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Supply Chain Risk Management

“Supply chain disruptions can arise from many sources—and more often than not without warning

 

—Jack Anderson”

INTRODUCTION

Supply chain management is the buzzword in today's competitive economy, where competition is no longer among enterprises but among supply chains. However, measures to operate the supply chain more efficiently lead to increased supply chain vulnerability. Single sourcing saves cost, but production continuity depends upon the single supplier. Outsourcing leads to more complex transactions in supply chain leading to increased probability to disruptions. Just-in-time production and inventory reduction eliminate the buffer to rely on when unexpected events occurs. In addition, uncertainties are becoming more frequent leading to disruptions in supply chains. Hence, supply chain risk management has become imperative.

Supply chain risk management is concerned with removing the ambiguity or uncertainty in supply chain planning, implementation and operations. Risk is pervasive in all parts of the supply chain. The size of the risk depends on the potential loss in terms of money or value for the event. In logistics activities, the risk is more visible closer to the end customer. International logistics can bring in added network complexities and supply chain risk considerations. Assessing and managing cross-border logistics risk is more complex issue as compared to domestic operations.

Today's marketplace is turbulent and clouded with uncertainty. Demand is more volatile than in the past. Product and technology life cycles have shortened. Larger number of products introduced in the competitive markets makes demand projections very difficult for the business firms. The compressed product life cycle makes the supply chain more prone to risks. It is not only the effect of external events such as natural disasters, strikes or terrorist attacks, but also the impact of changes in business strategy leads to the vulnerability of supply chains to disturbances. For example, strategy of ’lean’ practices, leads to outsourcing and a general tendency to reduce the size of the supplier base. However, this move potentially increases supply chain vulnerability.

Supply chain risk management area is likely to grow as supply chains become more and more exposed to risks. Accordingly, supply chain risk and disruption management will continue to attract more attention as supply chains will become more and more complex.

SUPPLY CHAIN VULNERABILITY

As a result of trends and developments within supply chain, organizations are continually faced with new or changing uncertainties because of the following:

• ’Hallowing’ of corporations or outsourcing
• Integration
• Cross-border logistics
• Demanding customers
• Dependency on technologies
• Spread of e-commerce
• Legislation

Vulnerability to sudden supply chain disruptions is one of the major threats of today's companies. To stay in control over the resulting consequences, increasing emphasis is laid on flexible supply chains. It is not only the effect of external events such as natural disasters, strikes or terrorist attacks, but also the impact of changes in business strategy such as the move to outsourcing and shortening the supplier base potentially increase supply chain vulnerability.

There is always a move to improve the efficiency of the supply chains and minimize losses due to stock outs, delayed deliveries or excess stocks. A need is always felt to speed up material movement through the supply chain. This brings with it a set of unforeseen problems which can disrupt the activities and increase the vulnerabilities of a supply chain to external and internal risks impacting the company's performance. A large number of events can affect the operations of a supply chain. These operations which have very intricate and complicated intertwined processes and dependencies generate their own risks and give rise to new ones.

Due to developments within supply chain, organizations are continually faced with new or changing uncertainties. These uncertainties crop up due to the following developments.

Firstly, due to reducing or outsourcing activities, which involve a certain amount of risks. These activities are not directly profitable and are closely related to the core business. It creates an increasing dependency of organizations in the supply chain. Secondly, downsizing or relocation of production locations and/or sales outlets, with an emphasis on greater efficiency and economies of scale. Thirdly, due to shorter product life cycles due to greater product variety and substitutes, as well as an emphasis on continuous innovation and flexibility. The growing value of market information also plays an important part here. Fourthly, due to increasing use of IT and communication technologies to serve the customer efficiently and effectively and to streamline the organization itself. Fifthly, increasing legislation on several areas is not only affecting individual companies but also entire supply chain, forcing supply chain members to collaborate. In order to become or remain compliant to different laws and regulations, areas like product liability, food legislation and strict environmental policies require new ways of finding the middle course between being compliant and remaining competitive. Sixthly, due to vulnerability to sudden supply chain disruptions is one of the major threats of today's companies. Terrorism, theft and disasters are some of the possible causes of these disruptions. To stay in control over the resulting consequences, increasing emphasis is laid on resilient supply chains.

