Procurement professionals are in danger of basing their risk management strategies around high impact but low probability events, while marginalising infinitely more likely, and indeed potentially more dangerous, scenarios, according to new research from Procurement Leaders.
That’s the key finding of a newly published study entitled ‘Supply Chain Risk: The Hidden Cost of the Human Factor’.
The research – which involved interviews with senior procurement figures across all major geographies and industries – found that the majority of respondents had experienced only a few disruptions to their supply chains over the past 12 months. A substantial number of these even went as far as to say that they kept no data on such incidents.
The fact that major disasters events often receive blanket media coverage doesn’t necessarily help either. That knowledge is automatically retained, while more prosaic, but often more frequent problems are more easily forgotten.
“You have these ’black swans’ – these low probability but high impact events – the September 11 type events - which come out of the blue,” says Jonathan Webb, head of strategy research at Procurement Leaders.
“People see those in the press and as such a lot of the problems here are derived from the media. If you look at newspapers, in order to sell they need interesting stories. People read these and then generalise. It’s human nature and it’s the same in procurement – people see these events and they’re the things that stick in the mind.”
Unsurprisingly, those memories then come to fore when formulating risk strategies, with recent earthquakes or terrorist attacks coming to the fore.
The key, according to Einav Ben-Yehuda, business transformation and procurement director at Hyde Group, is to develop an evidence-based approach.
“While it may be a natural human tendency to shudder at the spectre of so-called ’black swans’, the key to successful risk management is to focus on the evidence and remain calm,” she says. “Given the infinite range of things that can go wrong, companies almost inevitably have to rely on after-the-fact analysis to assess their risk management capabilities.”
The research illustrates just how costly this lack of focus on smaller but high probability events can be. According to respondents there are, on average, 7.6 disruptions to the supply chain every year that cost a company as much as €9.1m – a figure which represents around 0.5% of total annual spend.
This figure is not only costly in a financial sense, but it can also do irreparable harm to procurement’s reputation. It also flies in the face of the common perception that high-impact, hard-to-predict events pose the greatest risk to procurement functions.
The study found that 27% of disruptive events across different industries were considered to be high impact but low probability (black swans), while 35% were attributed to low-probability/low impact events.
This, the research stated, means "a sudden fire at a supplier’s plant or a one-day labour strike would happen more frequently and with greater effect".
“Good risk management shores a company up against both the black swan of terrorism and the common-or-garden risk of supplier bankruptcy,” says Ben-Yehuda. “While the latter is far less chilling or compelling than the former, risk management is not about drama or horror," the study added.
“It’s about assessing probability, and maintaining a business environment that is as robust and as predictable as possible, so that the company can run with optimal efficiency for the benefit of all its stakeholders."
The research also found that risk is much psychological as procedural, with many organisations working on the premise that there is always a frontier of ‘acceptable risk’. This level of risk is considered not just manageable but also part of the normal process of servicing a particular industry.
“Such occurrences rarely evoke a convoluted risk management or disaster-response process that requires resource from a range of departments. Instead, incidents of this nature are often glossed over and rarely reported. In some organisations, disruptions that qualify for the risk,” the research states.
The very nature of micro-risks also makes them more complex, numerous and difficult to identify – again, meaning they are often over-looked and receive little attention.
“It can be a very reactionary way of working,” says Webb. “You see what happened in Japan when the tsunami hit in 2011. Toyota suffered huge disruption as a result so they implemented a plan to earthquake-proof its supply chain. The likelihood of a tsunami of that magnitude hitting again is as remote as it was before but the company is building its supply chain around one very unlikely event.”
The impact of events such as the Japanese tsunami can clearly be huge. As this research illustrates, though, the impact of less headline-grabbing incidents can be even more disruptive and costly.
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