When it comes to supply risk these days, most organizations immediately concern themselves with the probability of disruption in their supply chain from potential bankruptcies or business failures. But often the more insidious form of supply risk is not supplier insolvency. Rather, it's an often slow decline in quality or performance that is difficult to detect from delivery to delivery. As suppliers look for ways to survive, many cut corners that they hope will go unnoticed. And these problems compound the farther up the supply chain you go.
Consider this example: At the lower levels of a supply chain, a distributor might hold less stock to improve its own working capital situation, resulting in longer lead times for a tier-two supplier. At the same time, in addition to minimizing inventory, the distributor might stock an inferior or alternative grade or specification, or possibly the same item from a lower-cost producer that they've not worked with in the past. Ultimately, once this material makes its way from the distributor's warehouse or stockholding facility to a tier-one or -two supplier that's felt the impact of the downturn in the same way (i.e., lower volume levels and price reduction requests), it's likely that they, too, will have found ways to improve margin at the expense of quality and performance.
At this level in the supply chain, perhaps the supplier will have also increased order lead time requirements (just as the distributor has). Or perhaps they've eliminated a shift on the shop floor, potentially one with a more seasoned (and more highly paid) team. And in nearly all circumstances in today's manufacturing economy, it's highly probable that they've reduced headcount in areas that have less impact when it comes to absolute throughput (e.g., quality assurance), but can still cause significant headaches for customers who might receive their shipments on time but with newfound quality and performance issues.
While this example highlights only some of the quality and performance risks that supplier cost cutting can produce, it can nonetheless serve to help an organization begin to think about specific risk issues within its own supply chain outside of the direct potential for disruptions due to insolvencies. But on a broader level, Procurement, Finance and Supply Chain organizations should also be aware of the direct correlation between supplier performance-based risk issues and overall supplier health. In fact, a number of companies who work with smaller suppliers often consider supplier performance metrics to be the best leading indicator of overall supplier financial viability.
How can companies best define a process to monitor supplier quality and performance information from a risk perspective? There are a few key elements that provide an ideal place to start. Our recommendation is to:
- Understand which are the areas of supply (e.g., based on geography or industry concentration) where quality, performance and financial risk factors are likely to be most pronounced.
- Define a systematic way to track and measure supplier performance using both systems data and qualitative insights (derived from scorecards, observations, etc.).
- Roll this information up to a level that can be shared, aggregated and analyzed amongst internal constituents (i.e., not Microsoft Excel).
- Integrate supplier information with supplier financial data and insights (when available).
- Ready both procurement and supplier development team members to take action when elevated risk is present.
- Create a closed-loop process that continuously monitors and assesses quality and performance variables not just once yearly, but quarterly, monthly or on a more frequent basis.
The best line of defense against supplier quality and performance challenges is to rigorously institute a programmatic effort that seeks to identify, manage and mitigate risk based on early warning signs. In addition, our experience suggests that the more an organization integrates financial risk indicators with quality and performance ones as part of a supplier risk management program, the more likely it is to reduce its overall supply chain risk profile.
Moreover, the integration of quality and performance indicators with financial indicators can reduce the chance of false positives. However, it's also essential to remember that risk indicators are just indicators – even when they encompass multiple views into a supplier's past and current performance and health. But perhaps the most critical point to remember is that if an organization does not have the right set of professionals ready to jump into action when a true risk arises, all the effort expended to create the optimal program to identify risk in the first place will be for naught.
About the Author: Jim Lawton is vice president and general manager of D&B Supply Management Solutions. More information at www.dnb.com.