MEANING OF RISK

As a layman understands, risk is an issue which leads to unpleasant reactions. In commercial terms, risk is a threat that a disruptive event may occur which will adversely affect the functioning of its normal activities. Risks may occur because of the complicated cause and effect due to interdependences of activities and the cascading effects each have on the processes impacting the final outcome. For example, due to the global recession the automotive industry has been adversely affected. The hardest hit will be the ancillary upstream units. As a result of recession, people have lesser money and demand for automobiles has drastically fallen forcing automotive manufacturing majors such as Tata Motors to shut their factories for a specified period because of lack of demand. As far as supply chain risks are concerned, at any point in the supply chain, from initial raw material sourcing to consumers, risks can disrupt the supply of goods and material or demand for products. They can cause sudden peaks in demand or collapses. Effects of risks can be short-term. Long-term risks are strategic in nature. The short-term risks are borne out of operational processes. There is a third one which is period-related risk. It is a tactical risk which deals with risks associated with budgeting and planning of activities for a specified period.

Changes in global economy, market demand, customer expectations and resource availability create supply chain risks, which need to be attended to, in order to be effective in the supply chain process. Risks arising in the value chain must be identified and contained before they create a crisis which could be harmful for a company which may have its working capital blocked in its supply chain.

However, as per regulatory requirements, all listed companies have to identify their risks and publish it as a paragraph in the chapter titled management discussion which forms a part of the director's disclosures. Identification of corporate risks and highlighting them is a mandatory disclosure under SO× 409 of SEBI and under clause 49 of SEBI.

In order to ensure that unpredictable events do not give rise to undesired outcomes on the company's performance, each critical activity in a supply chain process needs to be studied in detail and assessed. This is a risk and needs to be studied in detail and needs to be contained properly. The cascading effect of each risk (cause and effect) needs to be studied in detail to understand the root cause.

CATEGORIES OF RISKS

Supply chain management is responsible for the movement of material and information through the supply chain. Supply chain risk appears as an event which affects the movement of material in a supply chain and disrupts the planned flow of material and money starting from initial suppliers to the end consumer. These risks may prevent the ultimate objectives of the supply chain from being achieved and could even force abnormal termination of certain key activities. The supply chain risk management can be defined as:

the systematic identification, assessment and quantification of potential risks along the supply chain and an attempt made to understand and preempt such risks from creating a negative impact on the supply chain performance.¹

Supply chain disruptions can arise from external or internal risks. External risks include raw material shortage or cost inflation, variability in market demand, problems with trading partners, economic downturn, etc. Internal risks include poor quality, unreliable suppliers, machine breakdowns, uncertain demand, poor forecast, financial risks, etc. Management of these risks includes development of continuous strategies designed to control, mitigate, reduce or eliminate such risks.

There are four categories of risks: three related to the planning time span of activities and one related to regulatory risks in the supply chain. Strategic risks are aligned with the long-term goals and the vision, mission of a company. The risks due to acquisition, mergers, expansions, joint ventures need to be assessed properly. Most of the strategic process failures are due to inadequate due diligence or risk assessment.

Tactical risks involve inadequacies of supply chain configurations and inadequate innovation of products. Operational risks are those risks which are borne out of transactional activities such as inventory stock outs, operational continuity issues, etc. The operational risks involve failure of operational processes and deeply impact the financial results. Reporting risks involve weaknesses in reporting of internal controls and inability to prevent transactional inaccuracy.

As mentioned earlier, a supply chain process by its very nature is full of risks as there are several internal and external factors which impact the success of supply chain activities. Supply chain risks are numerous but critical supply chain risks have a high impact financial health of company. The other supply chain risks are economic risks, contractual risks, reputational risks, demand risks, market risks, flexibility risks, obsolescence risks, failed partnership risks, logistic risks, plant operations risks, outsourcing or sourcing risks. These risks originate either from the supply side or demand side.

