Balancing risk

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Two major humanitarian disasters – the Burmese cyclone and the Chinese earthquake – provided a sombre backdrop to ”Supply Chain Standard”s Roundtable discussion on supply chain risk. But as Dave Food, business development director from the meeting”s sponsor, Oracle, pointed out, natural calamities are only the most extreme end of a spectrum of risks to which the modern, global supply chain is exposed.

Dave Food set the scene: ”There are risks against which you have to protect as a business; there are also risks that present personal liabilities. In which parts of the supply chain can we try to control, manage or influence risk? We can put systems in to prequalify suppliers, to guard against reputational damage such as child labour abuse, to resolve the difficulties of forecasting, planning, monitoring and exception reporting in an extended supply chain, to protect our quality and intellectual property and so on. But whatever the system, it”s run by people and the challenge surely is to ensure that the systems are followed through. Inadequate staff training appears to be one of the biggest causes of supply chain failure”.

Chairman Nick Allen quoted from a recent Supply Chain Standard global sourcing survey, which found that 59 per cent of firms regarded sourcing from distant locations as only a ”medium,” risk, and 56 per cent believed they were carrying no more inventory than two years ago, suggesting that despite ever-longer supply chains, inventory is not being used to buffer against risk.

Andreas Stockert, head of supply chain management at Charles Voegele Trading, a fashion company, explained why. ”We source in risky countries – China has had the earthquake, Bangladesh, which represents 20 per cent of our volume, floods every year, other locations have regular riots. We can”t avoid these risks. Short term, if our production is affected in say China we can find alternatives in Romania, Turkey, North Africa – but long term the risk is everywhere.

”So there is no solution, but what does help is having relatively good information systems, so that we know where our orders are and what state they are in. We are just piloting RFID in China which will help us track right through from production to cash register. We already have very good monitoring at the box and pallet level; now we are getting item level tagging so we know what product is in what factory and its quality control status. We can manage in-country inspection, (and we work with NGOs and change our inspectors frequently) but still we don”t necessarily know what risks our sub-contractors are exposing us to.

”And while our product data flows are relatively secure, financial and sustainability supply chain information is less so. It is difficult for suppliers to tell us what their carbon footprint is, and there are no standards for sustainability reporting”.

Paul Cunningham, non-executive director, Holistica said that there are ways of looking at sustainability risk. ”Customer requirements for CO2 footprint data are increasing, and they publish the results. Even when we are bidding for business, we propose solutions on cost, service, and carbon footprint. What we haven”t got is a consistent way of expressing the risks in a contract – we can specify costs, service, emissions, but not the degree of risk attached.

”Contracts purport to reduce risk by offering compensation against failure, but it isn”t possible to include all risk in the contract. Profit models would not be sustainable if we carried the full risk of a failed supply, so contracts are actually there to limit our liability.” Sven Marlinghaus partner at BrainNet agreed. ”Harm to image from supply chain failure is potentially much bigger than can be put in a contract”.

Cunningham continued with the example of a recent negotiation. ”We were moving from a fragmented supply chain to one which offered end to end visibility and control; but the point of contention was that the client believed they were going to get full liability cover – if the goods were late for whatever reason, they would be compensated! We had to say, yes there can be performance measures and penalties for not achieving them – but we can”t gear to offer full consequential loss.

”Small entrepreneurs, oddly, might be prepared to take that risk to a higher degree, but if you want an end-to-end supply chain, the risk mitigation doesn”t lie in compensation, but in the ability to handle, control, change multiple flows and channels”.

Food pointed out that the trend towards factory gate pricing is seen as a cost driver, but actually brings to the customer more of the risks of larger, more remote supply chains. ”We have to look at the frequency of the risk, and the significance of the risk”.

Aidan Murphy, supply chain director of Bulmers said he wasn”t surprised that inventories are not increasing – cost drivers are still pushing stocks down. He added that, while it may make sense to contract supply chain operations, and their attached risks, out, ”at the end of the day you are still paying for the risk through some sort of premium”.

Anything has risk

Murphy added, ”Anything has risk. All you can do is mitigate against it. We have to order our cider 18 months ahead. In 2006 we didn”t anticipate the level of volume increase, we didn”t have enough fermented apple juice – and there”s nothing you can do about it! You can”t absolutely insure against all risks”. Allen suggested better forecasting would help – Murphy and Stockert chorused ”Better weather forecasting would help”.

Stockert continued by suggesting that there is now a greater understanding of the supply chain role. ”It was just about reducing logistics costs, through increasing velocity, reducing inventory. Now the supply chain is more value-driven – it”s about profits, cross-selling rates, improving shop floor availability. Inventory levels per se are less important”.

