Jan Fransoo

Extreme scenario analysis for the Coronacrisis

With the Coronacrisis now seemingly getting firm ground in Europe, we are in dire need of extreme scenarios for the supply chain. We have been seeing very unconventional supply chain effects unfolding over the past weeks:

  • Apple faces great difficulty with ramping up the Foxconn manufacturing plant in Zhengzhou due to an insufficient number of dormitories to quarantine incoming migrant workers
  • Liner shipping companies have been canceling huge numbers of sailings from China, both due to demand drops but also due to access limitations on crew
  • Road transport in China is scarce due to quarantine and travel restrictions across the country

The art of scenario thinking has been mastered by Royal Dutch Shell over the past 60 years. Unlike the thinking of many, scenarios are typically not possible realizations of the future for which to prepare. The purpose of scenarios is to help managers stretch their thinking. Stretching your thinking helps you prepare for less extreme developments than pictured in the scenarios.

Can we think of some components of scenarios that could stretch our thinking of this Coronacrisis? It would be good to share some of your thoughts on this, as scenario thinking benefits from co-creation, i.e. letting multiple ideas flower at the same time.

Some initial ideas from my side to spark the mind:

1. European border closures

Over the past two years we have seen many scenarios pass for the hard Brexit. We would see large queues at borders between the UK and the continent, products could be stopped from crossing the borders and people movement could come to a halt. The only advantage we had at that time is that companies had time to prepare. They did so by massively building up inventories. Suppose we would see Brexit-like border restrictions at every internal European border? It may hence many sense to build up some stock ahead of time.

2. Much slower rampup in China

While on the epidemic side the Chinese seem to gradually get the situation under control, at the same time it may very well be that the rampup is much, much slower than anticipated. Companies that I talk to have all been estimating that by April supply volumes should be up to normal. Now that Korea, as an important supplier of critical high value parts to many Chinese plants, is facing rapid growth in the number of infections, this could slow down the rampup drastically. Suppose it will not take six weeks, but rather six months until supply starts to ramp up? This implies inventories will really fall dry and sales will plummet due to lack of products. Do you have sufficient cash to overcome this? The Netherlands government has already enabled affected companies to allow employees to receive partial unemployment benefits. Not sure if other countries have followed suit.

3. Absence of containers for exporting your products to Asia

Even if you are not sourcing from China at all, and even your demand in China is not affected, a lack of containers my stop you from exporting. Container shortages have already been reported, in particular reefers. Suppose a general shortage of export containers would appear? Do you have sufficient storage space to store your products? Is there sufficient cash to finance this?

These are just a few scenarios. I am sure anyone could think of more. It would be good for any company to sit together with leadership and supply chain expert to think of such extreme scenarios as an aid to improve preparedness. If we cannot hope for the best, at least we have to prepare for the worst.

This article was published on LinkedIn in February 2020

Jan Fransoo

Smart mitigation investments can help the European petrochemical industry manage supply chain disruptions

The 2014 incidents and subsequent outages at the Shell Moerdijk plant received a lot of media and industry attention. Incidents like this significantly affect the petrochemical market, both in terms of price and product flows. In general, 2015 showed unprecedented production issues in the European chemical supply chain, over 50 force-majeures had been declared across all polymers. Given the age of the European petrochemical production sites, operational reliability remains recognized as a major challenge to the industry today.

Given this operational environment, there is a strong desire to obtain quantitative insights in the long-term effect of supply disruptions on the value, forecastability and volatility of EBITDA and the effect of potential mitigation options. However, chemical supply chains are highly integrated networks, implying that a disruption in one plant affects operations throughout the entire supply chain. Therefore, mitigation measures need to be evaluated coherently. Furthermore, there is high uncertainty about the location, timing, and impact of the next major disruption, adding additional challenges to the investment decisions. After all, ‘nobody gets credit for solving problems that did not happen’.

To improve the insight in supply disruptions and potential risk mitigation options, our latest published research – jointly conducted with my former student André Snoeck and my former colleague Maximiliano Udenio – provides a methodology to identify, categorize and quantify risks and the impact of disruptions. A specific risk mitigation option impacts several risks, whereas a specific risk can be mitigated by several mitigation options. The kernel of the project is the development and use of a two-stage stochastic optimization model to analyze these complex interdependencies and dynamics in an integrated way.

We draw three main conclusions based on our research:

1.      Supply chain risk mitigation investment trade-offs in the uncertain and interconnected chemical industry are not trivial and require advanced quantitative methods, such as stochastic optimization.

2.     Smartly placed small investments may outperform a much more expensive poorly placed investment. For instance, a combination of small buffer inventories with reduced response times for external supply might outperform multiple investments in redundant processing capacity.

3.     Investments that mitigate multiple disruptions are undervalued when considering disruptions and mitigation options in isolation. For instance, individual disruptions might not justify investing in decreasing lead times of external supply. Our advanced model that captures the entire supply chain shows the aggregate value that the investment provides to the network.

4.     There exists a trade-off between long-term expected costs minimization and short-term risk minimization, where the latter leads to a more aggressive investment policy. This implies that an increased focus on a stable and forecastable quarterly EBITDA actually justifies larger investments in supply chain mitigation options compared to a long-term focus on expected future EBITDA. Ironically, this implies companies under private equity aiming short-term returns may need to invest more in mitigation measures than companies aiming long-term returns.

There is a clear need for the European petrochemical industry to take supply chain disruptions seriously. Chemical supply chains are integrated, interdependent, and complex systems and evaluating risk mitigation investments should be complemented by advanced quantitative models. Such methods are not new to the chemical industry, advanced models are being used to optimize cracker operations for years. Leveraging this capability when dealing with supply chain disruptions will positively impact the value, forecastability and volatility of EBITDA.

This article was published on LinkedIn in January 2019

Note

The text above has been written for ease of public access, and may contain texts that have been simplified for this purpose at the expense of scientific rigor. In-depth and verified information can be found in our peer-reviewed journal article published in the European Journal of Operational Research. The article is based on a Master Thesis completed at Eindhoven University of Technology.