We are in a period of acute uncertainty. As coronavirus continues to move through country after country, it is likely to lead to production and supply problems for many months, and the economic impacts to most industrial businesses will be significant.

Many in Australia’s resources, energy, and other heavy industries are already facing challenges across their supply chain and responses are most valuable if taken rapidly. Aurecon and Quartile One Asset Performance are not coronavirus experts, but we do know how to manage assets through a crisis.

In this article we share our knowledge of the current supply chain situation, how business analytics can be used for predictive modelling and steps to take for evaluating and mitigating supply chain risk.

Through our deep understanding of the supply chain, expertise in business analytics and an ability to aggregate industry wide data points, we are helping many in the sector to rapidly identify areas of the supply chain where response plans are warranted. By acting early, generating forecasts quickly and accurately, and bridging gaps in data, we can navigate this crisis through forecasting, and stay ahead of the curve.

For those who take this approach, the cost of regret will be minimal, and their response can be actively managed as new information becomes available.

The current situation

Aurecon has been in close discussions with our supplier and customer networks in Australia and globally to establish a view of the current, and evolving, state of play. Combining this up-to-the-minute knowledge with publicly available information, we have identified two key areas of disruption facing Australia’s heavy industry operators – reduced supply chain capacity and interrupted logistics – which, if remain ignored, will have devastating impacts moving forward.

1. Reduced supply chain capacity

A significant proportion of Australia’s heavy industry supply chain depends on capacity from China. Restrictions on labour movements after Lunar New Year 2020 hindered the ability for factories to resume full capacity throughout the country, however the severity of this varies by region, resulting in different impacts to suppliers and part categories depending on factory location.

While latest reports from China indicate activity resumption (over 80 per cent of factories returning to operation as at time of writing), due to continued labour and logistics challenges, factories are continuing to operate below actual capacity. As the effects of coronavirus have spread globally, there has been further supply interruption from production centers in Europe and North America which are likely to continue the impacts from disruptions for the rest of 2020.

2. Interrupted logistics

The primary public health response to coronavirus to date has been quarantine, impacting the ability of road, rail and seaborne logistics networks to transfer work in progress between production centres. As this continues to be interrupted, finished goods with significant precision steel components have already started to signal delays, and it will take time to restart the production chain once logistics recommences.

Supplies of alloyed steel previously delayed from China have been alternatively sourced from Europe, however these production centres have now been equally disrupted continuing the downstream impact. There are emerging reports that smaller suppliers are struggling to stay in business due to the scale of disruption. Despite closing production, some of these suppliers continue to accept orders which further confuses the understanding of true industry capacity.

When will the backlog be resolved?

The total combined effects of quarantine and shutdowns in 2020 across China have reduced total production by an estimated 32 days (excluding the typical seasonal effects of Lunar New Year). With impacts spreading to production centres in Europe and North America, we can expect production delays for at least the remainder of this year.

Five critical elements to prepare for potential supply chain impacts

The full extent of the impact of coronavirus is unknown and changing rapidly. However, what is certain is that now is the time to prepare for the potential economic disruption through the supply chain. How? There are five critical elements to consider in preparing for and mitigating potential impacts:

1. Clear forecast of business requirements

To develop a supply chain disruption response plan, a clear forecast of the parts and materials required for the business must be developed. Some challenges faced and suggested approaches include:

Difficulty: no existing forecasts at the component level, and historical averages that are not representative of future ordering requirements due to age of equipment or change in usage
Approach: zero based forecasts at the component level can be generated using lifecycle modelling methodologies relatively quickly, which will account for changes in parts requirements due to age or duty cycle/utilisation
Difficulty: there is often a large backlog of maintenance tasks which are ’due’ or ‘pending’ however are being deferred and managed based on asset condition. This backlog will create an artificial spike in forecast demand compared to the actual requirement.
Approach: utilise equipment condition information to develop predictive degradation curves which estimate component usage over time. Where condition information is not available, this can be acquired in a targeted way based on category criticality
Difficulty: extrapolation of supply requirements to the lowest parts level requires a highly complex analysis and a very accurate master data set (rarely in place)
Approach: we have found it best to forecast at the maintainable item level in order to map to supply chain vulnerabilities, an approach which is more tolerant of incomplete master data

2. Verified view of supply chain vulnerabilities

Based on work done to date, risk to the supply chain can best be assessed using two primary criteria: 1) production location and 2) supplier/customer match.

The location of production has a strong correlation with availability of labour (and quantification of the cumulative effect year to date), and the impact of logistics disruption. The production location can be used to accurately define the expected disruption and does not vary based on the downstream user.

Where the supply chain has been disrupted (criterion #1), the actual impact will depend on the practices and policies of the supplier, including stock holdings, number of parallel production center options and the relative importance of each customer. For example, where production has been disrupted, the impact may still be minimal if the supplier maintains high local inventory, has several available production centres to source future requirements, and where the customer has a large and preferential supply agreement to gain first access to what supply does exist. Where these elements are not present, the disruption level will be high.

The complexity of the modern supply chain dictates that a bottom up analysis is not possible in the timeframe required to respond to this risk. For example, a single component (e.g. air filter) may state it is manufactured in Taiwan where the impact from coronavirus has been minimal, however the reality is that each sub component of the filter (filter media, casing, mounts) may have been manufactured from production centres across the globe including areas heavily impacted.

Another example is the progressive engagement of third, fourth and fifth tier suppliers within OEM supply chains, which means a single component may be sourced from up to a dozen small contract manufacturers who are disproportionately impacted compared to larger scale enterprises.

