Supply chain risk management: Beware these storm warning flags
Mariners recognize the Coast Guard flags below as warning signs of treacherous seas. We adapted them as signals for potential supply-risk tempests.
By Tom Stundza -- Purchasing, 7/16/2009 2:00:00 AM
Supply chain strategies of the past were designed to cut out the fat—slicing the number of suppliers and reducing purchasing costs—but weren't designed to manage the unknown, also called supply risk. Even today, while struggling through a global recession, there is little agreement between buyers and sellers at major manufacturing firms on what constitutes "maximum risk" in the procurement of essential production materials.
That's because there are different types of risks—from supply costs to delivery disruptions, from changing supply chain practices to changing market or environmental conditions—that all influence purchasing decisions, says Anurag Dixit, vice president of marketing at Zycus, a provider of spend management solutions. So, he adds in an interview that "procurement organizations need to build supply chain frameworks that will measure and predict risks based on their own supply chain practices, market conditions and supplier entities."
Many purchasing organizations "don't know what they need to navigate the realities of supplier instability" because they've spent the past 15 years or so developing a large supply base that helped build inventory of so-called competitively priced materials, says Jim Lawton, vice president of the Supply Management Solutions Group of Dun & Bradstreet in Waltham, Mass. "Today's recessionary supply landscape is confusing to many buyers because control mechanisms aren't up and running in an environment where fewer suppliers, less material and reduced costs are involved."
Recently, during a Purchasing webcast sponsored by Zycus, readers responding to a poll couldn't agree on one single parameter or factor that they could label as the biggest procurement risk, Dixit says. However, buyers and management consultants interviewed this spring could agree there are some "storm warning signals" that need to be addressed to minimize risk. These include:
Erratic delivery performance
Companies are struggling more than usual this year to understand and mitigate delivery-performance risks across their extended supply chains in what can be considered the worst economic conditions of modern times. Companies are consistently optimistic about future reduced risk in their supply chain, yet they constantly complain to their suppliers about late and incomplete deliveries without recognizing that is a supply chain risk that has to be eliminated.
"Missing the shipping window means that the supplier isn't processing orders and coordinating shipment planning procedures properly," says Nathan Pieri, senior vice president of marketing and product development at Management Dynamics, provider of global trade management solutions in East Rutherford, N.J.
Yet, a series of market studies by AMR Research in Boston has found that the most basic approaches to managing this risk—identifying poor deliveries and then conducting what-if analyses to understand the effect on their supply chain—remain underutilized by companies. "The level of performance volatility in our supply chains will continue to increase because of the recession," says Noha Tohamy, vice president of market services at AMR Research. "We need to be realistic about that." She says that "this increase in volatility can be attributed to globalization, to low-cost country sourcing, to outsourcing, to the Internet or to a slew of other reasons. Given that, it behooves companies to expect risk, model it, and plan to mitigate it for profitability."
Uncertain product quality
For more than a decade, consultants have preached that supply chain management quality-assurance systems had to become integrated into purchasing systems under continuous process improvement models. Results have been mixed even though buyers now agree with the consultants that a recession isn't the time to be putting out purchased quality forest fires by intervention teams. "Quality risks are a big concern and can sink a company, particularly as more companies do business across borders with less oversight than in the past," says Steve Cook, chief operating officer of MFG.com, an online marketplace for manufacturing firms.
Taking shortcuts may have been a tempting alternative for suppliers to meet price objectives but the buyers and consultants such as Lawton at Dun & Bradstreet say purchasing groups should have put supplier quality management process in place to catch glitches long before their products were delivered. However, there are no industry-led certification programs to establish consistent product-quality rules through auditable assessments of product design, manufacture and testing.
Of course, the best way of dealing with the issue is to embed quality standards and regulatory requirements into the design of products, says Welch of TradeStone Software. "This is even more important in a world where design-to-delivery cycles span continents and involve multiple languages," she says. "It used to be said that you couldn't inspect quality into products; it had to be built in. Now the mantra is you must design quality into your products."
Volatile commodity prices
Buyers in 2009 have been rushing into spot markets to take advantage of current deflationary conditions, but that has created innumerable problems for suppliers and consumers alike. But that also generates price-risk volatility in an extremely uncertain market. "We're in a period where the cost of goods purchased is coming down rapidly but buyers need to be very diligent to ensure they are getting a fair market price," says Cook at MFG.com.
Cook says that "buyers need to guard against complacency" because prices will remain cyclical and erratic unless the procurement groups make sourcing and payment decisions that may be unpleasant for some suppliers. "People tend to stay with what works so there's a lack of investigative information from the supply base about true costs and their relationship to market pricing," he says. Upshot: "Buyers need to guard against falling into a comfort zone of buying the way they always have and paying for materials under old-fashioned cost-plus-profit formulas."
Cook is just one of several buying consultants who suggest that the recession may be the perfect time to engage in due-diligence studies of suppliers' real costs and reset acceptable price parameters of what will be paid for materials. "If new cost and price bases are set now, in the middle of the recession, then there's a foundation for supply contract discussions when the economy picks up," he says.
Financial instability of suppliers
Frequent requests for early payments or reduced service staff may be red flags of financial problems. Lawton of Dun & Bradstreet says many buying groups today are faced with inaccurate, incomplete data about suppliers, the products they deliver, how they respond to marketplace disruptions and how financially viable they are.
"All too often, purchasing organizations are stymied in their risk-aversion and/or risk-management efforts by a patchwork of solutions that can't keep up with what's happening in the supply base," Lawton says. Agreeing that audits of supplier solvency are more important than in the past is Sundar Kamakshisundaram, senior solutions market manager for Ariba in Sunnyvale, Calif., another provider of spend management solutions.
