Risk Management: Run Your Supply Chain Like An Insurance Company

Everyone is aware of potential risks in running a supply chain but what is the process by which you evaluate that risk? And, figure out the alternative solutions to lessen or eliminate it?

Most companies, if not all, have no real objective risk management process in their supply chains. At best, they have processes in place for different organizational pockets within which risk is mitigated. Some examples are an evaluation of suppliers by the Purchasing Department to ensure supply continuity or redundancies in capacity, and even building too much, or too little, inventory—which proves more costly.

The fundamental question: what is the damage, when something goes wrong? And, what price are you paying to avoid such inevitable risks? Payment of an insurance premium is exactly that. You pay for a service that allows you to recover from a financial disaster or lawsuit. Insurance companies do their risk assessment very well and ask for a premium that makes them profitable even though every now and then they have to cough up the cost.   Are you doing the same with your supply chain? What is the premium you are currently paying (within your own supply chain) to avoid a potential disaster? What is the potential cost of that disaster? And, is it worth the premium?

A common example of this is delivery performance vs. inventory (mix) at hand.  You are probably familiar with the exponential operational curves that imply doubling your inventory for a 5% improvement in your delivery performance, from 92% to 97%. Does this make sense? How much is really enough? And, what is the actual cost of missing delivery rather than the cost of holding inventory?

Management teams are encouraged to avoid risk. In other words, their incentive is to deliver rather than miss delivery. So, the employees will go out of their way to ensure delivery at the company’s cost! Again, does this make sense? Example: “sand-bagging” the forecast and “padding” the supply to avoid shortages are steps taken by two different organizations and processes, Sales vs. Production. Furthermore, supplier selection, cost turbulence, and delivery issues are also padded in an isolated way, adding to the overall inefficiency of risk management.   How do you really assess the risk of one supplier over the other, especially as it impacts your bottom line and customer service?  Consider the recent unfortunate disasters in Japan, as many of the car makers are struggling for alternate resources to get their parts delivered;  earthquakes in Taiwan, SARS epidemic in China, dock worker strikes at Los Angeles ports are all other examples of supply risk.

Some element of risk avoidance is built into the jobs of each person, or department.  However,  if each person avoided risk in all the steps to deliver the goods, it would create too much cumulative redundancy–which would cause much higher additional cost in the final product.  This can be avoided with a more holistic approach.

We believe that objective risk assessment must be part of the supply chain planning process and systems, so that objective decision is made based on financial consequences rather than protecting select customers, or individual employees. To this end, a holistic approach offers more than just a simple spreadsheet-based S&OP process, but a Financial Sales and Operations Planning solution. The key word is “Financial”, that is integrated into the rest of the enterprise’s operations. Cost, revenue, profit, and risk become part of the supply chain equation, along with customer delivery and supplier management.

When was the last time you took a risk in your supply chain? What was the consequence? How much did the company benefit from it or lost because of it? Would you have liked to have a better optimization and analysis tool to evaluate your options? We invite you to join us in the creation of the next generation of supply chain tools, integrating Financials with Sales and Operation Planning (FS&OP).