By Poul Breil-Hansen
There is no doubt that companies around the world are currently feeling the cold winds of the global financial crisis. Some are feeling the burden more than others, but everyone is affected to some degree and according to all experts, the consequences for supply chains are significant. Let’s examine some statements from international SCM experts:
“The impact in the supply chain is very strong. Very fast and unpredictable price deflation in materials, constraints of supply because of suppliers’ financial problems, demand patterns totally unknown and new demands on supply chain finance to substitute the traditional finance system. Supply chain might need to rescue the finances of companies along the chain because the banking system is not working properly”, says Carlos Cordon, Professor Operations Management at IMD. He continues: “It is a humongous change for supply chain, from focusing on managing goods and information, to additionally manage cash and risks. It could be seen as a too far reaching change, even almost impossible. However, there is no choice since the financial viability of the companies in the chain is a prerequisite for the goods to flow”.
Everybody will be affected
“Every business will be affected by the financial crisis and hence the need to focus on the biggest single opportunity for cost reduction and value enhancement - the supply chain”, says Professor Martin Christopher from Cranfield University.
“The current financial crisis probably leads to a recession. We can already see strong declines in some areas of the physical world - the Procurement index dropped a lot, the automotive and construction industry is facing strong declines; China grows only 9.9% etc. Although this is all temporary, it is difficult to predict how long it will last. What is lasting is the depletion of our natural resources, and our environment. We have to put much more energy in finding more sustainable ways of co-existence”, says Professor Rene de Koster from Erasmus University.
Cash is king
Dr. John Gattorna who is Visiting Professor Cranfield University and Chairman Advisory Board Victoria University, Melbourne says: “Cash and liquidity will be tight under the new conditions, so supply chains needs to speed up the cash-to-cash cycle. New innovative financing models should be sought in conjunction with the banks, eg. banks to pay out suppliers at time of shipment and seek payment for goods and services on delivery. This has the effect of removing inventories from both sellers and buyers Balance Sheets for significant periods of time and is therefore a great assist to managing the business.”
John Gattorna continues: “Retailers around the world are in for a bad time as demand falls away in 2009, so suppliers will need to find innovative ways of supplying them in smaller batches, faster, as required. The consumer is likely to show low confidence and this will manifest itself in lower demand. Everyone in the chain will be affected, from raw materials to finished goods. The skill will be in managing capacity down, just as we have been trying to manage capacity up for the last decade”.
From one of the world’s leading logistics suppliers Maersk Logistics the message sounds: “The outlook for 2009 is still subject to uncertainty, not least due to the development in the world economy and the financial markets. During periods of uncertainty, supply chain management becomes increasingly important for businesses as many are looking to free up cash and are looking to lower cost alternatives for their transportation needs. Supply chain management will be an important factor in keeping many businesses lean”, said by Erling Johns Nielsen, who is Director & Global Head of Supply Chain Development at Maersk Logistics.
Put risk management on the agenda
Crisis and risk management are nothing new to companies and supply chain managers. According to the Center for Research on the Epidemiology of Disasters, the number of natural disasters has increased by threefold since 1970 and the economic consequences have increased by more than 1000%. Man-made disasters such as terrorist attacks have also doubled during this period. Globalisation and the implementation of Lean, Just-in-Time and consolidation of the supplier base have increased the vulnerability of supply chains.
Many supply chain managers are aware that external risks and their own cost-cutting measures encompass greater risks of disruptions in the supply chain. But according to many studies, this insight is rarely converted into action. Studies conducted by the American trade publication Purchasing Magazine and the consultancy company Aberdeen Group conclude that only half or fewer of the companies studied have procedures or systems in place for unforeseen events or crises, even though up to 80% of the companies have actually experienced events that have caused major disturbances to the supply chain in recent years.
However, companies’ CFOs appear to have an increasing awareness of risks in the supply chain. Many global studies of CFOs’ agendas indicate that they are greatly concerned about risks in the supply chain. In the study, “Global Supply Chain Trends 2008-2010”, conducted by PRTM, risk management is listed as one of the ten most significant trends in SCM.
5 steps to risk management
One easy way to prevent problems with the supply chain is to build up increased stocks. However, this strategy has the unfortunate side effect of increasing the financial risk of nonmarketable products. Therefore, a more intelligent approach to risk management is needed.
“Building up effective risk management of the supply chain is not an easy task. The problem with most methods is that they are either too simplified or unrealistic,” says Dirk de Waart from the global consultancy firm PRTM.