SUPPLY CHAIN RISK MANAGEMENT

Supply chain risk management is a pro-active approach to ensure effective management of all potential risks throughout the supply chain. The risk can be controlled throughout the supply chain in the most effective and efficient manner by establishing internal and external accountability to stakeholders with regard to risks and their management by monitoring current performance in supply chain risk management and the results to be achieved.

The scope of supply chain risk is wide, covering procurement, inbound logistics, operations, planning, manufacturing, transport and outbound logistics, as well as support functions. Risk in relation to a business entity falls into two categories of control which are as follows:

Risks Within the Company's Control

Design, planning, procurement, warehousing, inventory management, payment, investment recovery, asset management, contracts, people, supplier selection, internal auditing, data integrity, procedures and policies, taxation and rebates, and transportation.

Risks Outside of the Company's Control

Weather, innovation, marketing pricing, inflation/deflation, political policies, supplier business structure are the external sources for supply chain risks. The sources of risks either are natural disaster or internal events. Disruptions can also result from attempts to create a more efficient, cost-conscious supply chain environment. Hence, it is essential on the part of the organization to understand risk within and outside to the organization.

The organizations need to analyse the key risks spanning supply network connecting suppliers, manufacturers, distributors, retailers and customers. Risk analysis results in a better understanding of the potential sources and, most importantly, the potential costs of a disruption. Thus, business organizations can more effectively address risks arising out of:

• Shifting manufacturing facilities overseas.
• Not being able to address variability in consumer demand.
• Not having real-time inventory information.
• Managing every customer as if they were equal.
• Operational disruptions at suppliers or distributors.

In today's complex environment if the risk element in the supply chain is addressed properly, the financial performance and competitive advantage of an organization can be enhanced considerably.

MODELS OF SUPPLY CHAIN RISK MANAGEMENT

As a result of the heightened risk, organizations will need to develop appropriate programmes to mitigate and manage the risks. For this lots of studies are conducted, different models are developed some of them are explained as follows.

Model 1: Deloitte's Fully Integrated SCRM Approach

Deloitte's fully integrated SCRM approach comprises of four main phases:

• Step 1: Identify Risk—Recognizing relevant supply chain risks for the organization, that is, risk from suppliers and customers and from internal business environment.
• Step 2: Evolving SCRM Strategy—Considering all the options to evolve a suitable SC risk mitigation strategy.
• Step 3: Implementing Strategy—Execute the action plan by educating people who are involved in implementation process.
• Step 4: Monitoring the SCRM Process—Continuously evaluate and improve SCRM strategy and actions. Monitoring can be focused on change management (input), the current level of risk management (output) and the secondary effects of the strain put on the company objectives.

Model 2: A Review by Christopher S. Tang

According to this model, supply chain risks can be managed through co-ordination or collaboration among the supply chain partners so as to ensure profitability and continuity. Risk management can be thought of along two dimensions. The first one is managing operational risks and the second one is mitigation approach. The first dimension addresses the risk level of certain events. Operational risks are uncertainties such as uncertain customer demand, uncertain supply and uncertain cost. Disruption risks are disruptions caused by natural and man-made disasters such as earthquakes, floods, hurricanes, terrorist attacks, etc., or economic crises such as exchange rate fluctuations or strikes. In most cases, the business impact associated with disruption risks is much greater than that of the operational risks.

To mitigate the impact of supply chain risks, there are four basic approaches, supply management, demand management, product management and information management, that every firm goes in for a collaborative mechanism. Each of these four basic approaches is intended to improve supply chain operations via co-ordination or collaboration as follows.

First, a firm can coordinate or collaborate with upstream partners to ensure efficient supply of materials along the supply chain. Second, a firm can coordinate or collaborate with downstream partners to influence demand in a beneficial manner. Third, a firm can modify the product or process design that will make it easier to make supply meet demand. Fourth, the supply chain partners can improve their coordinated or collaborative effort, if they can access various types of private information that is available to individual supply chain partners.

