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Deploying Simulation to Compare among Different Risk Reduction Strategies for Supply Chains

Cameron MacKenzie, Defense Resources

Management Institute, Naval Postgraduate School

Japanese earthquake and tsunami

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Previous research

• Global macroeconomic impacts

MacKenzie, C.A., Santos, J.R., & Barker, K. (2012). Measuring changes in international production from a disruption: Case study of the Japanese earthquake and tsunami. International Journal of Production Economics, 138(2), 293-302.

• Disruption management strategies in the

automobile sector

MacKenzie, C.A., Barker, K., & Santos, J.R. (2013). Modeling a severe supply chain disruption and post-disaster decision making with application to the Japanese earthquake and

• tsunami. IIE Transactions, in press.

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Risk management strategies

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But this chart just shows benefits! What about costs of strategies?

Challenges of determining strategy

• No single objective function

– Maximize profit – Maximize demand satisfied – Maximize percentage of demand versus competitors

• Different costs for each strategy

– Spend $1000 on one strategy to save $10,000 in profit – Spend $500 on another strategy to save $7500 in profit

• Preparedness versus response strategies

– Spend $1000 on inventory to save $10,000 in profit if a disruption occurs – Spend $1000 to purchase from alternate suppliers once disruption occurs to save $5000 in profit

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Challenges of determining strategy

• Uncertainty over length of disruption, customer

actions, and competitors’ strategies

• No functional relationship between strategies and
• bjective function and/or relationships are highly

nonlinear

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Supply chain disruption in auto sector

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Illustrative example

Supplier 1 Supplier 2 Supplier 3 Supplier 4 Firm 2 Firm 3 Firm 1 Final consumers

55 21 8 12 8 26 13

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Severe supply chain disruption: multiple suppliers cannot produce and multiple firms are impacted

Simulate severe supply chain disruption Select response strategy Choose response strategy that performs the best according to an

• bjective

Repeat but assume that response strategy is being implemented

Simulation

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Discretize each strategy so that each strategy costs the same “small” amount

Preparedness strategies

Select one preparedness strategy

Response strategies

Choose preparedness strategy that performs the best Repeat but assume that preparedness strategy is being implemented

Firm 2’s preparedness strategies

• 1. Hold raw materials inventory

– Supply 1 – Supply 2 – Supply 3

• 2. Hold finished goods inventory
• 3. Arrange to purchase from alternate suppliers in

case of disruption

– Alternate supplier 1 – Alternate supplier 2 – Alternate supplier 3 – All alternate suppliers

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Firm 2’s response strategies

• 1. Purchase from alternate suppliers at higher cost

– Alternate supplier 1 – Alternate supplier 2 – Alternate supplier 3 – All alternate suppliers

• 2. Help supplier 3 recover more quickly

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Objective: maximize profit

• If no preparedness strategy
• Then best response strategy
• 1. Help supplier 3 recover more quickly
• 2. Purchase from alternate supplier 3
• 3. Purchase from alternate supplier 3
• 4. Purchase from alternate supplier 3
• 5. Purchase from alternate supplier 3

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Objective: maximize profit

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Preparedness strategies

• 1. Arrange purchase from all

alternate suppliers

• 2. Arrange purchase from

alternate supplier 3

• 3. Arrange purchase from

alternate supplier 1

• 4. Arrange purchase from

alternate supplier 3

• 5. Arrange purchase from

alternate supplier 3

• 6. Arrange purchase from all

alternate suppliers

• 7. Arrange purchase from all

alternate suppliers

• 8. Arrange purchase from

alternate supplier 3

Response strategies

• 1. Purchase from alternate

supplier 1

• 2. Purchase from alternate

supplier 2

• 3. Help supplier 3 recover more

quickly

• 4. Purchase from alternate

supplier 1

• 5. Help supplier 3 recover more

quickly

• 1. Purchase from alternate

supplier 3

• 2. Help supplier 3 recover more

quickly

• 3. Help supplier 3 recover more

quickly

• 4. Purchase from alternate

supplier 2

• 5. Help supplier 3 recover more

quickly

Objective: maximize demand

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Preparedness strategies

• 1. Arrange purchase from all

alternate suppliers

• 2. Raw material inventory for

supply 2

• 3. Raw material inventory for

supply 2

• 4. Raw material inventory for

supply 3

• 5. Raw material inventory for

supply 3

• 6. Raw material inventory for

supply 2

• 7. Raw material inventory for

supply 2

• 8. Raw material inventory for

supply 3

Response strategies

• 1. Help supplier 3 recover more

quickly

• 2. Help supplier 3 recover more

quickly

• 3. Help supplier 3 recover more

quickly

• 4. Help supplier 3 recover more

quickly

• 5. Help supplier 3 recover more

quickly

Greedy algorithm for preparedness

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Arrange purchase from alternate supplier 3 Arrange purchase from alternate supplier 1 Arrange purchase from all alternate suppliers Raw material inventory Finished goods inventory Arrange purchase from alternate supplier 1 Arrange purchase from all alternate suppliers Raw material inventory Finished goods inventory