PRTM has developed a pragmatic model that they believe balances the advantages and disadvantages of other methods, thereby resulting in a method that works. They have named the method “SMART”, which is an acronym for the five steps of the model:
- Specific: Be specific about what contributes to raw material risks in the company and identify risk characteristics and impact factors.
- Measurable: Quantify risks and the potential impacts on the business.
- Actionable: Go from studying risks to reducing or curbing them. Identify the risks that will have the greatest impact on the business and define measures that can curb these risks.
- Realistic: Understand which resources are needed in the work to curb or prevent risks. Prioritise measures to avoid resource obstacles.
- Time-phased: Develop realistic implementation plans with clear roles and division of responsibilities.
“The SMART model has a number of advantages. It makes risk management a measurable and analytic process instead of a subjective, opinion-based approach. It is stringent yet pragmatic, as it identifies high priority risks without the use of difficult and demanding probability models. It is scalable, duplicable and is possible to transfer to other risk areas in the company. But most importantly of all, it forces companies to reduce their operational risks,” says Dirk de Waart.
Let’s briefly examine the five steps of the method:
1) Specific: Define risks
The first step in any risk management process is to classify the company’s risk in two dimensions: risk or probability for an unforeseeable event in one dimension and the impact of the risk on the business in the other dimension. The impact tells us what will happen if the event occurs. In this way, we can prioritise risks both on the basis of their probability and their impact. Placing the risks in a matrix with risk and impact on X and Y axes makes it easy to visually determine the risks that should have the highest priority.
2) Measurable: Quantify risks and impact
The aim of this step is to quantify the relative risk and impact for every risk in the matrix. We are not interested in absolute numbers for the risk, but in what risks are more likely than others and which will have the greatest impact on our business. This step can be divided into four phases: Define sources of data, collect data, normalise data and calculate risk and impact.
3) Actionable: Define how you will curb risks
The greatest challenge in risk management is not identifying risks, but rather curbing or reducing them. Most organisations are opposed to spending money on activities with an uncertain payback. Risk reduction is one of these activities. Nonetheless, it can be vital to conduct risk reduction if your company wishes to protect its long-term earnings. In efforts to convince management of the advantages of risk reduction, it is often a good idea to quantify the impact of the risks on the business. Tell them in concrete figures what will happen if the risk factor should unexpectedly become reality. For example, a large car manufacturer has expenses of 5 million dollars for every day production is stopped. A significant disruption that causes a 20 day stop in production would cost the manufacturer over one hundred million dollars.
Risks typically relate to materials. If the number of materials is limited, it is easy to identify risk reducing measures. If there are hundreds of materials involved, it would be expedient to divide them into groups based on their risk profile. For example, if a materials group is currently purchased from a single supplier, you can consider the following risk reduction measures:
- Qualification of an alternative supplier
- “Insourcing” of some of the materials
- Identifying alternative materials
4) Realistic: Understand the resource obstacles
It is here that management truly makes risk management a realistic tool when the unexpected occurs. Every change initiative requires a realistic execution plan and an assurance that the necessary resources are both available and confirmed. Risk reduction resources comprise man hours, capital and expenses. Capital will typically involve increased stock, which is an expensive form of risk reduction that should only be used in accordance with top management. It is important that management from all affected functions in the company are involved when resource obstacles are identified.
5) Time-phased: Make a timeline
When management from all affected functions in the companies have signed the plan for measures and resource needs, it is time to make detailed plans for implementation of the measures. The plans must not just be a formal desk task, but must actually function as a contract between functions and the organisation. The measures are often cross-functional and therefore require an independent team to oversee implementation.
How ready are you for risk management?
PRTM has also developed a maturity model that describes five different levels of readiness. Level 1 means that the company has not defined any risk management, but follows its intuition. Level 2 has risk management at the function level, but not coordinated across functions. At level 3, risk management is a well defined process that is fully duplicable. Here, a methodology is used that enables cross-functional comparisons. Level 4 consists of developing risk portfolios. Resources are strategically allocated for various risks and risk management is no longer an annual exercise, but becomes an integrated part of the daily operations. The fifth and highest level consists of expanding risk management at level 4 to also incorporate suppliers and customers. Risks here are monitored in real time and the focus shifts from reducing risks to completely avoiding risks. According to PRTM there are a few companies in the financial sector that operate on level 5, but they are not aware of any such examples from the industrial sector.