Supply chain professionals need to ensure a reliable supply of materials.

A disruption in the supply of a critical component can halt production, leading to missed deliveries, unsuccessful promotions, customer churn or lost sales. All of these can have a negative impact on the bottom line.

Supply chain leaders can calculate the expected cost of s production stoppage in three different ways:

• Revenue at risk
• Direct costs
• Indirect costs

Revenue at Risk

Every minute that a production line is in operation, it creates value for your company. The converse is also true: every minute the line is down value is being lost.

To calculate the revenue at risk, you need to know the throughput of the line and the wholesale price of the final product.

Consider a disruption your company experienced because of the unavailability of a critical component or raw material.

• How many productions hours were lost per line?
• How many productions lines were impacted?
• How many final products were not completed during the downtime?
• What is the wholesale price of the product?

Determine the number of units that would not be produced during a stoppage and multiply that by the wholesale price.

However, the way that you will do this depends on whether you use discrete, process, or contract manufacturing.

Discrete Manufacturing

Let’s take a very simple example.

However, this is discrete manufacturing, and other parts of assembly can continue while a component is missing. Therefore, the revenue at risk is not the same as the total value. Depending on your industry, you could conservatively estimate it as a percentage of the total value.

One of our customers, a global automotive manufacturer, calculates the revenue at risk as 10% of the total value.

Process Manufacturing

As this is process manufacturing, and no part of the process could take place without the missing ingredient, the revenue at risk is the total amount calculated.

Companies Outsourcing Production to a Contract Manufacturer

This model evaluates revenue-at-risk for companies that use contract manufacturers, where the primary exposure is losing a scheduled production slot rather than experiencing a line stoppage.

The primary risk is missing your allocated production window. You cannot make up for lost time. Contract manufacturers run fully booked schedules.

If you miss your production slot due to missing components, the disruption cost is equal to the total profit you would have made for the period the production slot would have covered.

Direct Costs

Direct costs are the immediate, traceable expenses triggered by the disruption. These typically include:

• Idle labor costs (internal teams waiting on product)
• Overtime to recover downstream processes
• Expedited shipping for replacement components
• Customer penalties or chargebacks

Indirect Costs

Indirect costs reflect the organizational effort required to manage the disruption. McKinsey estimates that companies spend two weeks planning and executing a response to a supply chain disruption.

To calculate indirect labor costs, convert salaries to hourly rates using 50 working weeks:

Depending on your company, one of these may make a better framework than the other; or a combination of two or more may make the most sense for the way your company is organized.

Value at Risk: The Key Takeaway

While you can use any of these formulas to calculate the costs of a disruption, it is more powerful to consider them together. This is your value at risk calculation.

Value at risk = Revenue at Risk + Direct Costs + Indirect Costs