But algorithm could be too greedy

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Arrange purchase from alternate supplier 3 Arrange purchase from alternate supplier 1 Arrange purchase from all alternate suppliers Raw material inventory Finished goods inventory Arrange purchase from alternate supplier 1 Arrange purchase from all alternate suppliers Raw material inventory Arrange purchase from alternate supplier 1 Arrange purchase from all alternate suppliers Raw material inventory

Future research

• Refine simulation further

– Expand current path versus explore new path – Investigate number of simulation runs to obtain certain degrees of confidence

• Use simulation to generalize insights about
• ptimal risk management strategies

– When is holding inventory optimal? – When is buying from alternate suppliers optimal?

Email: camacken@nps.edu

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Simulation

1. Simulate response strategies given no preparedness strategy 2. Discretize each strategy so that each strategy costs the same “small” amount

1. Keep 10 units of raw material inventory for $100 2. Buy 5 units of supply from alternate supplier for $100 3. Spend $100 to help primary supplier recover more quickly

3. Simulate severe disruption with firm selecting one strategy 4. Choose strategy that performs the best according to an

• bjective (e.g., profit, customer demand) or weighted

combination of objectives 5. Repeat step 2 but assume that strategy chosen in step 3 is being pursued

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Results from maximizing profit

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Preparedness strategy Total expected profit lost due to disruption Arrange purchase from all alternate suppliers 392 Arrange purchase from alternate supplier 3 334 Arrange purchase from alternate supplier 1 397 Arrange purchase from alternate supplier 3 335 Arrange purchase from alternate supplier 3 328 Arrange purchase from all alternate suppliers 429 Arrange purchase from all alternate suppliers 331 Arrange purchase from alternate supplier 3 309

Results from maximizing profit

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Response strategy given best set of preparedness strategies Total expected profit lost due to disruption Purchase from alternate supplier 1 350 Purchase from alternate supplier 2 312 Help supplier 3 recover more quickly 309 Purchase from alternate supplier 1 312 Help supplier 3 recover more quickly 326

Results from maximizing profit

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Response strategy given no preparedness strategies Total expected profit lost due to disruption Help supplier 3 recover more quickly 471 Purchase from alternate supplier 3 466 Purchase from alternate supplier 3 462 Purchase from alternate supplier 3 458 Purchase from alternate supplier 3 454 Purchase from alternate supplier 3 450 Purchase from alternate supplier 3 446 Purchase from alternate supplier 3 442 Purchase from alternate supplier 3 440 Purchase from alternate supplier 3 437

Results from maximizing demand

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Strategy Total expected demand lost due to disruption Purchase from all alternate suppliers 674 Raw material inventory for supply 2 437 Raw material inventory for supply 2 562 Raw material inventory for supply 3 489 Raw material inventory for supply 3 659 Raw material inventory for supply 2 693 Raw material inventory for supply 2 575 Raw material inventory for supply 3 597

Results from maximizing profit

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Response strategy given best set of preparedness strategies Total expected demand lost due to disruption Help supplier 3 recover more quickly 795 Help supplier 3 recover more quickly 749 Help supplier 3 recover more quickly 640 Help supplier 3 recover more quickly 606 Help supplier 3 recover more quickly 597

Outline

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• 1. Motivation
• 2. Research contribution
• 3. Model and simulation
• 4. Application

Supply chain risk management

• Qualitative [1, 2]
• Quantitative

– Production and inventory models [3] – Game theory [4]

[1] Y. Sheffi, 2005. The resilient enterprise: Overcoming vulnerability for competitive advantage. Cambridge: The MIT Press. [2] C. S. Tang, 2006. Robust strategies for mitigating supply chain disruptions. International Journal of Logistics Research and Applications 9 (1):33-45. [3] B. Tomlin, 2006. On the value of mitigation and contingency strategies for managing supply chain disruption risks. Management Science 52 (5): 639-657. [4] V. Babich, 2006. Vulnerable options in supply chains: Effects of supplier

• competition. Naval Research Logistics 53 (7):656-676.

Disruption management [1]

• Disruptions cause operation plans to deviate
• Disruption management studies optimal way to react

in the midst of disruptions

– What should be done once a disruption occurs? – How to minimize the impacts and return to normal production?

[1] G. Yu and X. Qi, 2004. Disruption management: Framework, models and

• applications. River Edge, NJ: World Scientific Publishing.

What is new with this research?

Mitigation Preparedness Recovery Response

Supply chain risk management

Decision and actions by suppliers and firms during and after disruption

Research questions

• How can we model the

supply chain where

– Some facilities are inoperable? – Other firms experience a supply shortage?

• What can firms do to

mitigate the impacts of inoperable facilities and supply shortages?

