Gambling is cool in Vegas, but not in purchasing

Staff -- Purchasing, 11/3/2005

Las Vegas probably hates guys like Rick Jacobs.

While he is adventurous in many ways, he isn't a gambler who throws the dice without any forethought. And considering his profession, that's a good thing.

Jacobs is a professional supply-chain manager who knows that when it comes to suppliers, the fewer the risks the better. And for the few risks you take, there should be data that justifies the gamble.

The vice president of supply chain management for Eaton Corp., Jacobs is in the process of rolling out a risk-mitigation strategy throughout the corporation. His goal: identify troubled suppliers before their problems become Eaton's problems.

It's an important goal, he says, especially since Eaton has acquired several new companies—eight in the last year. When you acquire companies, you also acquire their suppliers, he says, and often they're suppliers you have no knowledge of or experience with.

Jacobs is using a database product from Open Ratings that, he says, will help him match his suppliers with the millions of worldwide companies in the database to see if any have financial or other problems. Among the criteria he'll be measuring his suppliers against: financial stability, product quality, on-time delivery record, SOX compliance and intellectual-property protection. The latter refers to the breadth of knowledge within the supplier company—the more employees with deep knowledge of the company's products and processes the less risk of collapse if someone leaves.

Risk mitigation is a growing concern among companies of all stripes. And no wonder: A recent study by Georgia Institute of Technology found that supply disruptions have a significant effect on profitability. In the year leading to disruption, companies on average see a drop of 107% in operating income, 93% drop in return on assets, 7% lower sales growth, and 11% increase in cost. "Today's aggressively streamlined operations are the result of an almost singular focus on reducing costs, and have absolutely given companies an edge," says Jim Lawton, Open Ratings' vice president. Now, he says, many companies are applying the same level of commitment to assurance of supply.

Lawton says best-practice supply-risk management includes several key tenets:

• Executive-level visibility into exposure and dependency: Sharing insight into which suppliers are struggling, up to the highest levels of the organization, can pinpoint the most critical trends and commodities to monitor, and enable informed action to establish contingency plans.
• Continuous monitoring of all suppliers.
• Complete, accurate, forward-looking supplier information: The earliest signs of pending supplier crisis often materialize in quality or delivery compromises. Lawton says credit reports, a common tool used to evaluate supplier stability, are historical in nature and provide no indication of operational and product trends, nor insight on the quality of products being shipped to other buyers.

United Technologies (UTC) found another benefit to risk management: It has actually helped suppliers improve their performance by identifying potential problems after researching them through the Open Ratings database. A financial review of one supplier to UTC's Sikorsky division, for example, prompted UTC to work with the supplier on improving their operations. Result: The supplier was able to quadruple its productivity and double its revenue.

"You can't ignore risk with new suppliers," Eaton's Jacob says. "The downside could be greater than the upside."