Category Archives: Risk Management

Risk – The More Things Change, The More They Stay the Same IV – Economic

In our last post, we discussed the top geopolitical risks facing your Supply Management organization that were chronicled in the World Economic Forum‘s 7th annual Global Risks report. Chronicling dozens of risk divided into five categories, this report did a tremendous job of covering the types of risk that an average Supply Management organization needs to prepare for. Today, SI is going to continue its coverage of the report by discussing the top risks from an economic perspective.

From an economic perspective, there are four major risks. These two major risks are exactly the same as last year:

Extreme Energy & Agricultural Price Volatility

Today’s organizations are ultimately dependent upon three things – people, raw materials, and the energy required to transform the raw materials into the product the organization will sell. If oil doubles in price, that could make the difference between being able to produce the goods in China and import them into the US for sale at a profit and having to import them into the US for sale at a loss (or risk losing the entire inventory). And food prices in certain categories have been approaching, and reaching, all-time highs ever since reserves hit all time lows since World War Two last year.

Fiscal Crisis

The fiscal crisis can lead to many things – currency volatility, a credit crunch, and overall infrastructure fragility. Weakening currencies can cause costs to skyrocket. A credit crunch can severely restrict cash flow and make it almost impossible for an organization to temporarily borrow the cash it needs to secure the inventory required to produce the goods it plans to sell to create revenue and, eventually, generate profit. And infrastructure fragility, which weakens every time there is insufficient cash to invest in necessary maintenance, can result in transportation lanes, power plants, and basic utilities becoming unavailable overnight. The ramifications of a fiscal crisis can reach far and wide.

These two risks have increased in severity since last year:

Chronic Fiscal Imbalances

Government debt obligations are rising out of control around the world. The recent government debt-crisis in Greece, which followed the bankruptcy of Iceland in 2008, could be just the beginning. With the US at its fiscal cliff, the UK increasing public sector and private sector debt at an alarming rate (while net assets are falling), and general government debt in Japan projected to reach 245% of GDP in 2013, this risk is getting extreme across the developed world.

Severe Income Disparity

The rich are getting richer and the poor are getting poorer, and this is true in the developed world and the emerging world. The recent occupy movements have brought to light how the top 1% receive almost 25% of the income in the U.S., reaching a high not seen since 1928 (just before the Great Depression). The gap between the rich and the poor is rising rapidly in China, where approximately 10% of the population live below the global poverty line (which is really, really low). And this trend is continuing around the world. This is scary as many revolutions throughout history have been based on the economic inequality between the rich and the poor.

Risk – The More Things Change, The More They Stay the Same III – Geopolitical

In our last post, we discussed the top environmental risks facing your Supply Management organization that were chronicled in the World Economic Forum‘s 7th annual Global Risks report. Chronicling dozens of risk divided into five categories, this report did a tremendous job of covering the types of risk that an average Supply Management organization needs to prepare for. Today, SI is going to continue its coverage of the report by discussing the top risks from a geopolitical perspective, which haven’t changed at all in the past year.

03: (Pervasive Entrenched) Corruption

Corruption can take many forms — bid rigging, bribery, collusion, fraud, embezzlement, organized crime, price fixing, and thievery just to name a few. Each of these can be devastating to your supply chain. Bid rigging, collusion, and price fixing can significantly increase your costs. Bribery and thievery can result in a loss of your IP and product plans which could negate years and tens of millions to hundreds of millions of research and development. Embezzlement and fraud could drain your organization of necessary operating capital and organized crime could result in an entire warehouse of inventory disappearing overnight. This is one risk that’s never going away.

02: Terrorism

Terrorism is on the rise, and terrorists are getting their hands on more powerful and destructive weapons by the day. And it’s not just religious extremists that you have to be afraid of. There’s also anti-establishment extremists, new-age radical groups, and anarchists. Each of these groups could decide that your goods or services are against god, pro-establishment, anti-progress, or too orderly and decide that your corporation needs to be taken down here and now. One well planned strike and your factory, or headquarters, is a smouldering crater.

01: Geopolitical Conflict / Fragile States

Civil unrest can often quickly escalate into civil war and civil war can quickly result in cities, counties, and even provinces becoming inaccessible and if the conflict escalates, entire borders will close. Once a border closes, nothing gets in our out. Your factories become cut off from the rest of the world, and all of your inventory, tying up all of your capital, becomes inaccessible for an indeterminate amount of time. And your supply management organization, like the goods in your cut-off factory, is at risk of total destruction.

