But just as Ford was starting to hit its stride, disaster struck. The Covid-19 pandemic not only disrupted key supply chains, but also led to an increase in demand for the semiconductor chips critical to electric vehicles. This global chip shortage led Ford to close several factories, reducing production, sales and ultimately market share.
“That was one of the things that really pushed Ford back as it got traction for its electric vehicles,” he says. Seyed Iravania Kellogg professor of courtesy operations 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,” says Iravani. “It’s a recurring reality that’s reshaping who wins and who loses in global markets.”
To understand how companies could best prepare for such disruptions, Iravani worked with Akhil Singlapostdoctoral researcher at Northwestern, Wallace Hopp of the University of Michigan, and Zigeng Liu, a former doctoral student at Northwestern. They used game theory to model the impact of a supply chain disruption on two firms competing for a limited spare supply of the same product item.
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 firms come through a supply disruption relatively unscathed. However, they also found that these situations are windows of opportunity for companies looking to steal some of their competitors’ market share.
“During the disruption, I may not be able, as a company, to produce enough cars or other products to sell to my customers,” says Singla. “So my customers will try to go to a competitor and then they might not come back to me. And that leads to a market shift.”
The model shows that how well a firm ultimately fares depends on preparation—how effectively the firm builds up backup supply and flexibility before the disruption and how efficiently it draws from that supply during the disruption.
“It’s not about if a disturbance is about to occur. it’s about whensays Iravani. “And whoever is ready will win.”
Prepare and answer
In the researchers’ game theory model, two competing firms must decide how to handle a possible supply disruption in two different stages.
First, before an outage occurs, each business must decide how much to invest in preparation or preventive measures: either securing part of a common back-up supply from suppliers or, alternatively, building flexibility into its product to access a wider back-up supply. The more a business invests at this point, the better prepared it can be to deal with a disruption. At the same time, if the business invests too much, it risks short-term damage, especially if the next disruption does not occur for a long time.
Then, once an outage occurs, each business must decide how aggressively to draw from its backup supply. The deeper he goes into the backup offering, the better his chances of capturing his competitor’s customers. But if the competitor already has enough spare inventory to meet the needs of its customers, then the first company risks accumulating more supply than it can use, thereby reducing costs.
There are numerous possible outcomes of this exchange between the companies, including several scenarios where both companies are able to retain their customer base. “However, it usually happens that one of them is the winner and the other the loser, because someone is going to steal market share from someone else,” says Iravani.
Indeed, the model suggests that the optimal way for a firm to prepare for a disruption is to capture enough of the common backup to prevent the competitor from creating enough of its own backup. This aggressive approach would potentially allow the first company to steal market share from its competitor.
But because this initial investment is often costly and could fail, a firm is likely to pursue this strategy only if it estimates that it can take enough of the competitor’s customers to be worth the risk. If a company does not believe it can do so, it will take a more conservative approach and secure only sufficient back-up supply to meet the demands of its own customers.
And if each company believes that a significant portion of its market share could be captured by its competitor, then, paradoxically, 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 business and other factors such as duration of disruption, probabilities of disruption, customer loyalty, size of market shares, premium cost of supply, etc.,” says Singla.
The researchers used their model to run several simulation scenarios and identified the top five factors that make it worthwhile for a business to invest heavily in preparing for a disruption:
- If the shared backup supply is infrequent.
- If it significantly affects the competitor to lose a customer.
- If a business is already at high risk of losing its own customers;
- If a firm is more likely to lose customers to substitute products than to its main competitor.
- If the competing company is much larger.
For example, a large firm has less incentive to invest in its reserve supply when faced with a much smaller competitor. This is because, “if the size of my competitor is small enough, then I [as a large firm] it won’t be able to justify the extra cost I have to pay to be an aggressive company,” says Singla. Conversely, a small company is in a better position to steal some of its large competitor’s customers during an outage than the other way around.
“Small businesses actually benefit more from preparation because any small increase in their market share is really good for them,” Iravani adds. “So if you’re a small company, be very aggressive and make sure you prepare [for disruptions] because this is an opportunity to expand market share.”
A shield and a sword
Iravani likens preparing for an upset to assembling a shield and a sword. “It’s a shield to protect you from other companies stealing your customers. It’s also a sword you can use to grab your competitors’ customers during crises,” he says.
In this sense, companies and business leaders could benefit from viewing disruption planning as a competitive strategy rather than an insurance policy. This shift in perspective will help companies mobilize preparation, in multiple forms: not only by securing back-up supply, but also by creating diverse supplier connections and flexible contracts, and designing flexibility into their products.
This high level of strategic preparedness was critical to Tesla’s success when the global chip shortage hit.
When Ford felt the pain of failing to secure an adequate backup supply of semiconductor chips, Tesla thrived. Not only did Tesla invest before Covid-19 in stockpiling a large back-up supply, it also simplified vehicle functions and rewrote software for its electric vehicles so they could use more than one type of chip. These moves allowed Tesla to turn a shortage into an opportunity, further expanding its position in the electric vehicle market it was already driving.
“Disruptions reveal the difference between businesses that simply survive and those that gain strategic ground,” Iravani says. “You don’t just think, ‘Well, I’m going to make sure my customers are safe.’ No—you should think beyond and see these disruptions as an opportunity.”
