A fine balance—September print edition

Ways to deal with risk continue to evolve

October 3, 2012
by By Michael Power

The world has gotten faster. Supply chains now travel at speeds—and to corners of the globe—no one would have expected just a few decades ago. And while many economies seem to be emerging from the worst of the Great Recession, recovery in many regions remains uncertain. Between natural disasters, fluctuating commodity prices, lead time concerns and other potential risks, procurement professionals have their hands full. So what risks do today’s supply chains face, and what can procurement professionals do to mitigate them?

The increased business pace and ever-shifting customer demands leave procurement little time to plan and implement risk management strategies, says Shawn Casemore, president of Casemore & Co. Decades ago, for example, someone might have made an automotive component that would change only three times in five years, Casemore says. Now, new models are released frequently and customer demands constantly change. That means organizations risk being stuck with additional inventory for which there’s no use.

“It’s difficult when customer change is more frequent and you have to manage everything around that,” he says. “You have to manage inventory levels. If there are engineering changes, how do we exhaust old inventory? What do we do if we’re not allowed to exhaust it? There’s a constant flux of customer change and increasing pace.”

Sole sourcing—or perceived sole sourcing—also carries significant risk, Casemore notes. Putting all your eggs in one basket can mean continuity becomes an issue if a supplier relationship sours. Today’s globalized supply chain means that with the cost of labour increasing in China, many organizations that spent years refining their sourcing are now compelled to look to Malaysia, Viet Nam and other nations. That forces companies to relive growing pains they’ve already experienced in China. That can take time in locations that have less developed infrastructures.

“You can’t call up UPS Global and say, ‘I need you to drive miles across this field to get to this guy.’ How do you even explain that?” Casemore says.
Indeed, sourcing globally can add complexity to supply chains, and organizations may not realize outsourcing can lead to smaller margins for additional costs, he notes. Companies must therefore be cautious of how their supply chains are structured and may want to look at whether more can be done internally.

Scott Byrnes, vice-president of marketing for global trade management software company Amber Road, puts supply risk into the three categories of compliance, supply and cost. For compliance, knowing trade requirements (is a license needed to import? Do sanctions exist against a country?) prior to sourcing in a specific location can help minimize risks. “From the procurement perspective, before anybody makes a buy decision they need to understand what the rules are related to buying from that country,” Byrnes says.

For supply risk, procurement professionals are more sensitive than ever to difficulties of sole sourcing, he notes. Supply risk is highlighted quickly when a supplier goes bankrupt or a country experiences a natural disaster—think floods in Taiwan, Iceland’s volcanic eruption or Japan’s earthquake and tsunami.
A resilient supply chain, Byrnes notes, can absorb natural disasters or major disruptions by using multiple suppliers in regions around the world. As well, visibility—seeing where goods are—can help mitigate those risks. And financial risks can also present the opportunity to reduce sourcing costs. For example, purchasers can minimize duties by taking advantage of preferential trade programs.

Mitigating risk on the compliance front is a complex challenge, says Byrnes. Seeking a consultant to perform risk analysis on global trade regulations can help. As well, technology solutions can automate the function to ensure organizations remain in compliance. An assessment of supply risk—and how badly a disaster would impact an organization—can also help companies deal with adverse situations. Step back and assess where supply sources are, whether they’re spread across the globe and how quickly you could find another supplier, he advises. Already having relationships in place with those suppliers can pay dividends if disaster strikes.

According to Fraser Johnson, professor of operations management at the Richard Ivey School of Business at the University of Western Ontario, supply chains are exceptionally lean these days and even slight disruptions can cause big problems for an organization. There’s pressure to reduce inventory, and just-in-time delivery demands means organizations are constantly fighting the clock to get supplies delivered.

Johnson divides risk into several broad categories, including the financial risk from factors like oil price volatility, foreign exchange and others. Operational issues like supplier capacity and lead times account for much of the risk in today’s supply chains. An organization can also experience reputational risk if they do business with a supplier that violates, for example, child labour standards or harms the environment. The final category includes “other” risks, or those unique to an organization or that stem from a function of the business, says Johnson.

Dealing with risk
Continuously seeking alternate sources of supply—by going global if necessary—to avoid sole sourcing can help cut risk, said Casemore. But doing so requires strategic thinking, which takes time. Procurement and supply chain management remains operationally driven and finding time to look at alternative sources can be tough. But it can be worth it in the end, Casemore notes.

Johnson agrees that more than one supply source can have its benefits. While sole-sourcing can be appropriate in some situations, dual-sourcing is especially useful for components that are critical to an organization. “I’m not trying to say that every organization should dual source, but it’s good to have alternatives,” he says. “Sometimes, it’s good to have a backup source established.”

As well, procurement excels at compiling robust contracts, Casemore says. But managing those contracts is equally important. Procurement professionals would benefit from tying key performance indicators (KPIs) to contracts. “Unfortunately, many (purchasers) just cut the purchase orders, make sure things are buttoned up and they walk away,” Casemore says. “They don’t follow up with meetings, milestones, thresholds or KPIs in those contracts. The risk is that if we don’t, we’re in deep water and now we have to swim out of it.”

The improved communication that arises from putting the procurement and logistics functions together can also help cut risk, he says. This may be less of a problem in smaller companies, but even smaller organizations have a buyer and a shipper. While purchasing may get “the best deal” in a contract from their perspective, that doesn’t mean they’ve landed the best costs from a logistics perspective. A buyer can get the best price possible, but if the goods don’t show up on time or if they show up damaged, the price makes little difference.

Transparency is key to managing risk in financial services, says Lori Benson, strategic sourcing director at Ernst & Young. Financial services institutions must maintain total transparency in relationships with other institutions and suppliers, Benson said. That can create challenges because relationships must sometimes be broken—sometimes at a moment’s notice—if problems arise with that relationship. Ernst & Young is heavily involved in pre-approval for suppliers and there are many terms and conditions to state if relationships have been properly vetted.

“You need to know your supplier,” Benson said, offering advice on how to deal with such risk. “You need to know about them, you need to know who owns the company. You need to investigate and ensure that your relationships are transparent—it’s also understanding that if the firm is getting into a relationship that they’re checking to see who the suppliers are.”

While much can be done to cut the risk procurement professionals face, taking chances has always been a part of the procurement process, says Johnson. While it’s an important part of the job, trouble arises when people don’t recognize and account for risk. Having plans in place to deal with it goes a long way. “The tough part is you can’t control for these things,” he says. “How do you control for an earthquake or a tsunami? How firms are able to deal with risks really differentiates them.” b2b