"Too often, investigations of supplier solvency and dependencies are limited to the initial sourcing project," Kamakshisundaram says. So, he recommends that "in the face of highly volatile markets where credit is tight," supplier performance and financial reviews should be done at least quarterly "with the most strategic and mission-critical suppliers," and semiannually with the next tier. He and other consultants suggest the implementation of continuous supplier evaluation reports that incorporate more substantial and annual analyses of suppliers' financial health.
Such inquiries could flag those suppliers that have been working with razor-thin margins that won't be able to hang on through this recession and will go out of business. The upshot for buying groups is the time-consuming and risky process of supplier replacement under get-it-done time pressure. "Buyers need to have a standardized infrastructure in place that supports vigilant efforts in assessing and auditing existing suppliers and on-boarding new suppliers," says Sue Welch, CEO of merchandise lifecycle management software firm TradeStone Software in Gloucester, Mass.
Jim Geller, CEO of Rapid Ratings International, a credit ratings firm in New York, adds that "corporate procurement-risk managers need to implement better evaluation methods that consider more than traditional credit rating models by looking deeper into the reasons for credit scores, payment information and cash flow analysis."
Poor communication on cash flow
Buying less and paying less in recession is understandable, the experts say, but buying groups can't blindside the supply base by reducing the buy without warning or explanation. Just as buyers get upset when suppliers cut back on manufacturing or shut down altogether without warning, the supply base needs to know when radical adjustments in buying are planned.
Also, Welch, of TradeStone Software, says that "in today's world of collaboration between buyer and supplier, everyone needs to understand exactly what a word, image, regulation or new law means and to be able to rapidly and clearly communicate that to all parties in the supply chain." This is why Lawton of Dun & Bradstreet insists that "risky situations can be predicted but only if buyers and suppliers understand their roles in the bigger picture."
He says that insight gained through real communications "gives purchasing the ability to create defensive and offensive strategies that turn risk into competitive advantage." Lawton points out that "tough decisions on reducing the buying group's exposure to risk have long-term effects on supply chain management, if done correctly." But, it can't be done in a vacuum, so supplier involvement is necessary. And that's why "risk managers need to implement better evaluation methods that consider more than traditional credit rating models by looking deeper into the reasons for credit scores, payment information and cash flow analysis," says Geller of Rapid Ratings International.
He says this does relate to knowing more about the financial health of suppliers, which some supply-base members are reluctant to share. "The lack of financial health transparency in the supply chain increases risk," Geller says. "For example, over reliance on Tier 1 suppliers creates risk concentration while over reliance on Tier 2 and Tier 3 suppliers can create supply chain volatility," he says. And these risks can only be avoided if there's better communication along the supply chain.
Unresolved, unexpected supply problems
"Buyers can expect more of the unexpected," says Bob Ferrari, managing director of the Ferrari Consulting and Research Group in Reading, Mass. That's because supply chain risk must be expanded into a much broader perspective, he says, and that includes coping with explosive energy costs, significant product recalls, more frequent natural disasters and even pandemics.
Supply chain processes can enhance or detract business strategies and overall corporate strategy implementation, says Ferrari, which is why supply chain risk management always has been the primary purview of procurement. The focus has—or should have been sharpened—by events in just the last 12–18 months that have disrupted and impacted the supply chain.
"More frequent occurrence of natural disasters—which impact internal facilities, logistics, transportation or production operations—are a major risk," he says. Also, significant product recalls have impacted quality, product management, and in some cases, the very existence of the brand. Then there was the unprecedented rise in energy costs during 2008, which had the potential to impact the economics of previous product sourcing decisions, and caused major concerns for transportation professionals.
More recently, the pandemic scare involving swine (H1N1) flu "was yet another reminder of how an outbreak can literally shut down commerce in a specific region," Ferrari says. Other outbreaks that had the potential to mess up supply chain activities were SARS (severe acute respiratory syndrome) in 2003 and the avian flu virus occurrences in 1997 and 1999.
His point is that supply chain risk management is now a cross-functional as well as cross-business concern. That's why risk management warrants more focus from purchasing management. "Companies need to have a multi-functional supply chain risk management team in place to lead efforts in identification of major risks to the business, mitigation strategies to such risks, as well as tactical action plans when the disruption actually occurs," says Ferrari.
That's also why corporate purchasing managers shouldn't underestimate the importance of such political risks as terrorism, civil unrest, regulatory change and the seizure of assets. The exposure has never been as great as it is today, according to Christa Davies, CFO of Chicago-based Aon Corp., the global risk-management consultancy and insurance brokerage. "People are doing business in more countries—and a more diverse range of countries—than ever before," she tells Treasury & Risk magazine. "They might have operations on the ground, or they could be exposed through their supply chains, by sourcing product components or services in certain locations, or simply through the customer base. It absolutely has to be a core consideration in the way people run their business."
Survey of supply chain risk expectations (Corporate perceptions of changes in risk levels a year from now)
| Higher | Lower | Same | |
| Source: 2009 Supply Chain Technologies and Services unit, AMR Research Inc |
|||
| Energy cost volatility | 47% | 10% | 43% |
| Commodity price volatility | 46% | 6% | 48% |
| Transportation cost volatility | 35% | 6% | 59% |
| Labor cost volatility | 27% | 7% | 66% |
| Supply chain security breaches | 23% | 4% | 73% |
| Information technology risks | 22% | 13% | 65% |
| Internet protocol infringement | 21% | 4% | 75% |
| Supplier failures | 20% | 9% | 71% |
| Supply quality failures | 19% | 10% | 71% |
| Internal product quality failures | 13% | 17% | 70% |
| Shortage in management talent | 11% | 21% | 68% |
| Natural disasters | 9% | 6% | 85% |
| Immature physical infrastructure | 8% | 14% | 78% |
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