Mitigating Risk in the Supply Chain

The author describes the importance of risk management and offers strategies for risk-management preparedness in supply chains.
Aug 01, 2010
Volume 2010 Supplement, Issue 3

When I began my career in manufacturing some 35 years ago, I don't remember much talk about supply-chain risk. Yes, we worried that supply could be disrupted, but quite frankly we dealt with those issues as they occurred. Although we strived for "just-in-time" inventories, we generally maintained "just- in-case" inventories and could easily withstand most outages. Most supply chains were regional, and we worried about potential labor-union work stoppages or a delivery truck breaking down en route. Although this description is somewhat oversimplified, supply-chain risk was not as complex or potentially damaging as it is today.

Besides supply disruption, which has evolved to include risks associated with material scarcity, natural disasters, political instability, and financial collapse, today's corporations must deal with additional significant risks exacerbated by the rapid global transparency of information affecting corporate reputation and even brand image. In this year, alone, we have seen the disruptive impact of a major earthquake in China, the Icelandic volcano, the Times Square bomb scares, and the Gulf Coast oil spill. The financial effects on supply chains from these incidents is already tens of billions of dollars and will surely be much higher before full resolution and a return to normal operating conditions are achieved.

The importance of mitigating risk and preserving corporate reputation is underscored by a 2007 study conducted by the global public-relations firm Weber Shandwick in conjunction with the opinion research firm KRC Research, which surveyed 950 business executives worldwide to evaluate reputation risk. The survey found that 63% of a company's market value is attributed to reputation. Nearly nine out of 10 survey respondents concurred that there has been a growing trend of corporate reputation risk. The report cited a 2005 study by the Economic Intelligence Unit, the research arm of The Economist, which showed that reputation risk is nearly three times greater than the risks from terrorism and natural disasters and surpasses regulatory, human-capital, information-technology, and market risks. Weber Shandwick's corresponding research showed that global media coverage of reputation risk has grown from being practically nonexistent in 1990 to almost daily mentions in 2007.

Reputational risk is at an all-time high and evident by several recent examples such as recent problems with corporate giants Toyota (i.e., automotive recalls) and British Petroleum (i.e., Gulf Coast oil spill). The question for all responsible executives is: "What is our preparedness to avert preventable risks or respond rapidly to minimize damage should an unpredictable event occur?"

Despite the importance of mitigating risk, companies may not be sufficiently prepared. Successful risk mitigation in today's complex environment takes a combination of policy, standard processes, technology, strong leadership, and analytical research.

Five important trends in risk-management preparedness

A comprehensive supply-chain risk-management strategy must involve five key principles: cash-flow management, a balance of low-cost versus low-risk sourcing, strategic-procurement initiatives, incorporation of sustainability practices, and responsible spending. These elements are further detailed below.

Sensible cash-flow management. With the changing environment of increased regulation, price controls, generic-drug competition, and longer and more expensive research and development cycles, pharmaceutical and biotechnology companies have become much more focused on supply-chain cash-flow management strategies (following the lead of other industries that began implementing these strategies as many as 25 years ago). These strategies consist of a combination of programs that strive to better balance cash inflows versus cash outflows. The supply chain contributes to cash-flow improvement initiatives by reducing inventory and extending payment terms to suppliers. Both strategies, when improperly applied, can and have created increased risk and significant financial consequences that far exceeded the gains. I know of at least one major corporation that mandated 60-day payment terms (from 30 days) when the credit markets were collapsing. This approach seemed almost reckless when considering that for every one million dollars spent with a supplier, a 30-day payment extension only results in a one-time working-capital improvement of $6667 in capital costs (derived from a theoretical savings of 8% × $1 million × 1/12 = $6667). This amount is a very small gain if it also contributes to the financial demise and subsequent closure of a key supplier.

lorem ipsum