Can manufacturers learn something from the insurance industry? Perhaps so, at least according to this article published here. The author suggests that “risk pooling” is the single most important concept in supply chain management. While this concept is not new, there are reasons why it is becoming more important than ever before. Those who work in the insurance industry will likely have a firm understanding of its importance.
The idea is that if you have a large enough population of independent random events, the variations will even out. This is why insurance companies depend on having a large pool of participants—so they can pool risks to reduce variability. In statistical terms, variability of a random variable is measured by standard deviation or variance. The sum of variances from a group of independent random variables is always larger than the variance of the aggregation of all the random variables in the same group.
Risk Pooling for Manufacturing
By applying this principle to manufacturing, an enterprise can reduce variability across operations by aggregating materials and resources across locations, across products or even across time.
So far, so good.
But there’s a catch: aggregation has a downside in terms of agility and responsiveness. A simple example illustrates this.
Suppose a manufacturer decides to pool variability risk by aggregating warehousing in a single centralized facility for all of Europe. It’s true that variability of demand would then decrease, but what happens when plants that are not close to the warehouse need to change their supply stream? Well, they would have to wait until new parts could be shipped from the central warehouse. In addition, such centralized facility also increases the location risk of the supply chain. What if there is an earthquake or a volcano eruption close to the centralized warehouse? What about business continuity?
The result, as the article points out, is that manufacturers must make trade-offs when using risk pooling. But what if there is another way to pool risk?
How A Manufacturing Operations Management Solution can Extend the Benefits
Insurance companies don’t have the trade-off problem described above because they don’t need warehouses. Insurance products are virtual and customers can be aggregated in databases.
Could manufacturers do something similar? Increasingly the answer is yes, thanks to the advancing technologies now available. Today many global enterprises have digitized and standardized their product design, manufacturing execution and supply chain management systems. This provides the visibility and control needed to implement risk pooling across multiple sites across geographical locations without significant trade-offs.
Returning to the warehouse management example, with sufficient visibility and integration between systems, a manufacturer could maintain multiple warehouses across multiple locations, while at the same time pooling inventory and resources to reduce variability. As long as you can see demand changes early enough, and respond quickly by robbing Peter to pay Paul, you can come much closer to the risk pooling benefits that insurance companies enjoy.
Beyond the Warehouse
Besides warehousing, the article mentions several other manufacturing areas where risk pooling could be beneficial, including transportation, push-pull strategies and product design. In each of these cases, a standardized enterprise platform across design, engineering and manufacturing operations could be a key enabler that allows manufacturers to take the concept of risk pooling much further than what is possible with legacy systems.
There has been a lot written about how taking an enterprise approach to manufacturing operations management can be an enabler of everything from Six Sigma and Lean manufacturing to manufacturing-as-a-service. The concept of risk pooling has added another reason to the list of why enterprises are transforming how they are running their business.
The investment in modern IT solutions to deliver clear visibility and control across a wide network of distributed plants, warehouses and distribution centers continues to unlock new value propositions in re-thinking how the processes of manufacturing can be done in new ways. Successfully applying techniques such as risk pooling could lead to improved delivery performance, reduced supply chain risk, less waste and greater operational excellence – all desirable outcomes in the increasingly competitive world of global manufacturing.
If you liked this article, here are others you might also find interesting:
- The Financial Case for an Enterprise Platform for Manufacturing Operations Management
- Managing Supply Chain Risk: What Drives Risk?
- Manufacturing as a Service
- Is Risk-Averse Innovation an Oxymoron?