Model 3: SAP Supply Chain Risk Management

The growing amount of globalization, supplier dependency and variability of demand has created an increasing vulnerability of supply chain networks when disruptions occur. While operating the supply chain through planning and execution, sensing deviations and responding to them lays the foundation of adaptiveness. To identify risks, develop efficient response strategies and monitor the actual processes, a disciplined approach is necessary. Managing supply chain risks requires taking a specific perspective on the supply chain and the involve business partners, locations and dependencies on different levels in the value chain.

To mitigate the ill effect of sudden rise of risk and disruption of supply chain thereafter, the organization can go systematically to address the problem. The organization may adopt the process of identifying, measuring, managing and monitoring the risk.

ROLE OF IT IN MANAGING RISK

IT plays a very important role in today's global supply chain. IT tools can help company's aggregate baseline data and create supply chain profiles. Enterprise-wide software solutions can also help traditional supply chains evolve from linear and sequential operations to adaptive networks capable of adjusting to changing economic and market conditions. The same functionality that supports supply chain network visibility, cooperation, and analytics can also enable supply chain risk management. Companies can synchronize supply to demand, and sense and respond to supply chain events through an adaptive network with real-time distribution, transportation and logistics capabilities.

Implementing enterprise-wide software solutions can be crucial because in many cases companies actually possess the data they need, but disconnected systems come in the way to make the right data accessible to the right people at the right time. With an end-to-end software solution, the overall result is a more transparent and responsive supply chain network that supports organizational efficiency as well as flexibility and resilience. With IT in supply chain, the risk in operation gets mitigated because of the following reasons:

• Increased degree of collaboration and transparency between partners.
• Reduction in inventory due to real-time information flow.
• Error-free handling of huge data.
• Information availability at anytime, anywhere in the right format.
• Technology increases visibility, coordination and integration.
• JIT implementation becomes possible.

SUCCESS FACTORS IN RISK MANAGEMENT PROCESS

In view of the growing complexities of a company's operations, a need is felt for a very elaborate risk management practice. This has a close look at all the activities that constitute key processes and having assessed the various risks involved, formulate mitigation procedures to minimize the impact of such risks. The risk management tool should be able to predict the down trends of events in processes before it turns into a crisis. An elaborate business continuity plan should be included as a part of an effective enterprise risk management process (Exhibit 24.1). This enables the company to plan for alternatives in the event of process risks surface. Risk management and business continuity processes should be elaborate and cover intra-and inter-company risks.

 

 

Risk assessment and management process is a very seldom practised process today and companies are waking up to the fact that they are carrying veritable risks with them, which could seriously undermine their chances of success at the marketplace. Very few companies have a well documented risk policy in place and further even fewer employees understand the risks entailed in their function. Similarly, very few companies with strong supply chain dependencies actually are verbose in listing the key issues involved in their respective supply chains which could pose as serious risks to the companies. Supply chain risk assessment and management process should be embedded within the performance management system of a company.

BUSINESS CONTINUITY PLANNING

Supply chain activities are critical in nature. Any disruption in these activities is catastrophic for the outcome of a supply chain process. Hence, every company which depends on the supply chain as a strategic process should have an inbuilt business continuity to take care of each of its critical activities such as sourcing, outsourcing, manufacturing, logistics, etc. Business continuity planning seeks to prevent disruption of critical activities. The activities are designed and tested to use for restoring operations in the event of disruptions. Key activity in business continuity planning includes finding viable alternatives for performing critical supply chain processes in the unlikely event of their failure. Various components of business continuity planning include crisis planning, contingency planning, business recovery planning and continuity planning.

APPROACH TO MITIGATE RISKS

The following approaches may help business organizations to reduce the degree of risk in supply chain operations.

