The Geography of Supply Chain Risk

Kerner kicked off the seminar presentation with the crux of the challenge: the global pursuit of profitable supply chains can set companies up for catastrophic (and very unprofitable) supply chain failure. Citing a UK study by the Manchester Business School, Kerner noted that the direct financial cost of supply chain breakdown can be exceeded by the combined indirect costs of economic losses, damage to corporate image, human and environmental costs, and other factors.

“Ironically, actions that are taken to drive costs out of the supply chain can drive greater risk into it,” he said. Consequently, the key focus of supply chain risk management should be to fully understand the cost of risk exposure – and then to protect profitability when the chain breaks.

To start with, companies must have a clear map of their supply chain. Companies should ask themselves, “Do you know your suppliers as well as you thought?” Kerner says. He noted that each supplier relationship brings associated risk factors, including other relationships, intellectual property, geopolitical and environmental exposures, skills and experience. These risks and other exposures can be identified through supplier surveys and other assessment tools, then evaluated and prioritized with the use of risk scenarios and risk grading.

The outcome of risk assessment should be supply chain risk strategies and informed business decisions that protect profitability, maintain the flow of funds to the balance sheet, retain customer relationships, and protect the reputation of the company brand, Kerner said. This comprehensive assessment also is essential in guiding the company’s selection of appropriate insurance cover.

In response to increased supply chain risk, insurance companies are becoming much more innovative and comprehensive in the products they offer. So-called “non-physical damage insurance,” for example, allows companies to offset not just direct supply chain losses, but also the indirect (and potentially very costly) losses associated with economic losses, damage to relationships and reputation, and other costs of supply chain failure.

Focusing on Single Points of Failure

Preparing for commonplace catastrophe can be an overwhelming task; within the near-infinite universe of things that might go wrong, how do you prioritize and focus limited risk management resources?

“The ocean is too big to boil,” so the only answer, Lynch said, is a strategic framework that builds resiliency into the entire supply chain while letting companies focus on their “black swans” – risk events that cross the normal threshold of manageability and threaten the overall business.

Lynch – author of Single Point of Failure: The 10 Essential Laws of Supply Chain Risk Management – says companies must use a “value filter” to segment and rationalize their product and services offerings. Margin, liquidity, asset and brand value, regulatory implications, and other strategic factors must be accounted for in a systematic way. If one product family accounts for 30 percent of sales but 42 percent of margin, for instance, that greater impact must be properly factored in, he explained.

Moreover, “Since failure of any type of resource can cause a material disruption, all resources needed to support creation of value should be mapped and analyzed,” Lynch explained. Companies must thoroughly understand the flow of their resources, from source (crop in the field or ore from the mines) all the way to the end customer – and know clearly what the impact of failure is.

Lynch cautioned that “threat-based analysis” can be extremely subjective. Instead, analysis should focus on impact “to identify, prioritize, and align exposure to investment.” Loss of your titanium supplier, for instance, likely is far more important than a missing fastener shipment or a disruption in the operations of a freight forwarder. Once risks are prioritized by potential impact, then companies can determine what risks can be insured or otherwise transferred, what alternatives are available for financing, and what risks will retained (and ideally mitigated).

With this understanding, companies can employ a data-driven “return on risk investment” model to evaluate their strategic and tactical expenditures for supply chain risk management. This “risconomics” approach, Lynch says, puts business value (rather than asset value) at the forefront of consideration and represents the best way to ensure efficient, effective allocation of scarce resources.

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John DeWitt, a contributing editor to PropertyCasualty360 and National Underwriter Property & Casualty, is principal and senior consultant for JW DeWitt Business Communications in New Salem, Mass.