Preparing the Supply Chain for the Unthinkable.

Ever since terrorists attacked the United States on Sept. 11, 2001, Corporate America has grappled with planning for business interruptions in case of another man-made disaster. But instead of a human threat, so far companies have had to cope with the wrath of Mother Nature.

Natural catastrophes, most recently the hurricanes that swamped the Gulf Coast, have had a devastating effect on businesses. Still, some firms are reticent to spend on contingency planning, as they don’t want to pay for something that may not happen.

Jim Rice, director of the Massachusetts Institute of Technology’s (MIT) Integrated Supply Chain Management Program, says that companies need to assess the risk and the cost associated in not taking preventive action, particularly in regards to the supply chain.

Rice spoke with the Consumer Markets Insider about the nation’s supply chain challenges with the specters of terrorism and disasters hanging over companies’ heads.

Consumer Markets Insiders: In terms of the supply chain, how is terrorism different than the natural disasters of last year?

Jim Rice: Both terror attacks and natural disasters are “high consequence-low probability” events. But terror attacks differ in a few ways; [terrorists] can adapt their attack depending on vulnerability, [while] terror attacks tend to affect businesses to a greater extent, as some studies show that 80 percent of attacks are directed at businesses rather than individuals.

The hurricanes have affected American supply chains. In addition to any firms with production facilities in the Southeast, most consumer product companies experienced packaging shortages as many of the packaging materials are petroleum based.

Additionally, there have been [other] disruptions that have affected the supply chain, such as the labor lockout of West Coast ports in 2002. Suppliers went out of business in this labor dispute, which closed [29] ports along the West Coast. About half of all American imports and exports pass through these ports. The 10-day shut down resulted in loses of $2 billion to $3 billion per day.

CMI: How did companies deal with the lockout?

Rice: The first couple of days, companies expected [a work stoppage], so they planned to have extra inventory to cover for the days they wouldn’t receive goods. But by the fourth day, raw materials had dwindled and finished goods weren’t making it into the port. Some companies elected to fly goods in.

In addition, companies had to use other ports. Goods were stuck in containers waiting for ships to get into the West Coast.

CMI: How can companies better prepare for disruptions?

Rice: Companies have to start looking at what happens miles away, and how it will affect them. There was a story in the Wall Street Journal about how a Chinese chemical company released toxic benzene into a nearby river following an explosion. The seepage into the river will affect cities over 100 miles away.

These types of incidents have a domino effect. Any company that uses water will have to shut down. We talked to a company in New Orleans, and until recently, they couldn’t use water to run its operations [following Hurricane Katrina]. They had to truck tanks of water to restore their operations, until they were able to drill their own well 750 feet below the plant’s operations.

CMI: You talk about a company being “resilient.” What does that mean?

Rice: Resiliency is the ability of a company to respond to an unexpected disruption and return operations to what they were before the disruption. MIT did a survey in 2003, interviewing mid- to large-size companies to find out how they responded to past disasters and how organizations are responding the new post-Sept. 11 environment.

Companies that worked on improving their responses by learning from past disruptions took actions to design and operate their supply networks to be resilient, as well as secure. This sets them apart from their competitors.

CMI: Given that we’re seeing the frequency of business interruptions increase, what do you expect that the supply chain will resemble?

Rice: We are often asked about the future and what the supply chain should look like and the skills and technology needed to run it. Our Supply Chain Response to Global Terrorism study revealed that companies should be focusing on business continuity planning, creating layers of backup and aggressively training people and making security and resilience a part of company culture.

Companies have improved physical security, such as securing access to corporations, putting in gates and have installing camera systems, although there is still a lack of “deep awareness” of securing extended [computer] networks rather than just their own physical operations. Other basic responses also included installing firewalls and software to detect intrusions and viruses.

CMI: What about more sophisticated strategies?

Rice: More advanced responses include extensive background checks, auditing business partners? information systems and working with industry groups to establish widespread use of industry standards such as radio-frequency identification, biometrics and smart cards.

[But] in creating resilient systems, companies have to remember that technology isn’t the end-all solution. When technology is combined with a great process and people, then great things can happen. Some companies achieve great things with not much dependence on technology.

CMI: How much of this will be government-mandated?

Rice: Companies will have to improve their business continuity plans, because Hurricane Katrina put continuity and disaster planning on the radar for the government and industry both. Companies need to look at what’s possible in terms of disruption and how vulnerable they are. Then they have to consider what is needed to create the resilience to keep their supply chain operating.

However, the planning and contingencies need to be balanced [with inventory management]. It would be impossible for firms to justify untold amounts of inventory “just in case” of a disruption.

CMI: But many companies are unwilling to spend money on planning for something that may not happen.

Rice: Some companies have a hard time justifying the investment in improving security and business continuity plans because they are investing to prevent a disruption — when you think about it, a security investment is successful when all disruptions and security breaches are avoided. It’s difficult to show a return on investment with nothing happens.

We need to use other measures to justify investment, such as taking a company-wide view of risk, and what will happen if these measures weren’t taken and a disruption happens. Companies should consider the benefits of risk prevention.

For instance, if companies decide to invest in the government’s voluntary program C-TPAT [Customs-Trade Partnership Against Terrorism, Container Security Initiative, Operation Safe Commerce], it would allow them to gain quicker passage through ports. It would also force them to conduct an assessment of how secure their supply chains really are.

CMI: So being flexible offers competitive advantages?

Rice: Planning for disruptions allows companies to be flexible if they are going to respond to events. For instance, one company that uses petrochemicals in their packaging now considers oil prices a determining factor for their packaging material. As oil prices have gone up, so has the price of packaging. The company realized package prices could jump so it decided to spend on redesigning its packaging.

Now they have flexibility to deal with the disruption in raw materials. Companies don’t have to wait for a disruption to be prepared. The peculiar thing is that the time to react is before a disruption occurs. If you wait until there is a need to be flexible, it’s usually too late.