Risk – The More Things Change, The More They Stay the Same II -Environment

In our last post, we discussed the top societal risks facing your Supply Management organization that were chronicled in the World Economic Forum‘s 7th annual Global Risks report. Chronicling dozens of risk divided into five categories, this report did a tremendous job of covering the types of risk that an average Supply Management organization needs to prepare for. Today, SI is going to continue its coverage of the report by discussing the top three risks from an environmental perspective.

According to the report, the two top risks, which are essentially the same as last year, are:

Rising Greenhouse Gas Emissions and the Climate Change that will Result

Climate change may not seem like a big risk, but it can have drastic consequences on your operations. Not only can it increase the likelihood of (tropical) storms, floods, blizzards, and ice storms, which can destroy your factories, wash away your delivery trucks, trap your workers in the factory for a week, and take down entire power grids, but it can wreak havoc on your operations. For example, if you want to drill for oil in the oil sands, you need the ground partially frozen. If six months are required to extract a year’s worth of oil but by the time the ground freezes there will be less than four months of drilling time, problem. And if the risk of flooding is significantly increased, so are the chances of your supply chain being brought to a grinding halt.

Unprecedented Geophysical Destruction

This is likely to take the form of:

Earthquakes & Volcanic Eruptions

The 9.0 magnitude earthquake in Japan in March of 2011 demonstrated the devastation that earthquakes could have on global supply chains. The earthquake and resulting tsunamis not only damaged or destroyed thousands of homes and hundreds of factories, which resulted in almost 20,000 deaths, but also resulted in the immediate declaration of a state of emergency at a nuclear power plant when dangerous levels of radiation escaped the Fukushima No. 1 (Daiichi) plant. In addition, it triggered the immediate shut down of 15 of Japan’s nuclear power stations and a crisis at the Tokai No. 2 Power station was narrowly averted.

However, this earthquake is nothing compared to what a well placed major volcanic eruption can accomplish. Not only can a major eruption near the edge of a tectonic plate trigger an earthquake, but it could launch enough ash into the air to make air travel through a region impossible for months. The recent volcanic explosions in Iceland in 2011 are nothing compared to some of the eruptions that have happened in the last few thousands years. Not even the eruption of Mount St Helens in 1980 was very big. It only erupted 1 cubic km of lava. The largest eruption, in terms of java discharged, in the last 99 years was Pinatubo in the Philippines in 1991. A whole 10 cubic kms of lava was released. The 1912 eruption of Katmai in Alaska released 12 cubic kms. And this is nothing compared to the 1815 eruption of Tambora in Indonesia that released 100 cubic kms of lava. And students of history are aware of how Mount Vesuvius buried Pompei under 4 to 6 m of ash and pumice. The eruption of Krakatoa in 1883, which was heard across the world, released so much ash into the air that it caused a volcanic winter. Temperatures worldwide dropped an average of 1.2° C for the next 5 years as a result of ash that was ejected 20,000 ft high. If this happened today, air travel would be interrupted for at least six months in the region. The interruptions in air travel as a result of the Icelandic explosions would be minor in comparison.

Flooding

The floods in Thailand last year and the floods in Bangladesh and the Philippines this year are a perfect example of the significant impact that floods can have on global supply chains. Economic losses in 2011 due to the Thailand floods reached 46 Billion by the end of 2011 (Aon Benfield), more than doubling the insurance losses that were expected to reach 20 Billion (Insurance Insight). The reality is that a single flood can cause so much damage that it could literally bankrupt an operation. The automotive sectors and electronic sectors were impacted the hardest by the Thailand floods — more than 400 Japanese companies in these sectors suspended operations or lowered output as a result of the floods.

And with global warming, which is causing many of the ice flows in the arctic to break up, the risk of flooding is greatly increasing. Many of the worst floods in history were ice-jam floods resulting from “breakup jams” which force ponding upstream and a rapid release of water when the ice dams breach. This is what happened in (April) 1952 on the Missouri River in (Bismarck) North Dakota where an eroding ice dam resulted in flow increasing from about 2,100 m3/s to more than 14,000 m3/s in less than 24 hours. The river rose 5 feet in less than 2 hours and submerged nearly everything south of US Highway 10. Fortunately, this was not a densely populated area, otherwise, instead of 200 houses being destroyed, there would have been 20,000 houses destroyed and likely thousands of deaths. If this happened near your factory, it would be wiped out almost instantaneously.

