Daily Archives: August 5, 2009

The Upside of the Recession for Supply Chain Risk Management?

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A recent article in CFO noted that, in 2008, as supply outpaced demand, insurance costs slid. Even as financial markets churned, and the annual tally of natural disasters reached the second-highest level on record, the total cost of risk fell by nearly 10% last year, according to the latest Benchmark Survey released by the Risk and Insurance Management Society (RIMS).

More specifically, insurance premiums fell to an average of $10.68 per $1,000 of revenue in 2008 from $11.78 per 1,000 of revenue in 2007. Why? A number of reasons. Corporations have been reluctant to undertake any (new) activities that contain the slightest amount of risk and the demand for insurance has been shrinking because of the recession as risk managers explore (less costly) alternatives to traditional insurance to keep costs down.

Is this a good thing? I don’t think so. First of all, since some of the “alternatives” to risk management include reducing the size of the risk management staff, you know this is only going to result in more disasters down the line. Secondly, innovation and profit always require some risk. Without a few chances here and there, your supply chain will stagnate and you’ll eventually be overtaken by a competitor who tried something new, succeeded beyond their wildest imagination, and stole the market out from under you. So while you need to be cautious and insure you don’t bite of more than you can chew in the risk department, you can’t stop taking the odd risk. That’s ultimately how progress happens.

Fixing Prices Causes Broken Supply Chains

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Editor’s Note: This post is from regular contributor Norman Katz, Sourcing Innovation’s resident expert on supply chain fraud and supply chain risk. Catch up on his column in the archive.

In the May 2009 edition of World Trade magazine, I read that three more global air carriers were found guilty of price fixing by the U.S. Department of Justice. For approximately six years, it looks like a total of 21 rival companies met with each other and conspired to set service pricing. The total fines exceed $1.8 billion, and three executives have been sent to jail.

Ouch … and shame on all of you.

As these air cargo companies were fixing prices they were also robbing their customers of competitive leverage in choosing an air cargo carrier. Price fixing is fraud and is illegal. In the United States, the Sherman Anti-Trust Act and the RICO (Racketeer Influenced Corrupt Organizations) Act can be used to prosecute against organizations that conspire to fix prices.

But the problem goes deeper, because with the price fixing supply chain performance metrics would have been skewed, also robbing the customers of the ability to accurately assess price-for-performance in air cargo shipping. By affecting this – and other – related metrics, customers could not accurately perform analysis to select the best air cargo carrier even while a current carrier was failing to meet performance requirements.

When service companies conspire to set prices, there may no longer the pressure to perform for competitive purposes. So what if performance slips a little? Without competitive prices, a customer may not likely jump from one company to another as long as performance is still within “tolerable” limits.

But here is where the greater problem can lie: As performance slips disruption to the supply chain grows, and costs through the supply chain increase. From empty spaces on store shelves to empty inventory positions, supply chains – whether regional, national, or global – rely more and more on tight timeframes. The impact of a few percentage point slippage in performance can mean lost sales and idle manufacturing shop floors. Compounding these costs, if coverage for poor performance causes buyers to increase stock levels – whether for raw materials or finished goods – this then forces these customer companies to hold higher levels of inventory which decreases cash reserves, robbing the companies of usable cash for other needs.

Expedited shipping to deliver goods to their final destination may now have to be incurred, and while this benefits those particular carriers – who may not have been involved in the price fixed conspiracy – here again the customer companies are forced to utilize cash to cover for the disruption due to fraud.

Higher operating costs increase a product’s Cost Of Goods Sold, which can ultimately be reflected in the higher price the consumer will pay for those goods, unless the company is willing to absorb those costs. However, the company’s profit margins are reduced, which, for public companies, can impact shareholder dividends and stock prices, so there may be reluctance for the company to absorb such higher operating costs because of the negative effect to financial performance.

This fraud is an excellent example of the cascading effect a disruption in one supply chain link can have across the entire length of the supply chain, and even beyond. Fraudsters don’t often consider the negative impacts of their crimes and the number of people that can truly be affected by their actions. Lots of honest employees at a few very large corporations had their lives adversely affected when the unethical and illegal actions of a few senior executives sent these companies crashing down like a toppled house of cards.

Isaac Newton’s Third Law of Motion states that “for every action there is an equal and opposite reaction.” Hmmmmm … I’ll bet Newton never considered how the damage wrought by so few could affect so many, and he might have amended his third law of motion if he had known about supply chains.

Norman Katz, Katzscan