Supply Chain Risk Management - Essay Example

?Supply Chain Risk Management Introduction The supply chain and logistics risks to an industry have attained greater importance because of globalization of business functions. It has become very arduous to minimize costs and increase performance levels without the support of distinct resources for benefitting from improved supply chain management. Therefore, the significance of supply chain management theories and their usage in all industry types has increased greatly. Supply chains are evolved by companies for fulfilling business needs and functions. Supply chains help business to survive and grow. Each business is a part of the supply chain completing the assigned task. A multi-tier supply chain includes various flows i.e. financial flow, Information flow and material flow. Third party logistics (3PL) services providers who manage and perform specific logistic functions for other companies arrange the inbound and outbound logistic functions of the suppliers or owners (Khan et al., 2010). The term “supply chain management” came into usage in the 1990s for earlier used terms like “logistics” and “operations management”. “A supply chain is a network of facilities and distribution options that performs the functions of procurement of materials, transformation of these materials into intermediate and finished products, and the distribution of these finished products to customers.”—Ganeshan and Harrison (1995)). Thus, it can be derived from the above definition that supply chain management (SCM) follows a set of approaches to effectively integrate suppliers, manufacturers, warehouses, and customers so that exact quantity is produced and supplied to the desired destination and at the exact time to reduce system wide costs while fulfilling service level needs. The general impression on SCM is that it helps in achieving the final aim of minimizing inventory risks (Khan et al. 2010). According to Kannegiesser et al. (2007), supply chain processes are not simple enough to be performed easily in the value chain. Good performance depends on the capabilities and integration among different departments, suppliers and customers. A three-echelon evolutionary route is followed by companies to gain value through the supply chain processes. The first level is completed via internal supply chain management activities associated with logistics and procurement. Procurement for companies’ stock can stockpile high inventory levels and additional transport costs if the inventory is not consumed due to lack of demand (Kannegiesser et al., 2007). The second echelon can help companies in optimizing supply chain processes via integrated management of supply chains. The central focus of supply chain management is to manage the risk of overflowing inventories and inefficient handling of information not only within the company but among all supply chain members, which could be original equipment manufacturers (OEM), maintenance, repair and overhauling (MROs) or third-party logistics (3PL) partners to minimize stock levels and achieving optimization in resource usage (Kannegiesser et al., 2007). As such, the aim of supply chain management is to cover the cost risk, to offer the desired service level and fulfill customer expectations. Production and distribution functions have to be integrated to achieve optimum performance volumes. As decisions on quantity and price of stock can not be taken beforehand, any drawback in integrated approach can reduce the profit margins although cost-cutting has been used as a tool in supply chain management (Kannegiesser et al., 2007). Research Background -- Theory Before discussing the study outcomes on total logistic costs based on general modeling approach, some theoretical background on current literature is necessary. There are two types of studies on logistic costs. One type deals with strategic parts of logistics and the other with optimal logistic decisions. This is the second type, which helps in mitigating risks, the leading purpose of which is finding system costs, which includes transportation costs besides inventory and purchase expenditure. Demand designs play a crucial part but less thought in the global supply chains has been given to appraise logistic policies. Vidal and Goetschalckx (1997)) have introduced a mechanism of future research possibilities for modeling of international production-distribution chains. The literature is deficient in finding the impact of taking pipeline inventory, a differentiator in increasing costs in any global transportation systems and not considering order processing costs (Zeng, 2002). SCM in Aviation Industry Importance of supply chain in any industry segment can better be evaluated by selecting any industry and company for analysis of its supply chain optimization processes; how the company is managing its internal and external logistics and supply chain processes for effective cost reduction and efficiency. Aviation industry offers huge potential for managing risks to its spare parts supply chain. Since 1968 a multiline technique for repairable item control (METRIC) model for covering cost risks on reusable spare parts has been developed by Sherbrooke (Deshpande et al., 2006). The model has helped in formulating repairable items stock management policies by using the base stock model. The aim of METRIC model is to minimize the risk of overstock at the base level, and reduce financial burden on overstocking and formulating indicators for optimum stock policy. When the items are not costly and their demand rate is high, it fits the policy implications. Base stock model has been used by many researchers at least in line of the supply chain. Indenture spare parts are chosen first for repair at each line or distribution centre. Multi-indenture repairable parts have also been chosen to model lower indentures. The base stock model can also be used in systems that support consumable spare parts (Al-Rifaia & Rossetti, 2007). Airlines are managing their overstock risks by multi-line stock keeping as shown in the research. These techniques offer great leverages. Deshpande et al. (2006) have done analysis on aviation spare parts servicing, attempting achievement of the optimal stock levels for meeting external demand without including the demand drivers. Other methods include the degradation signal modeling method, which focuses on using the signal that catches the degradation of an aircraft spare part to find the life of that part. The performance of aircraft spare parts for efficient SCM does not support making all new purchases of degraded spare parts as parts can be reused in future considering the cost factor among other causes of reusing them. Old parts are repaired therefore for repeat usage, which solves the risk of additional stockpiling. Literature on stock management is focused on reusing the used items by repairing them. The field of spare part related risk management for hassle-free operation of flights is deficient in theory and system support. Achieving optimization in aircraft spare parts supply chain management is not easy as there is a vast range of aircraft spare parts and their complex manufacturing process. No single theory can be applicable universally to all kinds of aircrafts. Therefore, the risk is resolved by attempting optimizations at the part level. The fact that total optimization cannot be reached has been recognized by leading airlines such as the British Airways; only part optimization can be attempted (MacDonnell & Clegg, 2006). Airlines have found different ways of cost cutting on spare parts. Airlines have opted outsourcing the spare parts management to a limited extent. The risk in repairing inventory is covered with different time extent demand through Poisson distribution that matches with the industry trend of manufacturers briefing airlines on the number of spare parts to be kept in the inventory (MacDonnell & Clegg, 2006). Yet another model has been in practice wherein performance of one-stock keeping unit, many retailers and non-repairable spare parts are managed efficiently through the inventory system. This model developed by Deuermeyer and Schwarz (1981) was improved upon by Svoronos and Zipkin (1988) by measuring in a distinct way the mean and variance of demand lead time (DLT) and accruing the warehouse DLT by joining two translated Poisson distributions. Thus, they measure the performance indicators at the warehouse similar to the measured number of backorders, used later to account for the delay at the warehouse because of split-stock (Al-Rifaia & Rossetti 2007). Rajgopal et al. (2009) have stated the risk of reducing the stock and its variants in a very easy way. At the start, a product is supplied in chosen small sizes but later demand is made in large number of unequal sizes to be made available by segregating those components from the given stock. The risk lies in finding the many parts of the stock of standard size to be parallel with the earlier designs to ensure the finding of all component requirements in reduced cost. In such situation decisions are taken in stochastic conditions wherein the formulations for such conditions offer least value to rest of the parts as they are meant to be rejected. Literature exists on finding value for the rejected parts of the inventory but problem comes in computing value of remaining parts. Impact of ICT over Supply Chains Nucciarelli & Gastaldi (2008) have discussed the effect of ICT on demand and supply side in aviation industry. The e-marketplace has got attracted with such applications like internet, intranet, business-to-business (B2B) and business-to-consumer (B2C). The e-market supply chain has become potent with relatively requiring reduced time in strategically managing risks in supply chain processes. Relationship between Supply Chain and E-marketplace Before analyzing the relationship between airlines’ e-business and e-supply chain, the aim of supply chain should be clearly defined, which is a long term cooperation among firms using shared resources to fulfill common and independent aims for the group of firms (Ketchen and Guinipero 2004)). The motive behind such cooperation is to reduce the number of suppliers and