Risk – The More Things Change, The More They Stay the Same I – Society

The World Economic Forum‘s 7th annual Global Risks report was recently. Again chronicling dozens of risk divided into five categories, this report did a tremendous job of covering the types of risk that an average Supply Management organization needs to prepare for. What’s interesting about this report is how the biggest risks in many of the categories haven’t changed at all since last year. Take Society for instance. While it chronicled seven major risks in this category, the top two dwarf the other five and they are the exact same as last year.

02: Food Security

People need to eat. As a result, they need access to safe, secure sources of staple foods at an affordable price point. If they don’t have access to safe, secure sources of staple foods at an affordable price point, they riot — as we have seen in Tunisia, Algeria, Bangladesh, Mogadishu, India, China, and even the UK and Canada this year. When people riot, property gets destroyed — property that could include your delivery trucks, your goods in your warehouses, and even your production plants. Try ensuring supply with no distribution mechanisms for raw materials, no working production lines, and no warehouses to store anything.

01: Water Security

Not only do people need water, but supply chains need water. First of all, supply chains need energy. Energy production requires water (as per the Water Energy Nexus). For example, in the USA, about 2 US gallons of water evaporates to create one kilowatt hour of energy. Steel, which is a component of many goods, requires 62,000 gallons of water for the production of a single ton. Semi-conductor fabrication plants often require up to 2,000 gallons of water per minute. No water, no goods, no components, and no energy. And if water gets too scarce, so is food. And a vicious downward societal cycle will begin.

It should be obvious by now that while the risks of pandemic, chronic disease, religious fanaticism, migration, and age aren’t going away, they aren’t going to matter much if we don’t have the food and water to sustain ourselves.

It’s About Time You Get a Grip on Risk!

Risk management is about more than just the disclosures the auditors make your accountants put in the fine print when you release your financial statements and annual reports. And it’s more than the identification, assessment, and prioritization of risks followed by coordinated and economical application of resources to minimize, monitor, and control the probability and/or impact of unfortunate events or to maximize the realization of opportunities. For example, from a supply management point of view, risk management is modus operandi for supply assurity when there is an average of 250 supply chain disruptions for public companies every month. (Source) And from a profit point of view, it’s value. Less money dealing with the financial and brand fallout from a disruption is more money spent on innovation to meet customer demand.

And, as per this recent Ernst & Young post over on the Harvard Business Review blogs, it’s money in the bank. Their recent research fund that companies in the top 20% of risk (management) maturity generated three times the level of EBITDA as those in the bottom 20%. Wow!

So why is this? I think it’s due to the fact that less than 40% of companies are actively managing (supply) risk to the level they should be. In 2008, a Marsh survey found that only 35% of organizations self-reported that supply chain risk management was moderately effective at their companies. In other words, 65% of companies did not have a risk management program that was at least moderately effective. In 2011, researchers at Vlerick Leuven Gent Management School and Ghent University did a supply chain risk management study and found that 64% of the companies have no one responsible for managing supply chain risks! That’s essentially 0 improvement in the last three years! And while the initial introduction of a risk management program will require a significant investment of talent, it’s not that difficult, relatively speaking. As the post says, the critical factors are communication, openness, leadership, framework identification, formal methods, coordinated planning, standardized monitoring, and occasional (stress) testing of the different facets. With the right leadership and training, everyone will be able to do their part. And in the end, just like the Global 50 consumer products company highlighted, in the post, the organization will have

developed a governance structure that allows it think about risk proactively, and has aligned its risk profile and exposures more closely with its strategy. Its governance leadership group and supporting management clarified the company’s risk appetite, defined its risk universe, determined how to measure risk, and identified which technologies could best help the company manage its risks. Aligning risk to strategy, by identifying strategic risks and embedding risk management principles into business unit planning cycles, enabled the company to identify and document 80% of the risks that have an impact on performance. This alignment of risk awareness and management practices, from strategy to business operations, enabled the company to monitor risk developments more effectively. Managers could keep the organization within acceptable tolerance ranges, driving performance to plan.

So just do it. You’ll double your EBITDA in the process!