Scenario Planning for Supply Chain Risk Management – Part Two

Abstract

We examine how to weigh and prioritize multiple supply chain risk mitigation options and the use of monitoring and triggers to guide level-headed decision making during a crisis, using the risk of a China-Taiwan-US war as an example. We also look at various other examples of high-uncertainty risks where our framework could be usefully applied.

Article

In this two-part series, we examine the risk of a China-Taiwan-US war, using it as an example to explore application of ChainLink’s  Framework for Mitigating Risk in High-Uncertainty Scenarios. In Part One, we looked at Taiwan’s role in the global economy, discussed a range of scenarios for a potential Taiwan Strait conflict and the knock-on effects of the conflict, and considered potential mitigation options. Here in Part Two, we look at how these different mitigation options can be weighed, the use of monitoring and triggers to guide mitigation actions, and consider some other examples of risks that could benefit from high-uncertainty scenario planning.

Weighing Options

Image by Arek Socha from Pixabay

Companies have limited resources and it will not make sense to pursue every mitigation strategy that comes up in brainstorming sessions. Choices have to be made on where to spend resources and money. Some risk mitigation strategies come at the expense of growth. The same resources spent on mitigating a risk (that may never happen) could be spent on investments to grow the company instead. It is challenging to weigh the value of investment in risk mitigation. Human beings are notoriously bad at assessing risks intuitively. Our gut feeling fails us dramatically when assessing how big and how likely a risk or danger is. And it is even harder to weigh the value of various risk mitigation options versus the value of other investments of human and financial capital.

This is where real options value calculations can be helpful, as we have discussed in the past. Real options are simply embedding flexibility (choices or options for the future) in your decisions and investments, such as second sourcing, developing workforce flexibility, or designing manufacturing plants to produce a range of goods. All of these provide some additional options (flexibility) that can be exercised at some point in the future, usually with some incremental option cost today and some “exercise price” in the future. Formal techniques for calculating the value of various real options can be useful for making decisions about high-impact, quantifiable decisions.[1] In the HBR article Making Real Options Really Work, the authors advocate integrating real-option valuation with Discounted Cash Flow analysis.

Monitoring and Triggering

Goddard’s Network Integration Center” by NASA Goddard Space Flight Center is licensed under CC BY 2.0

Once decisions have been made about what mitigation strategies to pursue, a monitoring and triggering framework should be put in place. This involves first defining how to monitor changes in the likelihood of a risk happening and then defining specific thresholds or triggers to take action. There are global event monitoring services available, sometimes referred to as Global Intelligence Services, Event Monitoring, Security and Threat Intelligence, and similar names.[2] Many of the same people and functions within the company that defined the mitigation strategies could also help decide what level of threat should trigger various actions within the mitigation strategies.

In our Taiwan example, the team may define threat levels from 1 to 4, based on events. Table 1 below shows a hypothetical example of triggers and corresponding mitigation actions. An actual plan would contain much more detail and specificity. Specific triggers would escalate the threat level, such as substantive preemptive sanctions, exploratory military action by China (such as temporarily occupying one or more of the tiny Taiwanese outer islands), military clash between U.S. and China involving deaths on either side, Chinese military capabilities passing certain thresholds, and so forth. Then actions for each threat level could be defined, as something like the following:

TriggerMitigation Actions
Threat Level 1
Significant cross-strait tensions
e.g., close-call encounters between fighter jets, China flyovers or missile tests over Taiwan, high tempo of US and allied war exercises around Taiwan

