When Supply-Chain Disruptions Strike, Preparation Is Everything

But just as Ford was starting to hit its stride, disaster struck. The Covid-19 pandemic not only disrupted key supply chains, it also led to a surge in demand for the semiconductor chips that were critical for electric vehicles. This global chip shortage drove Ford to shut down several factories, slashing its production, its sales, and, eventually, its market share.

“That was one of the things that basically pushed Ford back as it was getting traction for its electric vehicles,” says Seyed Iravani, a Kellogg professor of operations by courtesy and a Northwestern professor of industrial engineering and management science.

Global instability has made stories like Ford’s increasingly common in recent years. “Supply-chain disruptions are no longer rare anomalies,” Iravani says. “They are a recurring reality that reshapes who wins and who loses in global markets.”

To understand how companies might better prepare for such disruptions, Iravani collaborated with Akhil Singla, a postdoctoral researcher at Northwestern, Wallace Hopp of the University of Michigan, and Zigeng Liu, a former PhD student at Northwestern. They used game theory to model the impact of a supply-chain disruption on two firms competing for a limited backup supply of the same product component.

Among the many possible outcomes of this scenario, the researchers found that it was possible for the firms to reach an equilibrium point, where both companies get through a supply disruption relatively unscathed. Yet they also found that these situations are windows of opportunity for firms looking to steal part of their competitor’s market share.

“During the disruption, it may be possible that I, as a firm, am not able to produce enough cars or other products to sell to my customers,” Singla says. “So my customers will try to go to some competitor, and then they may not come back to me. And that leads to a market shift.”

The model shows that how well a company ultimately fares comes down to preparation—both how effectively the company builds a backup supply and flexibility before the disruption and how efficiently it draws from that supply during the disruption.

“It’s not about if a disruption is going to happen; it’s about when,” Iravani says. “And whoever is ready is going to win.”

Prepare and respond

In the researchers’ game-theory model, two competing firms must decide how they handle a potential supply disruption at two different stages.

First, before a disruption takes place, each firm must decide how much it is going to invest into its preparation or preemptive measures: either securing part of a shared backup supply from suppliers or, alternatively, building flexibility into its product to access a wider backup supply. The more that a firm invests at this point, the better prepared it may be to face a disruption. At the same time, if the firm invests too much, it risks a short-term loss, especially if the next disruption doesn’t happen for a long time.

Then, once a disruption occurs, each firm must decide how aggressively to draw from its backup supply. The more it digs into the backup supply, the greater are its chances of capturing its competitor’s customers. But if the competitor already has enough backup supply to meet its customers’ needs, then the first firm risks gathering more supply than it is able to use, resulting in a sunk cost.

There are numerous potential outcomes of this back-and-forth between the firms, including multiple scenarios where both firms are able to retain their customer base. “However, it’s usually the case that one of them is the winner and the other the loser, because somebody is going to steal market share from somebody else,” Iravani says.

Indeed, the model suggests that the optimal way for a firm to prepare for a disruption is to capture enough of the shared backup supply to prevent the competitor from building enough backup of its own. This aggressive approach would potentially allow the first firm to steal its competitor’s market share.

But because this initial investment is often costly and could backfire, a firm is likely to engage in this strategy only if it estimates that it can take enough of the competitor’s customers to be worth the risk. If a firm does not believe that it can do so, it will take a more conservative approach and only secure enough backup supply to meet its own customers’ demands.

And if each firm believes a sizable amount of its market share could be captured by its competitor, then, paradoxically, they both revert to a defensive strategy—each focusing on its own customers—to avoid a costly escalation.

Five key factors

The optimal strategy in the model varies “depending on the characteristics of each firm and other factors, such as the length of the disruption, the chances of a disruption, customer loyalty, size of market shares, the premium procurement cost, etc.,” Singla says.

The researchers used their model to run many simulation cases and identified the top-five factors that make it worthwhile for a firm to invest heavily in preparing for a disruption:

• Whether the shared backup supply is scarce;

• If it significantly impacts the competitor to lose a customer;

• Whether a firm is already at high risk of losing its own customers;

• Whether a firm is more likely to lose customers to alternative products than to its main competitor;

• Whether the competing firm is much bigger.

For example, a big firm has less incentive to invest in its backup supply when it faces a much smaller competitor. This is because, “if the size of my competitor is pretty small, then I [as a large firm] will not be able to justify the extra cost that I need to pay to be an aggressive firm,” Singla says. Conversely, a small firm is better positioned to steal some of its big competitor’s customers during a disruption than the other way around.

“Small firms actually benefit more from preparation, because any small increase of their market share is really good for them,” Iravani adds. “So if you’re a small firm, be very aggressive and make sure you prepare [for disruptions] because that is an opportunity for expanding market share.”

A shield and a sword

Iravani likens preparing for a disruption to putting together a shield and a sword. “It is a shield to protect you from other firms stealing your customers. It’s also a sword you can use to seize competitors’ customers during crises,” he says.

In that sense, firms and business leaders could benefit from viewing disruption planning as a competitive strategy rather than an insurance policy. This shift in perspective should help motivate companies to leverage preparation, in multiple forms: not only by securing a backup supply, but also by building diverse supplier connections and flexible contracts and designing flexibility into their products.

That high level of strategic preparedness was critical for Tesla’s success when the global chip shortage struck.

When Ford felt the pain of failing to secure a sufficient backup supply of semiconductor chips, Tesla thrived. Not only did Tesla invest before Covid-19 into amassing a large backup supply, it also simplified vehicle features and rewrote software for its electric vehicles so that they could use more than one type of chip. These moves enabled Tesla to turn the shortage into an opportunity, further expanding its foothold in the EV market it already led.

“Disruptions expose the difference between firms that merely survive and those that gain strategic ground,” Iravani says. “You don’t just think, ‘Well, I’m going to make sure that my customers are safe.’ No—you should think beyond and look at these disruptions as an opportunity.”