disruptions that are typical for said locations (and supply chain categories). In addition, 3) estimate the degree of vulnerability these supply chain categories represent, i.e. is ”directed” worse or better than ”limited”? Finally, 4) how do companies in the different supply chain categories prepare for supply chain disruptions? It is hoped then that Transportation Management, Freight management, Logistics, Supply Chain Management and Business Continuity Management can find a common research ground that is still not fully explored, and bridge the gap that exists today between the different professions.

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