The Strongest Link

Although it may be enjoying widespread popularity in conference rooms and today’s conference calls, the expression “supply chain” is problematic in the sense that its original meaning seems to wane just slightly with each utterance, as with a familiar word that’s been repeated until it sounds nonsensical.

It doesn’t help that literature on the subject is often mired in jargon. Indeed, the very words “supply chain” inspire wordplay. The image the term creates in one’s mind makes it difficult to resist. Who doesn’t respond to a visual of the weak link, that one overlooked supplier whose shoddy business practices or weak approach to risk management could prove to be the undoing of a supply chain already stretched to its breaking point?

Of course you don’t need to be told, using whatever words you choose, that supply chain risk is a pressing issue any more than you need to be told that globalization is kind of a big deal.

Today’s most profitable companies are often those that operate with little or no excess in the system. They include companies with supply chains as lean and elastic as a Giacometti sculpture — and just as fragile.

Rather than simply making the case that this type of risk deserves your attention, I’d like to offer several thoughts on how to identify, analyze and mitigate it.

SUPPLIER IDENTIFICATION AND PRIORITIZATION

Your company may have a few suppliers or perhaps hundreds. How will a disruption along that chain, somewhere in that constellation of participants, affect the profitability of your business? To understand your potential vulnerabilities, you must first understand your supplier network — how each supplier is connected not only to your operations, but also to other suppliers.

The first step is to identify key suppliers. This requires you to undertake a thorough analysis of your revenue streams and focus on the most significant of these in terms of current income as well as future strategic growth. Keep in mind that a product’s profitability is a better indicator than the size of the revenue stream alone. After you determine key suppliers that drive selected revenue streams, you’ll want to evaluate alternative sourcing options for each supplier. Using that information, you can winnow the list of suppliers down to those that are multiple-, single- and sole-sourced. Supply chain analysis can grow onerous quickly, and so multiple-and single- sourced suppliers with confirmed, adequate alternatives — i. e. those that do not raise notable concerns — can be exempted from further analysis. The goal is to evaluate only the suppli- ers presenting the greatest risk to your organization.

Suppliers should then be prioritized, ranked according to their financial impact on your organization. For example, what products or services would not be sold in the event of a supplier loss? One way to determine priority is to use annual business income value, calculated by subtracting variable costs from the related product line revenues.

What product does your company make? What components go into it? Where are they being sourced? The answers to these questions can help identify “pinch points,” helping you to put together plausible scenarios for a disruption at your facility or that of your suppliers.

Threatening to impede the identification of key suppliers is the sometimes tenuous link between risk management and procurement. Be aware that in some companies, procurement is out there establishing a supply chain; it is not necessarily keeping a line of sight to your risk management issues. Today’s risk manager must be prepared to forge new relationships, or strengthen existing ones, with corporate procurement to clarify the financial implications of individual supply chain exposures.

SUPPLIER ANALYSIS

Once you’ve identified key suppliers, the next step is to develop an awareness of the fundamental threats to those suppliers and manage the associated risk. This requires a deeper understanding of the supplier’s business operations and its ability to recover from a major disruption. It’s possible, of course, that the supplier will be highly resilient to a disruption, perhaps owing to a solid business continuity plan, thus presenting a smaller risk than initially thought. For example, a supplier thought to be the sole source of a critical component may in fact have the ability to produce that component at one or more additional locations. These alternate operations may be owned by the supplier or contracted elsewhere.

Provided access to a supplier location can be obtained, the goal is to understand the key facilities or processes needed to produce the supplier’s products or services.

You will have many questions. Is the supplier’s production based on a single location or multiple locations? What are the physical threats to these locations? How long will it take for the supplier’s business to recover from a disaster? Can the loss be mitigated through alternative locations or producers? Does the supplier have a comprehensive business continuity plan?

The good news is that, if your company follows strict property loss prevention standards in its own facilities, it can choose to do business with like-minded suppliers.

If your business is important enough to a supplier, that supplier might even allow you to audit its facilities. Or the supplier may agree to make risk improvements to achieve preferred-supplier status. Current business trends indicate suppliers are becoming much more willing to share information; this may hinge, however, on the amount of influence your company has on a given supplier.

RISK MITIGATION

Supply chain risk can be mitigated in several ways: through risk improvement efforts, by switching to suppliers with less risk exposure or by spreading the financial impact across multiple suppliers. Cultivating alternative sourcing arrangements, where possible, is typically the best way to mitigate supply chain risk.

Recall, however, that a sole-source supplier with a highly protected facility and effective business continuity management practices may not represent a significant risk. Businesses are trending toward leaner, more streamlined supply chains. This means not only fewer suppliers and more sole-sourcing, but also closer working relationships.

Expanding the supply base for alternatives is just one — and often very expensive — risk-mitigation strategy. Others call for:

• increased inventory levels (of raw material or finished goods);

• internal production capabilities;

• a merger with, acquisition of or increased equity investment in the supplier to better ensure control over supply and reduce potential threats;

• business continuity planning requirements for all suppliers;

• substitute products and services; or

• redesigned products, allowing for greater supplier flexibility.

If risk cannot be sufficiently reduced, you might explore risk-transfer options, but make sure you’ve sorted through the extent of coverage you need. Do extensions of coverage go beyond the suppliers’ or customers’ locations to outside influences that could shut them down?

Take, for example, a fire that burns up a power generator not located at your facility or your supplier’s. Let’s say the fire causes a service interruption at your supplier’s location, and that interruption affects your business. Will your insurer cover that loss?

Something else to consider: Do you have coverage if a port or rail line gets shut down? Getting products from point A to point B is essential to making the supply chain work. Rerouting can become very expensive. Be aware as infrastructures continue to get older and weaker, this scenario may become more commonplace.

DUE DILIGENCE IN TODAY’S ECONOMIC CLIMATE

It’s prudent to remind oneself that although current geopolitical, regulatory, financial and other risks tend to dominate the news headlines, supplier pr operty risk remains a potential blind spot for many companies. This is despite the fact that enhancing the physical risk quality of a supply chain builds resiliency.

Given the increasing scrutiny risk managers receive from boards of directors and audit committees in today’s dismal global economy, perhaps there’s no better time to ensure your company is keeping the arteries of its supply chain clear and profitable.

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It’s prudent to remind oneself that although current geopolitical, regulatory, financial and other risks tend to dominate the news headlines, supplier property risk remains a potential blind spot for many companies.