Mitigating Supply Chain Risk in Uncertain Times - Murphy's LawThomas L. Tanel
September 9, 2013 — 1,175 views
The simple fact is that in today’s longer global supply chains, product moves over greater distances and across more multinational borders than in the more localized supply chains of the past. This distance-based supply chain, whose links are forged by many supplier tiers in various countries, carries a risk dependent on its length and diversity. The longer and more diverse it becomes, the more it is susceptible to unforeseen circumstances. By consequence, the supply chain is rendered delicate, extended, and bloated in some way.
Are you equipped to succeed in a supply chain world of increasing difficulty and insecurity and multiple interconnected supply chains? Do you have the correct response to a supply disruption in the supply chain and the attendant supply-related risk?
Supply chain disruption can destroy shareholder value and corporate profitability. More importantly, taken together, total supply chain costs consume about 7 to 12% of corporate annual revenue across all industries,
In their 2005 study of the financial effect of supply chain disruptions, Kevin Hendricks, formerly of the University of Western Ontario, and Vinod Singhal, of the Georgia Institute of Technology, made some interesting findings. They discovered that the average effect of supply chain disruptions in the year leading to the disruption included a 107% drop in operating income, 7% lower sales growth and 11% growth in cost. Share price volatility in the year after the disruption was 13.5% higher than in the year before disruption. Don’t you think that BP can attest to this effect as a result of the Gulf Coast oil spill in the USA?
Risk is an everyday occurrence in business, and companies either consciously or unconsciously include it in their decision-making process when managing their operations. (See sidebar: Most Common Supply Chain Risks.)
Companies must invest in enhancing the integrity of their supply chains, in a manner that balances operational objectives with reputation risks (a type of risk related to the trustworthiness of business).
Supply chain risk exists in many varied forms. For instance, damage to a firm's reputation can result in lost revenue or destruction of shareholder value. Damage to revenue may be perpetrated by transportation disruptions, natural disasters, strikes, and political unrest—all of which may interrupt supply of product to the ultimate customer or components to the factory. By way of example, the European debt crisis, the Japanese earthquake and tsunami, and the Arab Spring uprisings all had a ripple effect in 2011.
As PPB Newslink reported in March 2011, more than 40% of the world’s USB flash drive supply is produced in Japan. In fact, one major supplier, Toshiba, supplies 30% of the world’s memory chips alone. When the tragedy unfolded in Japan due to the history-making earthquake and tsunami, memory prices jumped by 50 to 60% overnight–literally.
A major concern for purchasing and supply chain executives is supplier financial stability as the supply base shakeout occurs from the last four years’ worldwide financial reckoning. According to
PricewaterhouseCoopers LLP, many companies are beginning to learn that relationships with critical suppliers shouldn’t be taken for granted. Relationships must be acknowledged, protected, and nurtured to positively impact a company’s bottom line.
As a case in point, the effects from the March 2011 earthquake and tsunami, and the ongoing nuclear crisis in Japan: Automotive News reported that supply chain management at Honda was being stress tested, given that at least 113 of its suppliers are located in the affected areas.
Closely monitoring the financial health of suppliers has become an important part of the job for anyone involved in a company’s purchasing or procurement sourcing efforts. A solvent supplier yesterday may become an insolvent supplier today. While supplier insolvency is a known risk, the recent economic downturn has brought it to the forefront. To weather this and future storms, organizations must focus on a proactive approach to better anticipate changes in supplier viability and financial health.
According to a recent research project by the Procurement Strategy Council (PSC), procurement organizations pay, on average, an additional 4% to resolve a supply incident stemming from supplier financial distress. What specifically accounts for that 4% cost increase? According to the PSC research, the real cost of poor supplier risk management includes: supplier product line or facility closures; reduction in quality standards, and supplier layoffs and bankruptcies.
Recently, as a hedge against rising oil prices, Delta Airlines bought the Phillips 66 refinery in Trainer, Pennsylvania, to maximize its jet fuel production capacity. As reported by USA Today, “Fuel makes up between 25% and 40% of an airline's costs, and soaring prices in the past several months have dug into industry profits and led to higher fares for the flying public. The Pennsylvania refinery and products it produces will fulfill 80% of Delta's fuel needs in the U.S,” the publication said.
Clearly, understanding and mitigating supply chain risk needs to be recognized by the C-level of management. For example, what does this do to our supply risk and the increased supplier risk dependency? How do we assure ourselves of supplier viabil-ity and financial health in light of these trends?
Having assessed the risks and identified those that require action, plans need to be drawn up and responsibilities assigned to control and mitigate these risks. This means risk identification, risk assessment, and risk mitigation. The intent of risk mitigation planning is to answer the question, “What is our approach for addressing this potential unfavorable consequence?”
_ Avoiding risk by eliminating the root cause and/or consequence
_ Controlling the cause or consequence
_ Transferring the risk, and/or
_ Assuming the level of risk and continuing on the Supply Chain Continuity Plan
The allocation of risk should be dependent on the assessment of the likelihood and consequence of the risk and then the identification of who is best able to control or manage the risk. Normally a risk template has two critical elements:
1. Likelihood of occurrence (probability)—A risk is an event that "may" occur. The probability of it occurring can range anywhere from just above 0% to just below 100%.
2. Severity of impact or consequence (magnitude)— A risk, by its very nature, always has a negative impact. However, the severity or size of the impact varies in terms of cost and impact on some critical factor.
Does your organization have the wherewithal to implement a robust Supply Chain Risk Management (SCRM) strategy? If not, do you feel that your organization is flirting with disaster by not exploring and investing in SCRM measures? Since SCMR is becoming an increasingly visible, multifaceted phenomenon, what are you doing to mitigate it?
As companies look to recover from the uncertainty and economic turbulence of the last four years, the experience of managing supply chain risk across oceans and continents is still daunting for many organizations. Why? They unknowingly have realized that they have taken on greater exposure to risks and uncertainty as the supply chain today has been rendered weak and vulnerable.
Thomas L. Tanel
CATTAN Services Group