Category Archives: Risk Management

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 archives.

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

Today’s Spend Management Priorities ARE Today’s Spend Management Priorities

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This spring, Ariba conducted a survey across 225 Procurement and Finacne executives across a variety of regions, industries, and company sizes to determine the spend management strategies and approaches that companies are adopting to cope with the global economic recession. What they found, as chronicled in their white-paper on “The Return to Profitability”, shouldn’t be surprising:

  • Identifying savings opportunities faster is the #1 focus for most companies
    Companies are looking for a quick ROI and immediate savings to demonstrate the value of spend management before seeking executive support and funding for a wider roll-out.
  • Increasing spend under management is a key initiative for most companies
    Companies are recognizing the advantages of more spend under management.
  • Automating procurement processes is becoming a top priority for many companies
    Almost two thirds of respondents listed the need for automation across the entire source-to-settle process in their top five priorities as they are feeling the pain of depending on paper and people-intensive processes.
  • Mitigating risk and managing supplier performance is critical
    Concerns range from meeting customer demand if critical suppliers are interrupted to reduced supplier innovation to deteriorating quality and service.

Ariba, which has adopted their own variation of the best-in-class, leaders, and laggards classification of Aberdeen with their pioneers, survivors, and stragglers classification, found that pioneers had over 75% of spend under management, made moderate to extensive use of technology, and had over 50% of suppliers under a formal management program while stragglers had less than 25% of spend under management, made low to no use of technology, and had less than 10% of suppliers under a formal management program.

As a result they made the usual recommendations that organizations should:

  • improve spend visibility NOW to help identify savings opportunities faster
  • make procurement automation a top priority to maximize savings and compliance
  • not be afraid to get outside help to capitalize on current market conditions

So what does this mean?

It means that you need to take action now to avoid falling further from the path of profitability and recovery. Because when software companies are spending tens of thousands of their own money to verify analyst results, which have been cross-verified by multiple analyst firms, it means the results are right and that you have to take action now.

What’s all this talk about risk?

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Editor’s Note: Today’s post is from Dick Locke, Sourcing Innovation’s resident expert on International Sourcing and Procurement. (His previous guest posts are still archived.)

The issue of global supply chain risk gets a lot of attention nowadays, and it certainly should. However, I’ve seen a few silly statements. One is that global sourcing is sooo over. Another is that nobody should buy in China. (OK, I exaggerate, but just slightly.)

Here’s my perspective:

First, we need to clarify what “sourcing” is. Wikipedia says “In business, the term word sourcing refers to a number of procurement practices, aimed at finding, evaluating and engaging suppliers of goods and services“. That’s the definition I’ve always used, too. It doesn’t mean actually buying, it means looking around. Global sourcing just means looking around globally.

With that definition, you can see what sourcing globally gets you. It gets you intelligence on the prices, costs, and viability of potential sources all over the world. In other words, it gets you a potential reward in the form of the lowest supply costs. Rewards in purchasing, as in investing, go hand in hand with risks. You can’t evaluate the risks without knowing the rewards. Fortunately, in purchasing higher rewards don’t always mean higher risks.

Let’s suppose a global sourcing program shows that the lowest landed cost suppliers are in some place various gurus find risky and you can save a tremendous amount by your company standards if you actually buy there. Would you walk away from a deal just because it’s risky? I hope not. That’s not the road to success. The computer industry ships about $30 billion dollars annually from China to the US. Quality and intellectual property problems are rare. What are some of the steps computer companies take? I can name four: Include quality experts in sourcing evaluations right from the start, buy only from foreign invested companies in China, have not just feet on the ground in China but trained brains too, and carefully reference-check for intellectual property issues before proceeding. It helps, too, that products such as laptop computers are “economically dense” in terms of cost per kilogram so that air freight makes sense.

Philosophically, when you evaluate risk during a sourcing process, you are not comparing the risk of one choice to a mythical risk-free world. You are comparing the risks of choosing one supplier to the risks of choosing (or staying with) another supplier.

Some risks are digital or binary. They are go no-go tests that should be applied before a potential source is even allowed to quote. A propensity to steal intellectual property is one such test. Lack of adequate quality standards and practices is another. But please don’t claim that no supplier in a country can meet those standards.

Other risks are more like analog. You can measure their severity. The best way is to see how often or how much or how often a situation would have to happen before what looks to be the lowest cost supplier is no longer lowest. Exactly how much would a supplier’s currency have to appreciate before it becomes (in hindsight) the wrong choice? Exactly how often would you have to ship by a premium method at your expense before your lowest cost supplier is no longer lowest? While you’re doing this remember that the second and third lowest cost suppliers have their own risks too. If volatile fuel prices (or cap and trade programs) cause one supplier’s cost to go up, they will also affect other suppliers’ costs.

I have a concern is that every company has strong momentum to stay with their existing supply base. If consideration of risk is not done well, it becomes just another excuse to keep on doing what the company has been doing all along. I saw it at HP when I was developing its global sourcing program. It took a few years to overcome.

Dick Locke, Global Procurement Group and Global Supply Training.

Remember The Three Key Objectives of Supply Chain Risk Management

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As emphasized in an article in Industry Week from last fall on “Supply Chain Risk Management”, from a risk manager’s point of view, the following are the three key objectives of an effective supply chain risk management strategy:

  • identify and prioritize critical business elements,
  • map the entire supply chain to determine interdependencies, and
  • identify the potential failure points along the chain.

Not only is it important to keep these objectives in mind as you are analyzing your current supply chain for risks, especially those that could result from the failure of one or more suppliers or logistics providers, but it is doubly important to keep them in mind when you start re-evaluating your global sourcing strategy in the forthcoming upswing. Otherwise, you could make decisions that will put you right back where you are today when the next inevitable downswing rears its ugly head.