Managing Risk in the Supply Chain

Learn how leading companies go beyond cost-cutting to ensure continuing profitability


That story clarifies the irony of the cost management focus. Companies rejoice when they save US$10 to $20 million from the supply chain; they rejoice even more if efforts promise those savings year-over-year. But the downside of failing to manage risks can result in losses many times greater than the potential savings. If a supply disruption stops production on a single line, sales can easily be damaged to the tune of US$100 to $200 million a month. And lost sales can, as they did for Ericsson, threaten your entire position in a market.

The risks are especially great in high-margin industries such as pharmaceuticals where not meeting customer demand have far reaching consequences.

Where do the risks come from? Figure 1 summarizes some of the key supply-chain initiatives of recent years that have brought valuable benefits, but also increased risks. Our examples so far have covered the first line, the single-source risk. But there are additional risks. For example, though sourcing from Asia provides great cost benefits, Asian parts have to be shipped. The California dockworkers strike of 2002 held up shipments to the United States from Asia; just four days later a Fremont, Calif., truck-making plant ran out of parts and had to shut down. Many globally-sourced goods pass through numerous middlemen, and each step poses additional risk: labor strikes; fires, earthquakes, or tsunamis; economic and political instability.

Globalization represents just one facet of risk; another is outsourcing. Regardless of geographic location, many companies have chosen to let suppliers manage key operations. When this strategy works, which is often, it's efficient, inexpensive and reliable. But if it doesn't work? Poor quality, poor yield, theft of intellectual property outsourcing production doesn't mean you've outsourced these nightmares. They're still your problem.

The Growing Field of Supply Risk Management

Understanding these risks, many leading companies are beginning to focus on managing them. As Figure 2 shows, risk management lags behind cost reduction as a component of their procurement strategies. Although less than 25 percent of companies have plans in place that are yielding benefits, the majority have identified risk management as part of their strategy, and are developing or implementing plans.

What do these plans look like? Many companies are moving from single-sourcing to dual-sourcing to minimize risk. For example, one pharmaceutical executive says, Ten years ago, approximately 60 percent of [a certain type] of item was single sourced. Today, through sourcing initiatives, that percentage is about 45 percent. Another notes the same trend toward dual-sourcing, commenting, The exception is in cases where companies have product lines that they buy from proven alliances and therefore conduct single sourcing as much as possible for those goods in particular.

Many companies today are leveraging their supply base. They review suppliers annually based on quality, delivery, cost and competency. When they find supplier performance issues, they manage them intensively, developing a recovery plan and monitoring the supplier against it. They seek to help their suppliers implement Six Sigma quality efforts and ISO (International Standards Organization) certification. Finally, they encourage their Tier 1 suppliers to perform similar exercises with their own supply chain.

Philosophies of Supply Risk Management

Of course the specifics of any risk management plan will vary because the risks do. However, leading companies clearly follow basic philosophies, which are outlined in Figure 3. The first step is to identify risks. Most executives find that supply continuation far outranks other risks in importance, for the reasons outlined above. But other risks can fall into categories such as quality, inventory and systems.

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