Supply Chain Risk and 2010 Financial Planning
Learn from the lessons of the past year
The months of June and July are typically when many large corporations initiate efforts to refine or develop their business plan outlining their goals and associated actions for the next few years. Depending on the company this may be called the "Fall Plan," the "Annual Strategy" or something similar. More often than not it is really just a budgeting exercise with a set of assumptions determined by a person or group somewhere high in the corporate bureaucracy that are passed down to the operating units.
Too often the assumptions are simply some variation of "take last year's figures and add some target percentage for growth" coupled with "cut some target percentage to show we're getting more efficient." The 2010 planning cycle assumptions will be particularly interesting to observe. Given the severe recession and volatility in commodities, currencies and energy, what is considered a normal base to apply those magical target percentages?
A year ago, crude oil was nearly $150 per barrel, which then plummeted to below $40 per barrel and is now over a six-month high at $62 per barrel with demand trending higher. Similar peaks and valleys can be seen across the charts of many commodities and currencies. Some industries and companies have seen demand fall 60 to 80 percent. How do the planners in the corporation decide what is the baseline? Do they take an average? Apply a standard deviation? How do they predict when and how a recovery will take place? Will the charts trace a "V," "U" or an "L?" As Yogi Berra once noted, "It's tough to make predictions, especially about the future."
Accepted Risks of Global Trade
Logistics and supply chain managers have always had elements of risk management in their job description in terms of dealing with an imperfect physical world of severe weather and natural disasters, damaged product, mechanical failures of the shipping conveyance, port delays and, amazingly, even pirates. Cargo insurance, safety stock and back-up plans to re-route freight or use expedited freight are the typical means of dealing with these elements of risk. Considering the complexity of managing a large volume of shipments across multiple lanes, logistics and supply chain managers understand that you can't predict when or where a delay or incident will occur; however, historical data dictates that there will be some percentage of shipments that experience problems. The key to survival is preparation versus prediction.
How can a business prepare for the risks that can't easily be captured based on the history of previous transactions? The last 12 months have been unprecedented. You may have even heard that these challenging economic times have been a "once in a century" or "once in a lifetime" event. Let's hope so. But, is it really true? Maybe the root causes have been different to previous economic crises, but haven't economies had recessions, severe bear markets, high unemployment, and energy price spikes and sell-offs before? And, historically speaking, not that long ago? Yet, how many of 2008's corporate planning assumptions allowed for a wide range of scenarios and outcomes over the coming year instead of a single target number based on a singular view of the future? How many companies will overcompensate their 2009 plans downward in their outlook in establishing that singular view of the future after wildly missing the mark in 2008? That could severely hamper a company's ability to capture the benefits of a sharper-than-predicted recovery.
The Challenge: Recognizing Risks
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