Supply Risk Management - Risky Business

Finding time to assess and plan for the many supply risks which could face your company will pay dividends in the long term, say the experts.

On average, about 50 per cent of goods and services don’t stem from a company itself but from its suppliers. In other words, the dependence on suppliers and the suppliers of suppliers is enormous. This makes it all the more surprising that many companies do not monitor the risks of such dependence.

Increasingly serious and threatening risks are obvious at various points of the supply chain. Nevertheless, there is a gap in adequate supply risk management strategies capable of coping with them. The consequences of this can be tracked in the daily news. For example, in the automotive industry, more cars have been called back over the past year than ever before. In most cases, quality problems mainly occurred at the level of a suppliers’ supplier and were discovered too late or not at all.

In many other industries, quality problems which were largely unknown a couple of years ago are now rampant. Bribery is also one of the typical supply risks many companies do not monitor. Simply speaking, supply risks comprise all those risks that are associated with purchasing and supply management. To be more precise, supply risks are all risks that occur during materials planning, steering and control within the internal and external value chain of a company.

For example, sporadic fiddling is, of course, something of a problem but one which is far exceeded by virulent supply risks. We have identified 150 supply risks, and have developed concrete have actually prevented the production shutdown at the start, for example, by developing potential second sources.

Often, crisis management is very effective but comes too late. Essentially, the damage to a company has already been done. Crisis management is reactive, dealing with a problem that has already arisen. Supply risk management, on the other hand, is aimed at proactively preventing damage and is accordingly a more cost-effective strategy.

However, there are issues over implementation. although most organisations are aware of the risks they face, they will often fail to successfully implement an efficient supply risk management programme. Generally, companies seem able to introduce supply risk management successfully if certain pre-conditions are met.

Checking the potential risks
First, implement a top-down project. a project’s chance of success is good only if theinitiative stems directly from the management board and is headed by a board member. Additionally, the head of purchasing should be the main driving force behind the project, following the rule that supply risk management is their top priority. The problem is that even if this precondition is met, many projects will still fail especially if they are seen simply as “add-ons”. Supply risk management can easily become the office task nobody can find the time to deal with properly. For projects to be successful, the head of purchasing must be able to provide sufficient resources, capacities and time for staff to look after their risks. It is also crucial that they get the chance to develop risk awareness which takes further time.

Second, supply processes must be checked regularly for potential risks. Try to answer the following question: within which processes could potential risks reside – starting from the supplier and ending in sales? But what do sales – and marketing for that matter – have to do with procurement?

Supply risk management is not limited to procurement. Take the example of the automotive industry: imagine customers suddenly don’t want to buy blue lights any more. Purchasing is stuck with thousands of blue lights nobody wants. Therefore, it is essential to integrate people from the sales department into supply risk management from an early phase. This prevents you from stocking too many useless blue lights.

Third, integrate all central topics into supply risk management. At the Supply Management Institute, we distinguish six areas.

1. Supply risk strategy: how do we generally want to handle risks? What is the overall risk policy?
2. Supply risk measurement: which general options do you have to handle risks? These can be avoidance, prevention, transmission or compensation of risks.
3. Supply risk identification: which concrete risks currently affect your business or organisation?
4. Supply risk analysis: what are the reasons for these risks?
5. Supply risk evaluation: to what degree is there a chance that the identified risks will probably occur and what would be the impact?
6. Supply risk management: which specific measurements seem to fit to the identified, analysed and evaluated actual risks?

Fourth, consider visualisation and monitoring. Usually, risk situations appear to be stressful because they are difficult to overview. Take quick corrective action: visualise all actual risk situations using risk checks and other devices. Furthermore, be aware that there is a constant menace of risks: control the supply risks and the supply risk management itself. This is called monitoring.

Finally, put in place the necessary organisational set-up. As risks are a permanent threat, it would be helpful to see supply risk management as a continuous control loop. Make sure structures are in place to guarantee that this control loop is never blocked.

With the establishing of these five preconditions, supply risk management becomes efficient and effective. For example, in the aviation industry all airfreight companies are affected by the high risk of fuel and gasoline price increases. However, many US airlines got to the point of ruin because their risk management could not overcome the short-term profit ethos.

Lufthansa, on the other hand, took such threats seriously and protected itself against increased prices of kerosene by applying a large hedging portfolio.

Today, Lufthansa saves millions of euros compared with its competitors. This illustrates the importance of supply risk management. It is not just “nice to have” but is, in fact, a strategic success factor that can provide big cost reductions, competitive advantages and, in many cases, can actually help guarantee the survival of a company.

Sourcing from a single supplier is another risk facing many organisations. this is often homegrown. Purchasing staff strive for increasing cost reductions so they try to bundle purchasing volumes together until they end with single sourcing – purchasing huge quantities from one supplier.

This narrow focus upon price can lead to a bitter vengeance of the incurred risk: if this single source provider drops out or has substantial quality problems, the resulting costs will usually be much higher than all savings generated in the first place by bundling. Many companies overlook this risk because they don’t have a systematic supply risk management scheme in place. However, a manufacturer from the automotive industry got around this problem by persuading his board to build a complete production line at his company’s headquarters, despite the fact that a single facility in Eastern Europe could have produced the necessary goods. He decided that this would have entailed so many risks that the in-house option was better. All external risks were avoided – although of course other sources of risk remained. Overall, the number and gravity of supply risks has increased during the past few years. This in itself is not necessarily worrying, depending on the answer to one key question: “How well do you manage these risks?”

Professor Christopher Jahns is executive director of the Supply Management Institute at the European Business School, International University, Frankfurt. Dr Michael Henke is research fellow at the SMI focus group on supply risk management