Systematic Risk in Supply Chain Networks

Industrial production output is generally correlated with the state of the economy. Nonetheless, during times of economic downturn, some industries take the biggest hit, whereas at times of economic boom they reap most benefits. To provide insight into this phenomenon, we map supply networks of industries and firms and investigate how the supply network structure mediates the effect of economy on industry or firm sales. Previous research has shown that retail sales are correlated with the state of the economy. Since retailers source their products from other industries, the sales of their suppliers can also be correlated with the state of the economy. This correlation represents the source of systematic risk for an industry that propagates through a supply chain network. Specifically, we identify the following mechanisms that can affect the correlation between sales and the state of the economy in a supply chain network: propagation of systematic risk into production decisions, aggregation of orders from multiple customers in a supply chain network, and aggregation of orders over time. We find that the first effect does not amplify the correlation; however, the latter two intensify correlation and result in the amplification of correlation upstream in supply networks. We demonstrate three managerial implications of this phenomenon: implications for the cost of capital, for the risk-adjusted valuation of supply chain improvement projects, and for supplier selection and risk.