develop long term strategic collaboration resulting in ‘lock-in’ of suppliers and ‘lock-out’ of competition (Nucciarelli & Gastaldi, 2008). E-marketplace, on the contrary, boosts competition and allows buyers to locate trustworthy suppliers. An open e-marketplace can hold back airlines to actively be a part of offering sub standard products. Airlines’ relationship with current suppliers can be damaging for buying specific products (Jones and Mithas 2002)). As a result, the ‘move to the middle theory’ (Clemons and Reddi 1993)) puts doubts over the actual compatibility between e-marketplaces and supply chain management because of the interest focused on long term relationships with selected suppliers only (Jones and Mithas 2002)), as cited by Nucciarelli & Gastaldi, 2008). E-business and supply chains Transparency and collaboration among the supply chain partners plays a decisive part in collecting and sharing information. With the inclusion of ICT new roads have opened for many e-business applications making it difficult to choose a singular model for companies. Companies get the leverage from e-business applications as their application results in increased efficiency, increased resource usages, satisfactory customer service and better value for the shareholders but the e-business model has been targeted for not totally adhering to the concept of supply chain management (Nucciarelli & Gastaldi, 2008). A Case Study of Cathay Pacific Airways Cathay Pacific Airways Limited is one of the globally operating airline when it comes to performance optimization. The financial position of the Cathay Pacific from business generating perspective has been remarkable. To continue with the remarkable performance levels in earnings and growth, the airline wanted to optimize its supply chain business processes in the stock keeping units. The top bosses of the company have relegated the job to concerned department functionaries of finding means to cover the risks related to operations management in all areas of the supply chain, specifically in inventory management (Yen et al., 2009). Spare parts buyer market In the buyer market of aircraft spare parts inventory there was no prevailing opinion over the quantity of spare parts required because demand of spare parts was made on the basis of given information on stock keeping, stock-planning and mapping future needs on usability, which was never accurate as demand patterns changed intermittently. Out of total stock of spare parts, only 30% was being used and the other 30% had to be kept in stock although it was not used more often because of insufficient demand and the rest of the 40% stock of spare parts was never used. Investment made on maintaining sufficient stock were highly under-utilized; only 10% was used from the airlines’ stock keeping units and MRO companies’ current stock. Management of spare parts was quite costly and was excluded from the final output of spare parts kept by the airline industry; 80% cost was shared by the carrier companies (Yen et al., 2009). Supplier Market in General Off-late, recession has affected the market of aviation spare parts. Airlines are struggling to survive amidst worldwide recessionary trends by searching means of cutting costs as air traffic has reduced considerably. Globalization and desire to reduce cost has given spurt to outsourcing of MRO functions, particularly of the aircraft frame part. Behavior of lower-tier suppliers has been shifting while big suppliers have been hard in not bargaining with airlines and MRO suppliers in the current market downfall worldwide. Still MROs have the potential to reduce cost of aircraft spare parts. Industry experts have felt the appearance of monopoly features in the market functioning with the original equipment manufacturers (OEMs) bent to increase the rates of repairing and overhauling of aviation spare parts as is the opinion of the MROs. “Because it’s a monopoly market... you have to purchase spare parts from the same guy, and also repairs,” remarked Gunther Kruse, vice president of corporate purchasing for Lufthansa Technik (LHT) (Adams, 2009). Supplier Market of Cathay Airlines Cathay Pacific also depends on OEMs of the supply chain, as there is no other alternative present other than OEMs that are well positioned to benefit from the situation besides only OEMs can adhere to strict quality parameters. Aerospace giants like Goodrich Corporation and Honeywell Aerospace are on the top in the supplier market. Anti-trust law is a hurdle in going for joint collaboration by airlines to impact the procurement process. In countries such as Australia such collaborations can not workout as are entered into by supply side giants impacting the supply market. Spare parts arranged via the regulated program referred as “PMA”, (Parts Manufacturer Approval) is considered to be the solution for locating spare parts in reduced lead time and at reduced cost. For used spare parts, PMA has been a correct choice but for new parts there is no other option other than the OEMs as only OEMs know and have the desired skills of repairing and over-hauling spare