Outline

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• 1. Motivation
• 2. Research contribution
• 3. Model and simulation
• 4. Application

Simulation

Supply shortage for firms Move production to alternate facility? Firms receive required supplies Buy from alternate supplier? No Yes Supplier’s facility is closed Finished goods inventory? Demand not satisfied or customers buy from other firms Supplier’s facility reopens? No No Yes Yes No Supply inventory? No

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Produce at alternate facility?

Per-unit cost of producing at alternate facility Fixed cost of moving production to alternate facility Expected lost revenue

• f not

producing Per-unit cost

• f producing

at primary facility Probability primary facility

• pens next

period Probability supplier’s customers buy from other suppliers

Cost at alternate facility Expected cost at primary facility

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Produce at alternate facility?

Per-unit cost of producing at alternate facility Fixed cost of moving production to alternate facility Expected lost revenue

• f not

producing Per-unit cost

• f producing

at primary facility Probability primary facility

• pens next

period Probability supplier’s customers buy from other suppliers

Cost at alternate facility Expected cost at primary facility

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Threshold parameters for supplier

𝑞 = 𝑠 − 𝑑+ 𝜄 𝑑+ − 𝑑 1 − 𝜄

If probability that primary facility will open next period is greater than 𝑞 , supplier will not produce at alternate facility

Per-unit cost of producing at alternate facility Per-unit cost of producing at primary facility Probability supplier’s customers buy from

• ther suppliers

Per-unit revenue

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Threshold parameters for supplier

𝐷 = 𝑞𝑎 + 𝑨 𝑠 − 𝑑+ 𝜄 − 𝑞 𝑑+ − 𝑑 1 − 𝜄 𝑞 1 − 1 − 𝑞 1 − 𝜄

If fixed cost of moving production is greater than 𝐷 , supplier will not produce at alternate facility

𝑞 = 𝑠 − 𝑑+ 𝜄 𝑑+ − 𝑑 1 − 𝜄

Cost of alternate facility Cost of primary facility Probability of buying from

• ther suppliers

Revenue Probability primary facility opens next period Per-period demand Backorders

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Threshold parameters for supplier

Probability of primary facility opening 𝑞 = 𝑠 − 𝑑+ 𝜄 𝑑+ − 𝑑 1 − 𝜄 𝑞 Never produce at alternate facility 𝐷 Fixed cost of moving to alternate facility 𝐷 = 𝑞𝑎 + 𝑨 𝑠 − 𝑑+ 𝜄 − 𝑞 𝑑+ − 𝑑 1 − 𝜄 𝑞 1 − 1 − 𝑞 1 − 𝜄 Produce at alternate facility but may wait some length of time

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Never produce at alternate facility

Firm’s influence diagram

How much to produce? Maximize profit in current period Satisfy demand Value Time when suppliers’ facilities reopen Customer loyalty Inventory

• n hand

Selling price Cost of alternate suppliers

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Modeling insights

• Incorporating business decisions in midst of

supply chain disruptions

• Solving for optimal production decisions as

function of model parameters

• Measuring impact of preparedness decisions
• n firm’s ability to respond during disruption

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Outline

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• 1. Motivation
• 2. Research contribution
• 3. Model and simulation
• 4. Application

Supply chain disruption in auto sector

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Application inspired by auto sector

• Supplies required for production
• Several model parameters gleaned from news

reports

• More precise information needed for cost and

revenue parameters Supplier 1 Supplier 2 Supplier 3 Supplier 4 Firm 2 Firm 3 Firm 1 Final consumers

55 21 8 12 8 26 13

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Simulation results

Average production when suppliers do not move to alternate facility

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Simulation results

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Average production when suppliers do not move to alternate facility

Simulation results

Average production when suppliers do not move to alternate facility

Simulation results

Average production when suppliers move to alternate facility

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Sensitivity on parameters for Firm 2

Parameter Low Base High Tradeoff between

• bjectives

Maximizes profit Equally prefer both objectives Satisfies demand Final goods inventory 0 periods 6 periods 12 periods Cost of alternate supplier Primary supplier + 6 Primary supplier + 3 Equal to primary supplier Selling price Equal to cost Cost + 1 Cost + 2 Primary supplier’s recovery (expected time) 36 periods 26 periods 3 periods Supply inventory 0 period 2 periods 4 periods Customer loyalty (probability firm’s customer does not buy from competitor) 0.01 0.61 0.99

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Application insights

• Illustrative example reflects actual situation

– Toyota and Honda’s share of production in North America fell from 10% to 7% each – Nissan’s share of production in North America remained constant – Detroit 3 automakers increased their share of production in North America by 4%

• Application provides insights into best strategies for

response and recovery

– Buying from an alternate supplier may be a better long- term strategy than inventory – Costs of different strategies should be incorporated

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This work was supported by

• The National Science

Foundation, Division of Civil, Mechanical, and Manufacturing Innovation, under award 0927299

• The Center for International

Business Education and Research (CIBER) at The George Washington University

Email: camacken@nps.edu

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