By Ann Grackin

Introduction

Over the last few years, we have evolved supply chain practices and systems from industrial age concepts to the information age—an age rich with connectivity and data. This has allowed us to change the foundational structure on how we manage the enterprise. The information age that brought us supply chain systems has allowed us to begin to control the chaos that we have found about us.

Scientists define a chaotic system as one that appears to behave randomly, but is, in fact, governed by rules. Chaotic systems are highly sensitive to initial conditions, the seemingly insignificant and arbitrary events that ultimately can have profound and seemingly unpredictable results. But in reality, the results are fairly predictable if our measurement devices sense these inputs.

Market formulation is like these chaotic systems, where the confluence of many activities ultimately creates an organized storm or system. What is true is that many of these events are understood and the outcome of them can be predictable. But today, these are not modeled in the systems we have. Supply Chain systems to date have represented the back-end of that process of servicing markets, which heretofore appeared to be the tail end of the chaotic system—the least powerful and uncertain.

Managing Uncertainty: The Third Paradigm

The supply chain, in embracing the digital world, has taken us a long way in replacing assets with information. But the fact is, building products still takes a long time. Contrastingly, markets require short response times—days. So far, the game plan is still to hedge with assets—people, plant and materials. Leaner, yes—but we are still victims of the uncertainty created by the gap—between market uncertainties and the expectation for definitiveness.

Firms have tried various methods to deal with this—outsourcing many processes to dump risk down the chain, reduce product selection and specialization, and charge more (when they can) for customizations. Some of the thought process around this is healthy, since it forces firms to think about their differentiation. If the customer is going to wait, it had better be worth it—like handcrafted components in a Rolls Royce vs. an assembly line created Toyota Corolla. Yet even in this mid-market, some customization is expected. And the expectation is fast response to the customer chosen feature. Here of course, is the first key to managing uncertainties. It is the ability to design products and service delivery models that isolate what will be customizable, and the rest is off the shelf. But even within the narrowing of choices, the risks are wide and large.

Risk Management Supply Chain Application

For the last few years, we have been beginning the process of trying to understand the unplanned event, the introduction of the so-called event management software. This begins to allow us to see out of plan activities. But this technology provides a system of alerting, based only on known models. However, we are just beginning this new capability, (figure 1) the Third Paradigm.

Figure 1

So, we are planning for the unexpected—reducing risk! Again, even in our chaotic model, the early stages have many of the same elements that we are oh so familiar with.

I will spend the rest of the article briefly describing the concepts. There are algorithmic underpinnings to these concepts, but here we only have space to introduce the topic and illustrate the positive impact that applying this can have to your business^[1] .

So what does it mean to plan for uncertainty?

The first and second paradigm systems deal in knowns—this is what I think I need and therefore this is what I will buy. The Third Paradigm focuses on the uncertainty elements (figure 3) to understand risk. This is the key. Isolate, understand and organize the chaos—creating an operational and financial model.

What is the co-relationship between those uncertainties and burdens—additional costs, time, the changing of agreements or relationships? If there are shortages, for example, we might pay increased costs or try to lock down supply partners with inflexible terms. But if we have a game plan, we may not have these penalties.

Figure 2

A simple example will clarify the concept. Firms are reluctant to overbuy stocks. We might wind up with too much inventory, and that capital investment can have a huge opportunity cost—preventing us from making other critical investments. With products where we have a fair knowledge (low risk) of their behavior in the market, we can set up contracts that build in volume discounts, set lead times, and manage a lean inventory model. But in new product introduction, for example, there is much uncertainty. If the product does not take off, we have huge inventory losses. However, if it does take off, we can miss the market timing, and lose revenue. Even worse, our competitors are watching, and determine to introduce a similar product. They will seek out suppliers—maybe our suppliers—which will create shortages and higher prices. There goes your market leadership, your margins, and maybe your market. Big risks!

Figure 3

A paradigm of two systems would not identify or isolate these issues. It would help you to pick a course—one course—and you would procure against that. In the Third Paradigm, we can isolate the issues; build options that create the most favorable plan, including the uncertainty factors—not ignoring them!

Conclusion: Making it a Process

Another aspect of the Third Paradigm is to make managing uncertainty part of the business process where the organization contemplates and codifies these assumptions about how the business will behave. This takes us from hallway conversations into management of the risk. I find that so many organizations have many stories and fears about these issues, but they never actually take the steps to rationally and deliberately build a plan to master these dynamics—and win. If markets are risky, and you manage risk better—are you not, therefore, ahead of your competitors?

Technology and process can take us a long way to entering this Third Paradigm. As Aristotle said: “It is through knowledge that I gain understanding…and understanding lets me do by choice what others do by constraint of fear.”

[1] For more in-depth understanding and discussion of these concepts go to: http://www.chainlinkresearch.com/parallaxview/V2_03/home.htm.

©2005 ChainLink Research, Inc.