parts (Yen et al., 2009). Strategies in the Aviation Marketplace There is pressure to reduce costs by 10-15%. This is because business models are inefficient. Industry experts’ opinion is that until Lean strategy or some steps are taken the cost reduction measure won’t produce desired effect. A change in the interaction between airlines and airframe MROs could be the desired strategy by opting maintenance outsourcing. The cost cutting measures adopted by airlines have created the risk to sustaining the outsourcing functions, as it is affecting the MRO’s capabilities; they are unable to provide timely repair services of spare parts. Spare parts timely delivery risks can not be mitigated by levying penalty to the MROs. MROs are the important and crucial link of the aviation supply chain. By entering into partnerships on profit sharing basis with them by the airlines can help MROs to increase their resource utilization strength by purchasing new material and effectively performing. In this regard, the example of such collaboration between Lufthansa and LHT can be given. Risk can also be covered by creating a pool of spare parts; LHT has done such an arrangement, offering “the entire spectrum of parts down to consumables.” Europe has been leading in accepting a pooling solution but in this regard North America has lagged behind because of insufficient resources, various maintenance programs, and unavailability of needy spare parts and lack of interest by the engineering staff on the usability of pooling concept (Adams, 2009). Risks of Supply Chain & the Case Study In Cathay Pacific, the airline’s Engineering Commercial division manages supply chain risks in three fields that include procurement, inventory operations (IOP) and planning. Routine stock needs related to spare parts of the aircrafts are attended by IOP while procurement risk is managed at commercial level with suppliers (Yen et al., 2009). Division of service parts (Boylan and Syntetos, 2008) is a crucial function in Cathay Pacific’s supply chain management. It tackles issues of SCM at four levels: • Finding of service aims • Fixing of inventory targets • Selection of forecasting approach • Selection of forecasting method Importance of Information Exchange in Spare Parts Supply Chain Likewise supply chain manufacturing risks, interruption in the supply chain of information exchange can be another ajor risk if left unattended. Cathay Pacific has been using Ultramain, a mechanical and engineering application developed to provide total information on stock of spare parts and logistic solutions. The application is customized for the airline’s internal supply chain needs but it is not comprehensive enough for providing risk cover on reusable spare parts. The functionality of Ultramain is not satisfactory in the provision of critical spare parts (Yen et al., 2009). Information sharing is a crucial factor between customer companies and irregular suppliers. Supplier side information is very crucial to the tail end customers of the supply chain. The given information can be used by all stakeholders as information flow is not always a one sided process from customers to suppliers. Risks can be covered in spare parts management if information flows on either side of the supply chain. Supplier can share information on the stock of available spare parts for customers’ record and end customers, which are airlines, can place orders for such parts not possible to provide by the OEMs. Such stock items can be arranged from suppliers for stock purpose to be used in future by airlines, as stochastic spare parts. Alternative spare parts can also be provided by the supplier to resolve the risk in case a spare part is not there with supplier or the supplier can make new parts identical in “Form, fit and function”. The functioning of supply chain processes should be transparent in the supply chain, including latest inventory availing consumers for attending to their spare part needs and building value for all stakeholders of the supply chain. The supplier is the primary stakeholder on the supply side for building a pool of spare parts and relevant insurance policies (Martin et al., 2010). From operational outlook, such an understanding in the supply chain can control and manage local demand changes. Theoretically, all partners of the supply chain can play a part including the tail-end customers by offering their unused stock, and reverse-streaming the process from down to upside. The increased transparency level of spare part stock in the supply chain can help in the “aggregation of demand” to positively effect in the reduction of supply chain risks (Martin et al., 2010). Pooling of aircraft spare parts can be effective medium of managing related risks, as appeared in an article in the Aviation Week & Space Technology. Airlines can build a buffer stock of spare parts by delaying unwanted maintenance, using extra inventory, reducing inventory, and using parts of outdated aircrafts, which according to the David Stewart, a principal with AeroStrategy, is going to be a practice in near future. Talks are in advanced stage on