To respond to this challenge (i.e. ‘the complexity of the integrated supply chain which cannot be evaluated using bottom up analysis in a reasonable timeframe’), four approaches should be adopted:

Categorise maintainable items by type and qualitatively assess each one’s exposure in the market through interview and research of publicly available information
Test the market lead time through placing orders and confirming local stock levels
Estimate global demand for each key component (based on industry asset counts) to evaluate the short-term requirement compared to industry averages
Aggregate information from the experience of many users to create a consolidated reference point in the industry

As an example, recent analysis identified certain size bearings as a high-risk item. By interviewing through the supply chain and evaluating the response to placing orders from multiple users, we have established an aggregated picture of the disruption based on location (high), and the relative positions of each supplier/customer match in the local market. In this case, forecast demand is estimated to be above historical requirements. This information then enables each customer to develop the appropriate response plan according to their position.

3. Choose level of disruption to mitigate

Organisations will need to determine the level of risk mitigation appropriate for them, which depends on multiple factors, overlaid with the common denominator of ‘time’. Each organisation must look critically at their operation and evaluate the length of time they can financially afford to protect against. Although we are in an uncertain environment, tangible points of reference should exist to commence breaking this down.

We seek input where possible from: contractual or reputation consequences from failing to meet production requirements; financial ability of the business to mitigate supply risk; and policies such as a defined risk matrix and ‘delegation of authority’. When choosing a level of disruption to mitigate, assumptions must be clearly understood so to pivot quickly where external factors change.

Challenges faced and suggested approaches to tackle those challenges effectively are:

Difficulty: stakeholder alignment is a challenge, especially in large, complex organisations and when not resolved, can result in inconsistent application of risk mitigation. Adding to these challenges are globally-dispersed stakeholder networks, pressure to meet customer demands and a lower appetite for risk.
Approach: getting buy-in from stakeholders is crucial on your agreed collective disruption level. Use ‘delegation of authority’ to collectively drive a group discussion. Align stakeholders on the overall level of disruption and create a timeline to illustrate who has decision authority and when.
Difficulty: contract application is difficult due to being drafted for management of day to day scenarios, typically not for times of disruption or disaster. While parties are contractually able to apply the contract, each party will be affected differently and may not be able to respond sufficiently, e.g. the supplier has closed their business, or employees are working from home, or cannot get supplies from their suppliers and so on. Subjective application further challenges the ability to quantify consequences from a supply shortage and whether it falls under an inconvenience or breach of a contract. Force majeure is becoming more topical in application, but cannot be applied without consideration as the definition and inclusions vary contract to contract.
Approach: scenario plan what different contractual outcomes could mean for your business, understand the sensitivity to revenue, create scenario teams and maintain contact with customers

4. Category response plan

The major difficulties and suggested approaches to consider when developing a category response are:

Difficulty: there is little difference in criticality between parts and components – any missing part is typically critical to the ongoing operation of the asset. When everything is critical it is difficult to prioritise a proportionate response.
Approach: rather than prioritise based on the consequence of supply gaps, it is more constructive to assign a proportionate response based on the ability for the supply to be substituted, either through alternative supply, renewal or fabrication
Difficulty: difficulty in judging the appropriate response for each category and being able to escalate the response over time as the situation changes. This is even more challenging in the current environment where the initial mitigation actions are becoming less effective over time.
Approach: the following is an example of a mitigation response planning template. It can be applied to an OEM focused supply chain. A graduated response allows the level of mitigation to be chosen and adjusted over time.

Increasing levels of mitigation	Description
1. Order in advance	Review your current coverage of ‘in advance’ orders and increase if deemed necessary to lock in supplier commitment.
2. Identify off book stock holdings	Request the supplier to reserve stock off book.
3. Consignment stock holdings	Hold stock which is still the property of the supplier but where payment is only made when stock is sold or used.
4. Utilise strategic supplier agreements	Put pressure on suppliers to either confirm to an existing long-term contract or commit to a new one.
5. Virtual supply chain management	Create a virtual supply chain within your organisation, to digitally share parts and link with supplier stock levels.
6. Change the demand profile	Discuss options with your customer of potential alternate equipment usage to change profile of demand.
7. Build inventories	Build your own stores over time and increase inventory to mitigate concerns over truth of supply information.
8. Alternative supplier	Seek alternate channels for supply to diversify your current supply portfolio.
9. Supplier development	Create your own stock through either supporting an entrant to the market or building inhouse.

5. Actively monitor activity and adjust

We have learnt quickly that the situation is rapidly changing, with unforeseen consequences from second and third order parties in the supply chain. As new information comes to light, assumptions must be iterated to enable the risk response and for recovery to begin.

Difficulty: there is a portfolio of actions across multiple work streams, based on multiple scenarios and triggers. The decision-making web is complex.
Approach: apply an Integration Team or project management office (PMO) approach to act as a single source of truth and ensure sufficient resources are deployed to manage actions. This team sets the overall tone of the response, creating a critical high tempo culture. The PMO understands the intent for each at-risk category and empowers the project manager to deliver on the plan.
Difficulty: there is no playbook. By the time a response is formed, the situation has changed, and the scale, speed, and impact of issues have unexpectedly intensified.
Approach: always understand your contingency plan if an expected assumption or trigger is different. Update the scenario models on a weekly basis to iterate through each step, aligning team leaders on potential scenarios and plan B actions.
Difficulty: irrespective of how long the crisis will last, the other side will not look like the ‘normal’ of recent years
Approach: need to start thinking ‘how are we going to change to get through this’ as opposed to ‘how are we going to get through this’. The new normal emerging and evolving needs to be tested against the business risk profile with adaptations where required.

Despite ongoing reassurance from parts suppliers and original equipment manufacturers, we must not ignore the emerging signals which illustrate significant supply chain disruptions. It is critical that all large asset owners take measured responses now and consider how these five critical elements can help them successfully navigate this challenging time.

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