Strategic Planning

A company with a strategic planning process will avoid conflict of cost vs risk and bring value improvement, speed to market, and innovation. Cost efficiency can reduce supply chain risk, provided that cost-efficient processes focus on core trading partner relationship management. The tool for managing this relationship is the contract, which can be written to include service level agreement for transaction compliance. This arrangement increases the ’visibility’ of supply chain partners’ performance, thereby reducing risk.

Co-operation, Collaboration and Integration

To achieve a common objective co-operation with all supply chain partner is must. To close the skill gaps the collaboration between them is essential. However, for continuous operation, integration in assigned set of work is a must. For sorting out the issues involved in mitigating complex risks requires a greater degree of collaboration. The vulnerabilities arises out of lack in co-operation, collaboration and integration.

Tradeoffs

The inventory will address the issue of increased service cost. But it may create the issue of stock outs and opportunity loss. Hence, tradeoff is must to optimize the risk. The tradeoff solution in general should cover the following:

• Assessment: To identify key risks in supply chain to understand its potential economic consequences.
• Analysis: To arrive at an optimal future state risk profile for supply chain.
• Roadmap: Develop plans needed to implement the changes required to mitigate organization’s future risks.

Supply chain disruptions can arise without warning. These disruptions can be entirely external, such as a natural disaster, or they can be internal, rising from the failure to integrate all functions in a supply chain.

A supply chain must be fully integrated. Its inability to understand the potential vulnerabilities makes it weak to handle unexpected and sudden shocks. For being fully integrative supply chain organization need to embrace the extended supply chain (i.e., their customers and suppliers as well as their customers’ customers and their suppliers’ suppliers).

In an attempt to make supply chain more cost-effective and efficient, organizations adopt techniques like just-in-time (JIT) in their manufacturing operations. In fact, this adds to supply chain complexity and risk thereof. It will be prudent on the part of the organization to take a note of the potential risk in adopting these techniques and think about the solutions in advance.

The supply chain disruptions have a great impact on financial performance of the organization. However, the firm's ability to effectively manage the impact of potential risks can create a strategic advantage in a competitive marketplace.

To mitigate the financial impact due to supply chain disruptions, the organizations should look into the following:

• Understand the dependencies within the supply chain.
• Identify the weak links within supply chain.
• Identify the SC risks that may be mitigated, or eliminated.
• Incorporate the element of risk in decision-making.
• Assess the flexibility of SC to encash on opportunities.
• Capture an enterprise-wide risk profile.
• Use tools and skills to understand the financial impact of risks.
• Benchmark the activities that make up effective supply chain.

Finally to address risk, firms should understand the global business drivers that affect an organization's profitability and performance.

REVIEW QUESTIONS

1. What do you mean by supply chain risk?
2. What are the various types of risks associated with supply chain?
3. Discuss the various models available for mitigating supply chain risk.

INTERNET EXERCISES

1. AMR research provides advisory services and peer networking opportunities to supply chain, sustainability, and IT executives in the consumer products, life sciences, manufacturing and retail sectors. For studying SC risk mitigation strategies visit http://www.amrresearch.com
2. Visit http://www.pwc.com to study the cases on SC Risk Management.
3. Follow link http://www.sdcexec.com/print/Supply-and-Demand-Chain-Executive/Bench marking-Green-and8212-Supply-Chain-and-Product-Lifecycle-Strategy-Guide/1$10842, to understand how to execute programmes that mitigate supply chain disruption, comply with regulations, and enable sustained performance.

VIDEO LINKS

1. Supply chain risk management strategy, http://www.youtube.com/watch?v=LbNgYYB7tV0
2. Supply chain risk reduction—Professor Richard Wilding, http://www.youtube.com/watch?v=QlZ6TyUaYpw&feature=related

PROJECT ASSIGNMENT

1. In the event of natural calamities, the organizations with global reach, faces the disruptions in their supply chains. The disruption may discontinue raw material/components supplies or disruption in manufacturing operation. The global companies like CISCO, Hewlett Packard have successfully tackled this problem. Find out whether the same can be made applicable to Indian companies with global operations. Select any Indian global company in any industry sector of your choice for this exercise.