  • Develop alternate designs using prior-generation chips. Build prototype and test.
  • Establish relationships with suppliers of prior-generation chips.
  • Renegotiate contracts with suppliers of advanced chips, providing guaranteed higher volume supply options (at a cost) with meaningful penalties for non-delivery.
  • Begin financial diversification and modest improvements to balance sheet.
  • Stress test suppliers for the invasion scenario and develop improvement plans.
Threat Level 2
US-China clash involving deaths
e.g., planes colliding, warning shots resulting in casualties, etc.
  • Begin handoff to manufacturing of alternate design produce.
  • Make substantial forward buy of advanced chips (begin stockpiling)[3].
  • Establish alternate banking arrangement and lines of credit, move funds, pay down debts.
  • Find and establish relationships to alternate suppliers for those that have not made sufficient improvements to survive an invasion. Begin to dual source from them.
Threat Level 3
China initiates limited but provocative military action
e.g., takeover of outer islands, partial blockade of commercial vessels
  • Begin limited production of alternate design product.
  • Make massive forward buy (all in) of advanced chips.
  • Increase price of advanced chip version of product to mildly suppress demand.
  • Improve cash position and lines of credit as much as possible.
  • Transition bulk of supply to suppliers that can better survive the invasion.
Threat Level 4
Full blockade or invasion commences
Full blockade of all vessels and aircraft and/or invasion of main island of Taiwan
  • Volume ramp of production of alternate design product.
  • Institute further price increases for the advanced chip version, to further reduce demand and stretch the now limited supply for duration of the conflict.

Table 1 – Example Triggers and Corresponding Mitigation Actions (Source: ChainLink Research)

Besides geopolitical and financial trigger events, other types of events that might be monitored include competitors’ actions (pricing, new products, etc.), commodity price fluctuations, extreme weather events, business failures, trade volumes, etc.

Examples of Other Risks Ripe for High-Uncertainty Scenario Planning

There are other risks that may be ripe for this type of scenario planning, such as:

Multipurpose Mitigation Strategies

Fortunately, many if not most mitigation strategies are useful beyond a single type of risk. For example, multi-sourcing with geographic diversity can reduce risk in a very wide range of types of disruptions. Mitigations strategies for the geomagnetic storm mentioned above would help prepare for long-lasting disruption to the power-grid, regardless of the cause. When evaluating the attractiveness and tradeoffs in investing in a specific mitigation strategy, the combined benefits across different disruptions should be considered.

Avoiding War

Writing this article has been sobering. It has brought into focus just how devastating a U.S.-China conflict would be. Beyond the risk mitigation that individual companies can take, we as a nation need to do everything in our power, short of capitulating to the takeover of Taiwan, to avoid such a conflict. This includes continued unwavering support for Ukraine, building strong deterrence through military alliances with Japan and Taiwan, strengthening Taiwan’s self-defense capabilities, and implementing mechanisms and policies to avoid unintended escalation. Fiery rhetoric and China-bashing may make for good domestic politics, but they make for terrible and reckless geopolitics. This is not to promote being soft on China. They are a formidable threat and must be dealt with firmly.  Rather it is to encourage calm, determined, clear-eyed actions and statements, rather than raising the temperature with provocative and inflammatory rabble-rousing. A war with China would be a terrible, terrible thing for the U.S., China, Taiwan, and the world. Let’s do everything we can to avoid it.


1 It is particularly useful in placing a value on various options within a flexible supply contract. — Return to article text above

2 These services constantly monitor news feeds, social media, blogs, and other data sources (e.g., AIS data on the movement of ships, weather feeds, etc.) and send alerts about events that are relevant to your specific business. Determining relevancy is part of the configuration of these platforms. Some platforms include mapping out your supply chain, so they know where key suppliers and supply lanes are, thereby notifying you of events impacting those locations. — Return to article text above

3 The stockpiling option needs to consider the timing of onset of panic buying more broadly across the industry. Clear signs of an imminent Chinese invasion would likely trigger a panic where many buyers of Taiwanese semiconductors attempt to place large forward buys to hedge. At that point, even if your company has a contract that guarantees seniority in such a scenario, unless you are a large powerful customer, the contract may not be honored. — Return to article text above

4 For more, see Here Comes the Sun—to End CivilizationReturn to article text above

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