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Different Types of Risk in Your Supply Chain, and How to Avoid Them

May 21, 2014 • SPECIAL FEATURES, Supply Chain

By Cathy Johnson, Hitachi Consulting

There are different types of supply chain risk, and nowadays, these can be very easily exposed due to the power of social media and be incredibly detrimental to your business. This article looks at how each one can be easily avoided by capable senior management.

 

Risk results from any form of uncertainty in a process or the environment. Risk is relative to the ability to identify and predict its impact in advance. More importantly, it is relative to the ability to prevent the occurrence of risk in time and to minimise the outcomes of the risk if, in spite of the preventive action, it occurs after all. There are many areas of study supporting risk assessment and recommendations of how to deal with it. Whole industries and professions, the insurance and actuarial profession, for example, are built on the assessment, calculation and management of risk.

In the Supply Chain, risks can occur in supplying a product or service to a customer in terms of cost, timely delivery and impact on image. The sourcing and supply of products and services to businesses and consumers is becoming more and more complex and with it, the assessment and management of the associated risk. Some risk management techniques and modelling can be applied to the supply chain but typically will not be as mathematically sound as in the insurance industry, as there is not an equivalent comparable body of knowledge and experience to quantify all potential outcomes.

Supply chain risk affects a wide range of stakeholders. The direct players in the supply chain are the producers, the logistics, retailers and the customers. In addition, there are the providers of finance, the consumer pressure groups, and politicians to name a few.

External risk is driven primarily by issues which lie outside of the direct influence of the business. This includes not only the national political situation but the volatility of the global political landscape. Trying to predict how politicians will decide is probably not anyone’s priority activity, as it would require some type of modern-style crystal ball, but it is essential to keep up with what could potentially influence business operations and a recovery or mitigation plan.

This has a major effect on financial markets and interest rates which in turn will affect business decision-making. We saw the effects of that during the recent recessions when businesses reduced variable costs, stopped borrowing for investment, and worked on utilising existing resources as best as possible.

Purchasing raw materials and commodities is often underwritten by banks and financial institutions. Transparency of where product is sourced from, under what conditions it was produced, and where it is intended to go are important criteria for the financing decision. Any risk that the product source is unethical can impact the ability of the business to access future finance, which is a risk for the bank and the business. This means anyone involved in the sourcing of materials must have processes in place to ensure that they are not exposing the company to risk. The financing institution is also open to public scrutiny which needs to be managed. In the age of social media, information which may previously have been withheld or not available to the press is now accessible by a range of people and can very quickly become viral. This means that the impact of a risk on reputation is higher and less quantifiable in advance.

Suppliers and third parties in a process can be an exposure if there is insufficient control over what is happening. The European horsemeat scandal is a good example of risk with far reaching effects. The suppliers in this chain were reliant on the information provided on the source of meat. The high input price of meat led to some suppliers outsourcing the supply to smaller subcontractors and, either turning a blind eye to inconsistencies in the product description, or trusting the process to deliver.

Consumer groups testing the quality and source of meat act as an additional check point in the process and expose the issues. The impact of the risk taken here is the public image of the retailer in the first instance as the supplier is largely unknown to the consumer. The reverse of this process is the opportunity for those who control their supply chain and can prove the authenticity of the product supplied, in this case, local butchers who can trace the beef back to the cow from which it came. In other cases, consumers are showing a willingness to pay a premium for ethical products. So in summary, it is about weighing up the risk to image and loss of revenue, and consumer support.

 

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Geographic complexity

The supply chain in many areas today involves researching, marketing, producing and moving products and services across different geographies each with political and socio-cultural components. Local knowledge helps to weigh up the relative risk of operating in a country or region. What to an outsider may seem treacherous is seen from a different perspective by a person living in the environment. This knowledge must be incorporated into the risk assessment process.

Hitachi Consulting has observed examples of how the operational set up and execution can lead to risk. Our recent survey and views on the disconnect and misalignment of supply chains is an indicator of where risk can lie, namely in the link between senior management, the top level stakeholders and how the business executes the business strategy.