creating a worldwide parts service through finding algorithms, according to Burkhard Pfefferle-Tolkiehn, Lufthansa Technik's director of component product sales, with Germany's Federal Ministry of Education (Burchell 2009). Pooling of aircraft spare part can tilt the balance to compensate the loss of time and performance in logistics by using pooling tactics. General opinion also sponsors integrated solutions based on large scale pool-sharing, guaranteeing provision of parts at affordable cost. An Oliver Wyman study has also agreed to the idea of pooling of aircraft spare part inventory, pointing that the North American pooling has $700 million in repairable spare parts in assets, which can be converted to liquidity (Burchell, 2009). Conclusions The supply chain management of aircraft spare parts is a complicated matter, as impacting performance level if not managed properly. By using an integrated stock optimization of the supply chain, risks can be minimized. Need is to honestly follow the related processes, as Lufthansa Technik has proactively managed to raise the level of its services by attending to three significant functions: 1. Providing functional flexibility by verifying customers’ demands individually by specifically focusing on critical needs, outsourcing crucial parts from strategic partners and providing alternative arrangements if customers face aircraft-on-ground (AOG) . 2. Efficient IT Support and Processes need to be included in management tools with better performance levels, providing interactive interfaces to all partners of the supply chain. Data and information needs to be of relevant high quality and error-free. 3. OEMs, MROs or VMIs – all strategic partners should build regional stock keeping units (SKUs) and use pooling resources to reduce response time, logistics and local presence. All stock needs to be concurrently maintained as per criticality, investment and processing needs. The risk management in the supply chain is a big initiative to meet customers’ spare part needs effectively. Equally important is building of internal mechanisms and creation of tools which is a cumbersome task. Software solutions need to perform concurrently with process and organizational happenings. Managing spare part in the situation of an AOG can be very risky and challenging (Bussmann & Bauer 2007). The research on stock optimization through aviation supply chain management has provided knowledge on the complications and risks on managing aviation spare parts supply chain. It has analyzed forecasting of spare parts demand as based on theory and its application on single fleet, two-line and multi-line supply chains. Performance in optimization of spare parts depends on sharing of information between all links of the supply chain. No single organization can accomplish total optimization singularly. Information exchange at airlines’ internal management process’ level is not enough to realize the desired outcome but integrated management of the supply chain network can be decisive in achieving spare parts optimization. The research has thrown light on the processes that handle inventory management issues. The significance of spare parts in aircraft operations shows how important is to manage risks by maintaining optimum level of stock of all categories of spare parts to avoid the aircraft on ground situation, which can cost an airline 100,000 EUROS besides inconvenience to passengers. The role of supply chain partners is very important whether they are original equipment (OEMs) manufacturers or maintenance, repair and overhauling (MRO) partners with whom airlines enter into parts stock maintenance agreements. These agreements could be material or performance based logistics (PBL) agreements. Important role of e-marketplace in bringing the supply chain partners nearer and developing strategic partnerships of end-customers with suppliers and other stakeholders such as MROs namely Lufthansa Technik and Embraer for creating an optimized pool program is foremost and detrimental in managing risks to aviation supply chains. References Adams, Charlotte. (2009). Supply chain: problems and solutions. Aviation Today. Retrieved from http://www.aviationtoday.com/am/issue/cover/Supply-Chain-Problems-and-Solutions_32278.html Al-Rifaia, Mohammad H., Rossetti, Manuel D. (2007). Special section on cost engineering. International Journal of Production Economics, 109 (1-2). Retrieved from http://www.sciencedirect.com Burchell, Bill. (2009). Pooling pays: maintenance, repair & overhaul. Aviation Week & Space Technology, 171 (14), p. 38, ?). Retrieved from http://proquest.com Bussmann, Johannes ., Schmidt, Thomas., Bauer, Andreas. (2007). Proactive event management in the supply chain of aircraft spare parts. Lufthansa Technik AG, Germany. Retrieved from http://www.springerlink.com Boylan, John E., Syntetos, Aris A. (2008). Forecasting for inventory management of service parts. Complex System Maintenance Handbook. Available from http://www.springerlink.com Grisi, Roberto Maria., Murino, Teresa., Zoppoli, Pasquale. (2010). 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