Why big business needs to revisit the risk vs. efficiency trade-off
Corporate Canada is going to have to undergo a shift in priorities to balance efficiency with risk management if the country is to become more resilient to the next inevitable economic downturn stemming from a crisis.
Fraser Johnson, a professor of operations management at the Ivey Business School at Western University, says the coronavirus pandemic has thrown a wrench into the long- held corporate view that excess capacity is wasteful and that getting the lowest price for supply, often through arrangements with far-flung global suppliers, should be the driving force.
“We need to balance risk and efficiency — the pandemic is shining a light on the risks we’re taking,” he said, noting that this holds true whether the next crisis is driven by a health threat, cyber attack, or natural disaster.
Businesses in sectors from retail to manufacturing have been hit by supply chain disruptions during the pandemic. In some cases, plants running without backup have been forced to shut down due to COVID-19 outbreaks. For meat processors disrupted by the pandemic, such as Alberta’s Cargill Inc. plant, this has had repercussions for the food supply to their customers, including restaurants and supermarkets.
Years of tightly calibrated production of medical supplies, meanwhile, led to ongoing shortages of personal protective equipment for medical workers and respirators for patients. The result was bidding wars and trade conflicts as manufacturers across industries had to suddenly figure out how to ramp up production.
To better prepare for next time, Johnson and other experts recommend companies across multiple sectors adopt stress-testing of various hypothetical scenarios to identify and then mitigate risks — similar to what big banks did in North America and across Europe in the aftermath of the financial crisis a decade ago.
Stress tests would force companies to consider more than just price when they negotiate contracts with suppliers, Johnson said, adding that questions such as “How do we build when there’s sudden demand?” should be at the forefront of such deliberations going forward.
New measures could include training more people to keep on standby, like “weekend warriors” in the military reserves, he said. Contingency plans could also include a roadmap to quickly re-tool operations to produce strippeddown product lines that require fewer workers.
“Being able to manage risks comes with a cost,” Johnson said. As a result, he doesn’t think it will be quick or easy transition from the mindset that excess capacity is wasteful and that the lowest cost for supplies is best.
Part of the difficulty is that the emphasis on lean, efficient supply — forged in the automotive industry and embraced by a host of other industries including agrifood — is now ingrained in incentive systems governing compensation and executive bonuses.
“We need to balance and align the incentive systems” to put a higher value on other inputs, Johnson said, adding that change runs the risk of igniting “witch hunts” or finger- pointing if, for example, stockpiled supplies go unused.
“My concern is we’re going to go back to our old line of thinking” after the pandemic eases, he said.
“My experience is that organizations have got short memories.”
Perrin Beatty, president of the Canadian Chamber of Commerce and a former federal cabinet minister, said global supply chains will undoubtedly be part of any discussion in government, and in boardrooms across the country, about preparedness for the next crisis.
“Whenever our supply lines can be cut, whether because of war, politics, terrorism, pandemic or natural disaster, we have a vulnerability,” said Beatty, whose portfolios in government included national revenue, defence and treasury.
He said there would undoubtedly be an economic cost to adopting measures such as increased inventories or sourcing more supplies domestically.
“However, if you can’t be sure that you will be able to get supplies when you need them, you have little choice but to make the trade-off,” he added. “It’s a matter of risk management.”
Beatty said he has seen a number of recent examples of supply chain breakdowns during the pandemic, including a luxury goods maker whose deliveries were thrown into disarray because it was unable to get one part — an 80-cent zipper from China.
“As a result of this experience, boards all over the world will be carefully considering this issue,” he said, adding that “risk mitigation” is a key responsibility for every corporate board of directors.
Hossein Abouee Mehrizi, an associate professor in the department of management sciences at the University of Waterloo, said the “bottlenecks” and “choke points” exposed by the COVID-19 pandemic are a natural consequence of efforts by many industries in recent decades to get leaner and more efficient.
“We may alleviate one bottleneck, only to encounter another,” said Mehrizi, who is also a Canada Research Chair in health-care analytics.
“The downside of this efficiency success is that we don’t have enough buffer in the system — equipment, human resources, etc. — so we can’t meet the excess demand arising in a pandemic or crisis.”