Internally, within a business, one of the main risks is in understanding the detail of the supply chain and being able to take decisions at the right time. Senior management have to balance growth ambitions with what the business can afford to invest. In large businesses, the leaders of the business are focused more on managing shareholder perceptions and external stakeholders, and rely on their management structures and operating model to have the finger on the pulse of the processes. There is an element of decision making which has to assess risk real time and steer a business in a direction. So senior management may not have all the information available all the time to assess the risks in operating the processes.

Operational risk in the supply chain can occur even where the senior management believes they run a robust and mature supply chain which ticks all the audit boxes. Cost optimisation means that business decisions are made farther away from the core process and become slower as a result.

One example of where the risk manifests itself is in the area of planning. Products and the various decision-making processes attached to the process are increasingly complex. However, people who act upon the process and make the decisions may fall back into their own ways of working when faced with demands.

We have observed instances where on the one hand, there is a theoretical image of what should be planned versus the reality of how the production is driven functionally on a cost per unit basis. Satisfying erratic demand works conversely to the needs of efficient manufacturing, so the planner will use this excuse to either not plan or decide to satisfy the needs of the production metrics.

Data quality compounds these issues as the systems. Spreadsheets and gut feel override the quantitative analytics. The consequences are higher stock holdings to meet demand peaks rather than an optimum flow of product through the chain, which costs capital, storage and suboptimum logistics. In production, cost focus can remove some of the agility required to respond to demand if the decision is made purely within the function. The overall risk to the business is the inability to respond timely and loss of orders, delays and impact on customer service can have far wider cost implications than the marginal saving.

Another risk is knowledge. As mentioned earlier, local knowledge can reduce risk by providing a body of experience and competence to deal with issues in the appropriate way. Globalization allows businesses to embrace local cultures and build local knowledge. From a process perspective however, the tacit knowledge within the business which may have been built over time can be lost through footprint decisions and losing people from traditional locations. This cannot be the driver to maintain unprofitable sites, but it is an aspect of risk management which needs to be considered in the process.

 

What can actually be done to manage the risk in the supply chain?

First and foremost, one must ensure that there is visibility and alignment of the value chain towards the ultimate goal of supplying the customer. Visibility requires firstly a full understanding of the flow of value along the chain. It requires a clear view of what good looks like, what success is and how it can be measured, and what can prevent that success from happening. Organisations need, in effect, to identify the “bottleneck,” or the weak links in the process, and take the appropriate action. This could be a risk assessment which weighs up the risk and mitigating actions or specific resolutions.

Creating ownership beyond silos

Secondly, there needs to be ownership of the whole chain in such a way which allows the risks along the chain to be tackled. There is evidence that supply chains are often managed functionally with metrics, systems and behaviours geared to managing the performance of a specific area. Whilst detailed functional knowledge and understanding are essential to delivering a quality product, a narrow view can leads to a potential misalignment of the different elements of the chain towards the end goal. Senior management needs to ensure that decisions which are taken at the top are not sub-optimised in the operational execution. In practical terms, this means a real transformation in how measurement systems are designed and implemented to ensure that there is full understanding of how the business interlinks. Individual incentives and success need to be aligned for the achievement of overarching goals, not purely functional excellence.

Skills and capabilities to execute

Thirdly, the skills and competences across the supply chain must be secured. This starts with the functional skills in each area to provide the depth of executing a process. Then there is the ability to look beyond the function and see the holistic relationship of an action taken in one area and the impact in another. True maturity of the organisation can be measured in terms of how top down and across the organisation the supply chain is embedded, how the supply chain is really performing at each stage, and how risk is being assessed and acted upon on a daily basis. Also, competences in managing the data requirements and using IT systems need attention. The return on any systems implementation is only achieved when all people are fully using the potential of the system to manage the process, predict risk and actively make decisions at the right time.

 

The author would like to thank Martin Bunk, Manager, Operations at Hitachi Consulting, Germany, who is an expert in integrated planning, for his contributions towards this article.

About the Author

Cathy Johnson

VP, Consumer Industry

Hitachi Consulting

Cathy has spent 20 years working in operational consultancy and industry and has direct experience in delivering manufacturing excellence programmes (including supply chain projects) in the consumer industry.

 

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