procurement


Supply Chain Risk Management – Fail to prepare, prepare to fail

At regular intervals, a local crisis occurs in some country around the world, and the ramifications on global trade are felt for months afterwards. We can all probably name political coups, ash clouds, earthquakes, and tsunamis that have had a devastating effect on many sectors for months after their occurrence. Here in Ireland the recent collapse of UK construction company, Carillion, has left subcontractors and regulatory bodies scrambling to recover the situation and keep the planned school building programme on track.

Benjamin Franklin famously said “Fail to prepare, prepare to fail”. This phrase couldn’t be more apt when it comes to dealing with anticipated and unanticipated risks in the supply chain. Supply chain risk can be defined as the probability of an event occurring that will influence (usually negatively) the ability of a business to serve its customers. Effective identification and management of risk will enable an organisation to guarantee continuous cash flow and profitability. In this blog I will concentrate on identifying and mitigating risk in the supply base.

There are all types of operational risks which need to be considered, ranging from suppliers who create goods and services used in a company’s own operations, to third party providers who distribute the company’s products or services to the customers. By using the following 5 techniques when planning and agreeing to third-party involvement in your business, you will reduce the risk of damaging situations and implement an effective risk management policy. The key factor is to do your research on the suppliers and carefully plan and prepare for all possible supply interruption situations.

 

  1. MAP THE HIGH-LEVEL SUPPLY STREAM

For each key product and service, identify and map nodes (the inventory holding points) and activities (the inventory movement between nodes). This visual map on paper is typically completed by the procurement/purchasing teams.

 

  1. PERFORM A HIGH-LEVEL RISK LISTING ON THE SUPPLY STREAM

Brainstorm along the stream, all the worst-case scenarios from global issues, plant shutdown, loss of goods, restricted transport links, strikes, to internal breaches. Typical high-level categories are

  • Quality risk (the primary concern of most organisations)
  • Political (including government stability, legal and regulatory requirements, tariffs etc.);
  • Socio-Economic (including religious observance, holiday periods, counterfeiting, bribery);
  • Supplier organisation stability (ownership, management ethos, financial standing, safety & quality record, insurance)
  • Geographic (including distance, transportation mode, number of ports of call, time)
  • Climatic (including heat, cold, climatic turbulence, earthquakes);
  • Monopoly/supplier dominance (single source supplier, unique technology, patent restrictions, supplier very large by comparison with organisation), and
  • Pricing and future currency fluctuation (commodity price increase/decrease).

This step is similar to the first step in a traditional failure modes and effects analysis (FMEA) exercise.

 

  1. CROSS REFERENCE THE SUPPLIERS TO THE RISK LISTING

Using your vendor database, identify all approved and non-approved suppliers. Create a matrix that identifies which risks apply to which suppliers. Prioritise the list in the areas of greatest risk.

The above sample table uses a scale of 1 to 3, where 3 is the highest-level risk. The results of this exercise, typically performed by the procurement/purchasing team, are used to devise a proposed risk mitigation strategy for each supplier. For each of the risks identified, the mitigation plan must include a cost of implementation and quantification of the reduction in the risk. Aim for a 50% reduction, or greater in the risk. The proposals are then presented to the management team for amendment and approval.

 

  1. IMPLEMENT THE MITIGATION PLAN

In order to flesh out the mitigation plans, owners need to be found who will be responsible for taking action. This typically involves several months’ worth of work that needs to be planned, resourced and tracked through to completion. Here is where most risk mitigation plans fall down. Often senior management is prepared to live with the risk (‘It won’t happen to us!’) than invest in a mitigation plan.

Some useful risk mitigation strategies include:

  1. Vendor-owned consignment hubs close to your organisation (infinitely preferable to organisation-owned safety stock)
  2. Safety stock
  3. Second and third sourced vendors
  4. Alternative transport (e.g. air freight vs. sea freight)
  5. Alternative routes
  6. Late delivery penalties
  7. Contract cancellation option
  8. Sue the supplier for breach of contract.

The above options range from the collaborative (most desirable) to the punitive (least desirable).

  1. STANDARDISE THE PROCUREMENT APPROACH

The process of sourcing new suppliers involves asking where in the world should your organisation purchase raw materials, components, services? Once the supplier is identified, due diligence on intellectual property, capability, quality, pricing, flexibility and confidentiality etc. are all part of a standard contract negotiation process. Your organisation now has a template and guidelines to incorporate risk analysis and fail safes into future procurement processes e.g.

  1. Pre-plan the supplier identification and negotiation process, using the risk analysis template developed in 2 and 3 above.
  2. Standardise and simplify the contract template.
  3. Address the limitation of liability, indemnification, and supplier insurance that covers the potential risks identified. Ensure your organisation is covered in the event of being sued by the supplier or any 3rd party in the event of failure to supply products or services. Incorporate the requirement to keep certificates of insurance up to date.
  4. Include opt-out terms in the event on non-fulfilment of terms.
  5. Use credit rating agencies to assess the financial stability of the company. Regarding an Irish business, you can obtain financial reports from www.solocheck.ie.

Points c and d above are a different way of looking at the traditional catch-all force majeure contract clause. It’s can be a fine line. You don’t want to be overly-restrictive in the procurement of third-parties which ultimately leads to reducing your options of encouraging new suppliers and innovators to step-forward or tender. There will always be risks, but it’s about a willingness to take intelligent risks in order to generate profits for the bottom line.

In summary every organisation should strive to establish a collaborative relationship that will benefit both your organisation and the supplier. There is no zero-sum game (I win, you lose) in successful supplier-customer relationships. That being said, disasters can and will happen, out of the blue. I hope the above 5 step approach will help you to prevent or avoid them, or at the very least to significantly reduce their effects on your ability to supply your customers.

So, as you ponder what intelligent steps you need to take to mitigate risk, remember one more quote from Mr. Franklin “Never leave that till tomorrow which you can do today.

Bernie Rushe is a former lecturer on the undergraduate and post graduate programmes in Supply Chain Management at the University of Limerick.