Untangle Your Supply Chain

Today’s business strategies are great for minimizing costs and increasing profitability. They can also snarl your supply chain beyond recognition. Interestingly, geopolitical, regulatory, financial and other risks tend to dominate the supply chain conversation, while supplier property risk has been a potential blind spot. As the world gets riskier, here are three basic steps risk managers can take to work out the kinks. A case study demonstrating the use of these techniques appears on Page 16.

Step 1: Identify and prioritize key suppliers

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 a thorough analysis of your revenue streams, and a focus on the most significant in terms of current income as well as future strategic growth. Keep in mind a product’s profitability is a better indicator than the size of the revenue stream alone. After you determine the key suppliers driving the 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. Because supply chain analysis can grow onerous quickly, multiple- and single-sourced suppliers with confirmed, adequate alternatives and having no notable concerns may be exempt from further analysis. The goal is to evaluate only the suppliers presenting the greatest risk to your organization. Suppliers should then be prioritized 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.

The sometimes-tenuous link between risk management and procurement can threaten to impede the identification of key suppliers. Today’s risk manager should be prepared to forge new relationships or to strengthen existing ones with corporate procurement to clarify the financial implications of individual supply chain exposures.

Step 2: Analyze your suppliers’ risk exposure

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. Of course, it is possible the supplier will be highly resilient to a disruption – perhaps owing to a solid business continuity plan – and present 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 – locations that are either owned by the supplier or contracted elsewhere.

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 provider even may allow you to audit its facilities or agree to make risk improvements to achieve preferred-supplier status. Current business trends indicate suppliers are becoming much more willing to share information. However, this may hinge on the amount of influence your company has on a given supplier.

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. Some questions to consider asking your supplier might include: Is your production based on a single location or multiple locations? What are the physical threats to these locations? How long will it take for your business to recover from a disaster? Can the loss be mitigated through alternative locations or producers? Do you have a comprehensive business continuity plan?

Step 3: Mitigate your supply chain risk

Supply chain risk can be mitigated in several ways. It can be done 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, which 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 a very expensive – mitigation strategy. Others call for:

• increased inventory levels (of raw material or finished goods);
• internal production capabilities;
• 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, to allow for greater supplier flexibility.

Where risk cannot be sufficiently reduced, you can explore risk-transfer options. To be prepared in the event of a supply chain-related loss, check with your insurer to understand how your property insurance policy will respond to this type of loss event.

Case Study: Chain Reaction

Recovery from a Supply Chain Disruption

Today’s companies look to minimize costs while increasing productivity. They also want to get to market quicker, without stockpiling inventory or tying up capital. Businesses are contracting for material and services that are no longer cost-effective to produce themselves, building new alliances with suppliers. Any break in the chain can cause the entire system to collapse, resulting in lost sales, customers and market share; delayed or missed deliveries; a drop in operating income; damaged market credibility and reputation; and investor and shareholder uncertainty.

A leading electronics company nearly came face-to-face with these issues not long after it had signed a deal to become the exclusive supplier of LCD screens for a major consumer company’s new product line of mobile phones, computers, video games, TVs, satellite radios and GPS devices. The multi-level deal stretched resources to their limit, affecting many companies along the supply chain. Production orders were assigned to various original equipment manufacturing (OEM) partners; they in turn relied on smaller companies to supply component parts.

Within the first year of the contract, the electronics company was hit with what could have been crippling events. A landslide in Korea destroyed a factory that was the main component supplier to a key OEM. A fire broke out at a critical supplier’s chemical plant in Europe — a large producer of liquid crystals — putting a stop to LCD production. A typhoon in southeast Asia shut down several ports, stranding a container ship scheduled to carry 200,000 new video-game systems to the United States.

Though difficult and costly, in each circumstance, the company responded, mitigating the impact on its operations. For example, it helped the supplier in Korea shift component production to another local factory, arranged temporary housing for workers and negotiated a rush order to replace equipment. It arranged for liquid crystals to be supplied by several smaller companies, located in different countries. It re-routed the video games, by rail, to a port city in another country, and shipped them from there.

Fortunately, the company had prepared for the unexpected. It had identified and assessed the potential for risk all along its supply chain, and collaborated with its suppliers to develop an inclusive strategy for improving that risk. It even conducted a comprehensive review of the economic, social, political and environmental conditions in the regions in which it did business. It understood its exposure, and made the decision to protect itself. It learned that risk management in a global marketplace requires more than just insurance. More importantly, it put itself in a better position to compete, even if disaster were to strike.