Murphy agreed, ”People are taking, and feeling comfier with, a more globalised view. They aren”t optimising individual bits, they are optimising the total supply chain. For us, that may drive total inventory down, even though we hold more fermented juice. It”s about balancing the risks”.

John Benwicke, supply chain manager at Leigh”s Paints explained that his firm works in specialist fields with erratic demand, and is often dependent on patented inputs – so dual sourcing isn”t an available risk-avoidance strategy. ”But with more understanding we can push risk back up the supply chain, working with suppliers to collectively manage the risk, and with the transparency that engenders, we can drop inventory levels with confidence”. Murphy added that as the supply chain has become more dynamic it can change quicker and that in itself reduces risk.

Marlinghaus recognised the trend towards pushing risk and inventory towards suppliers but questioned whether we have the tools to manage suppliers that way. ”If you use suppliers as risk buffers but without the right tools, it may take two or three years until the problems come out, but they will. A lot of companies I know can”t manage their own internal risks let alone risks bought in from suppliers.

Ailsa Duncan deployment manager at GSK described a big ongoing programme with suppliers on how GSK sources, and feeds its factories. ”It”s about how we manage suppliers, how we give them visibility, how we treat them as partners, so that we can manage risk. And there are things we have to change ourselves if we are going to treat them as internal partners. Then there are different levels of integration, from small suppliers with a fax and email, to full-blown VMI: we”re not at that level yet, but it”s the direction we have to go”.

A broader meaning of risk

Duncan pointed out that ”risk” has a broader meaning in pharmaceuticals – it involves lives, not just money. ”We can”t do it justice from just one part of the organisation. Always, the focus is on not endangering lives. We have global risk registers, cascaded from top to bottom, and everyone has a responsibility for risk.

”In the last five years we”ve acquired a greater understanding of supply chain risk, as opposed to product risk. And as margins have eroded we are under pressure to cut, for example, our stocks of active ingredients. Because we have a better knowledge of our suppliers and our supply chains, we have the confidence to do that. Importantly, we”ve invested in the skill sets that enable us to ask the right questions about the supply chain”.

Paul Robinson, Financial Supply Chain Management, Global Transaction Banking at HSBC said that ”From the banks” point of view, if you have got that better understanding, we need to be able to pull that out, so that when we lend against your transactions, we can price the risk better. ERP systems can feed information that banks can respond to and price the risk accordingly. Traditionally the banks” relationship has been with the Treasurer, but we really need a relationship with, for example, Global Sourcing”.

Robinson suggested that retail and consumer goods firms, and more recently pharmaceuticals and electronics, are ”latching on” to concepts of financial risk. ”They are realising that extended payment terms, factoring and so on are actually extra expenses and will feed back into supply chain costs 18 months down the line, which itself is a risk. Banks can help you price risk, but we want some of that gain back! Firms have been driving the costs of the physical supply chain, but have been reticent on the financial supply chain”.

Marlinghaus suggested that ”The main risk in the next five years is the quality of people handling the supply chain. How many chief procurement officers can ”play the piano” of financials? How many have that cultural background? It isn”t taught them in the universities. We need to understand and manage our budgets for qualifying people”. Robinson (who had a supply chain background before moving into banking) agreed – ”Traditionally, the CPO and the Treasurer have been working on very different metrics”.

More skills required

Paul Graham, supply chain director for Kenwood DeLonghi agreed. ”The supply chain is changing and more skills are required. It isn”t just about inventory and moving supplies, it”s about getting connected. The firm may be suffering, not getting paid, because someone can”t get a proof of delivery to a retailer, they”re getting the basic processes wrong”.

Murphy explained that ”I have a finance group person in a direct line to myself. We are starting to look at the complete benefit of the supply chain to the entire organisation; for example in collaboration rather than chopping and changing suppliers, because we are uncovering the costs over three or six months of getting a new supplier in – costs that have been hidden from manufacturing. The fact that banks like HSBC are hiring supply chain people like Paul [Robinson] shows how things are moving”.

Food welcomed the ”maturation of dialogue” between finance and supply chain and Stockert gave an interesting example of a very nice win-win. ”Our vendors have to refinance their raw materials at local interest rates of 18 per cent. We have a much lower interest rate, so we are doing the finance. With high rates, suppliers avoid holding stocks, which delays our orders, and we end up having to fly goods in. If we can arrange the finance, they can order materials earlier and smooth the workflow”.

[asset_ref id=”349″]”Traditionally the banks” relationship has been with the Treasurer, but we really need a relationship with, for example, Global Sourcing”
Paul Robinson

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