Nicole DeHoratius: Supply Chains Are Rethinking Their Low-Cost Focus

Nicole DeHoratius is adjunct professor of operations management at Chicago Booth. This transcript is taken from an interview conducted April 14, 2020.

How do you prepare a supply chain for disaster?

Supply-chain-management professionals have been facing incredible challenges, and they are rising to the occasion. They are under a tremendous amount of stress, and for the most part, the right product has made it to the right place at the right time in the right quantities—although the health-care supply chain has been disrupted, and in ways that are unimaginable.

Supply chains have contingency planning—they do all sorts of risk-mitigation techniques—but typically when there’s a disruption, it’s local or regionalized. Think about the Japanese earthquake and tsunami in 2011—or the 2017 NotPetya cyberattack of [shipping and logistics giant] Maersk that shut down parts of the supply chain. These were majorly disruptive events. But the difference now is that this event is global: it’s happening at all places at all times, and it’s impacting both supply and demand. That’s what has made this incredibly challenging for supply-chain-management professionals to mitigate.

I don’t think many companies prepared for a correlated disruption around the globe. Most of them have in place regional activities so that they can reposition inventory in the face of a hurricane, say. Walmart, Home Depot, and [US regional grocery chain] H-E-B have been doing this for years. These companies know how to deal with regional disruptions and are basically scanning the marketplace for any disruption that might occur. Many of them have warning indicators. Some companies, H-E-B included, received early warnings that something was going on in China, and they increased their inventory levels in their systems in anticipation of a disruption.

When it comes to thinking about what’s next for supply-chain management, I predict we will see a more formalized approach to risk mitigation.

One of the things that I find really imperative is that supply-chain-management professionals recognize the lack of visibility in the system in terms of where inventory is, what products are needed, and who has the capabilities to produce them. Medical distributors such as Medline, Owens & Minor, and Henry Schein have asked for permission from the government to collaborate, so that they can share information about where inventory is and where it’s needed.

Absent this collaboration, they don’t have enough information to make good decisions. There is no omniscient person who makes decisions on behalf of a centralized supply chain. If you have all these entities working without coordination, you won’t have the optimal supply-chain solution. But when you have companies saying to the government, “We’re going to collaborate for the purposes of this pandemic. Afterward, we’ll stop, but we’re going to collaborate now so that we can make sure that our resources are effectively allocated within the channel,” that’s a wonderful thing. 

How will COVID-19 change supply chains?

The most important element of this pandemic will be how we rethink the trade-offs between cost and responsiveness. When operations professors teach about supply chains, we talk about how many companies are looking for the cost-effective solution. They’re chasing the lowest per-unit cost of the good, and that sends them to places with low labor costs for their manufacturing. They also transport their goods via ship, which can take weeks to reach the United States. They are focused on building a supply chain that’s extremely cheap in order to produce goods that are sold for low prices.

But I challenge my MBA students to think about the flip side. Right now, we see clearly the value of being responsive, of shortening the lead time. We see Project Airbridge, in which FedEx is working with the government to airfreight goods, including personal protective equipment such as masks and gloves, from factories in Asia and elsewhere to the US, to cut the lead time from weeks to several days.

It’s easy to identify the costs of a supply chain: I have data on the labor and the raw material. What’s hard to estimate is the value of responsiveness. I teach my students how to value it. How do you estimate the cost of being understocked, or the cost of having extra inventory? Those metrics are often noisier than the cost metrics, and there are more assumptions to be made than on the cost side of the equation. That’s why we tend to overemphasize cost at the expense of responsiveness, and we’ve seen this in today’s supply chain. Part of the problem now is that we don’t have agile, resilient supply chains for some of the goods we need, where we ought to have had them in place.

Supply-chain-management professionals will think differently about how they value agility—about whether they’re willing to pay a little bit more to have a contract with a vendor that might be able to go online quickly if need arises.

My expertise is in the retail space, and I predict we’re going to see additional adoption of robotics sooner than we might have otherwise. In Europe and some parts of Asia, most distribution centers have extensive robotics and automation. We don’t have that in the US, but this pandemic has caused us to think differently. Walmart, for instance, is rolling out a robot that can count items and help with replenishment. We see another company bringing automation into its fulfillment centers to help pick and pack goods going to the end consumer.

How healthy are supply chains following the advent of COVID-19?

Many of these supply chains are fairly robust, and they have been smart about how they’ve been running their factories. Take consumer goods and some food and beverage companies. In the past, they might have made 100 variants of a particular product. Now they’ve said, “OK, I’m not going to make 100 variants, because for each variant, I have setup time. I’m going to only make one or two, and as a consequence, I can increase my capacity.” As a result, we might have less choice as they focus on one or two units to maximize their capacity.

The only thing I worry about, particularly for retail, is that we’ve seen a big spike in demand for consumer goods, and we’ve seen a depletion in demand for durable goods and industrial products. The effect has been pretty large in the apparel industry, so we see a lot of displacement of workers in the apparel and fashion industries in Bangladesh and Cambodia. Textile orders were down by 35 percent, and imports were at a five-year low. These have implications for the long-term supply chain. How quickly can companies ramp up again once demand comes back?

Visibility within the supply chain is something that supply-chain-management professionals often identify as one of their biggest obstacles to performance improvement. They might be able to see one tier down the line—who’s supplying to them—but they have no visibility into the suppliers of suppliers. This affects their ability to plan and mitigate risk. In the future, we’re going to need tools to provide visibility further down into many of the subtiers of our supply chain.

In response to consumer demand, big food companies have been trying to find out the exact sources of their products. The same is true in some other industries, including apparel. Consumers are demanding to know a bit more about the source, and companies are spending the money and time to figure that out. But it is not easy.

We’ve often seen companies reactively approach risk and disruption, and this situation might induce them to be more proactive and to have formal mechanisms in place. There are some stellar companies that already had the warning signals, stress tests, etc. But those that didn’t will be thinking seriously about how to put a robust risk-mitigation system in place.

Overall, the signs are that the supply chain is doing quite well. The need for transportation and warehousing has gone up. We have a logistics-performance index, which, over the past five years, had been declining, and it just went up because of the need for these things. I can’t promise that there are not going to be bankruptcies and an elimination of some links in the supply chain, but we’re in a robust enough setting that the chain will keep going.

What worries me a bit more is the retail space, especially retailers that were already weak, now that we have changed our buying behavior. We’ve become much more accustomed to buying some things, including groceries and clothes, online far faster than what one would have predicted for the US.

This consumer behavior, if it persists, could be problematic for some retailers. Many companies haven’t invested in digitizing the supply chain. Tractor Supply is an example of one that had been slowly rolling out the option to buy online and pick up in store. It had a methodical, well-thought-out rollout—but just said, “You know what. We need to do this now.” The company rolled it out to all their stores, and that is impressive.