The hidden costs of supply chain disruptions

Buckle up, world. The supply chain disruptions of recent years aren’t stopping anytime soon.

“The world is far more volatile, [and] getting more volatile all the time,” Ted Stank, co-executive director of the Global Supply Chain Institute at the University of Tennessee Knoxville’s Haslam College of Business, told CFO Brew.

Even as supply chain disruptions become increasingly visible, there’s a reason supply chains stay out of sight and mind most of the time.

“I always tell students, supply chains are like a bunch of dominoes, and they all have to fall down, right? If you take one domino out of that chain, the whole chain fails, and supply chains are like that,” Lance Saunders, a professor of supply chain management at UTK’s Haslam College, told CFO Brew. “Most people don’t see that because supply chains work, and it’s because they work most of the time [that] you’re not seeing all those steps that have to happen to make that package show up at your door.”

But when they don’t? Oof. Supply chain disruptions have fairly obvious cost implications, Stank and Saunders noted: Missed sales, increased transportation and inventory costs, paying overtime for workers, operating plants on double or triple shifts due to closures elsewhere.

This article isn’t about those costs, though. It’s about everything CFOs may be overlooking while scrambling to address those costs.

Hidden costs There’s one immediate overlooked cost from supply chain disruptions that applies to just about any public company, Stank noted: a hit to the stock price. 

When companies have to report on disruptions—say, a crisis at one of their manufacturing plants—research finds a “major impact on share price within a day of announcement of disruptions like that,” he added. And research from Georgia Institute of Technology and the University of Western Ontario found that “even if major disruptions are infrequent, it can severely hamper a firm’s stock price performance for years to come.”

So that’s number one. But another overlooked mistake you might make when addressing supply chain concerns? Misguidedly trying to calculate the exact probability of a given risk, Saunders said.

Navigating any supply chain disruption is really just a risk calculation, and when you get down to it, Saunders stresses that all risk really means is the “probability of something happening times the consequences if it happens.”

“Common sense would tell you, we’ll figure out the stuff that has the highest probability and the highest consequences, [and] go there,” he continued. “But I think a lot of companies start trying to get too specific on: Is this a 2.3 chance or 1.2 [chance of happening]? The biggest danger is, if you don’t consider a risk in general, you’re assuming its probability is zero.”

Point is: Don’t get bogged down trying to get everything exactly right. Instead, it’s better to consider all possibilities, and “start thinking about how you might control it, whether it’s [to] eliminate it, reduce it, [or] mitigate it,” he said. You really never know: Starting a year ago, Houthi rebel groups attacked commercial shipping vessels in the Red Sea. Good luck finding the company that calculated the precise likelihood of that.

How to address these costs? But wait. You can’t possibly consider all potential disruptions. Striking longshoremen? Bridges collapsing?

In order to better address the costs that might slip through the cracks amid a supply chain disruption, it’s all about covering your bases. Risk management techniques like risk matrices exist for a reason.

“Obviously, you’re going to work on the [risks] first that have the highest rating or consequence, and the highest probability,” Saunders said.

But beyond that, considering all potential risks could mean spending more now to avoid unwanted costs down the line. “If your supplier goes down, having dual sources of supply, sometimes that’s more expensive up front, but when it goes down, it allows you to not have a disruption,” he noted. “Sometimes it’s taking an up-front cost to avoid the big potential costs that happen because of the risk.”

That goes for most aspects of a given supply chain. Accounting for extra shifts, extra inventory, or building good relationships with backup supply or transportation sources can help you cover your bases better before a disruption has occurred, Stank and Saunders said.

Enemies close. And the single best thing CFOs can do to avoid hidden costs amid supply chain disruptions? To paraphrase: Keep your risks close, and your supply chain leaders closer.

Stank notes that in the 35 years he’s been studying supply chain topics, “the companies that have made the most impact financially…[by] using their supply chains in a really smart manner” were (not coincidentally) the ones that also had their “chief supply chain officer as the biggest partner of the CFO.”

“Those two together can win many arguments at the C-suite and enable the firm to make decisions around the supply chain that help it to really optimize that revenue generation, cost reduction, asset turnover, that’s so important to financial health and cash flow,” Stank said. “It’s been really amazing to see in every case [when] the chief financial officer and chief supply chain officer see eye-to-eye on things.”