By Dr. Robert Gordon, CPC
Risk is always a possibility in any endeavor. Organizations seek to reduce or exchange risk through contracts and agreements. However, it’s not possible to truly eliminate risk, especially when it comes to internal and external risks that businesses may face.
Some supply chain professionals think they can mitigate supply chain risks by outsourcing responsibilities to suppliers to take care of products or services. However, just because you have a contract does not mean that those suppliers will always be 100% dependable.
The more risk that is put on a supplier, the greater the chance that one of those suppliers will encounter problems. A classic example of this happened in the aftermath of the 2011 earthquake and tsunami in Japan. The quake caused global supply chain disruptions that impacted many organizations worldwide.
The Four Types of Supply Chain Risks
In any transaction, there are always potential risks. Organizations understand that risk exposure is a part of today's business and that a supply chain disruption can occur. However, many organizations are less tolerant of supply chain risks because many risks can be controlled or contained.
It is essential for the head of the supply chain to perform risk identification and pay attention to risk mitigation. Supply chain managers might not be able to eliminate all risks. However, mitigating risks, being aware of potential failure points, paying attention to regulatory compliance, and using mitigation strategies are all important to maintaining a competitive advantage over other businesses.
Supply chain risks are various types of potential problems that can occur within the supply chain process. These risks can be categorized into four main types:
- Global risks
- Operational risks
- Natural risks
- Economic risks
One easy way to remember all of these risks is to use the acronym “GONE.”
Global Risks
Global risks stem from political changes or instability in countries where a supply chain operates. It’s also important to remember that even stable countries can be impacted by regional geopolitical problems. Global risks can include changes in government policies, trade restrictions, wars, or political unrest.
These risks can create supply chain disruption or increase costs due to tariffs or trade barriers. Ideally, a supply chain manager should remain up to date on global matters because many issues could arise due to global risks.
For example, significant recent paint shortages have occurred due to the Russian-Ukrainian war. Russia and Ukraine are primary suppliers of titanium oxide, according to AK Painting. Titanium oxide is needed for the production of many paints.
Chemical shortages will continue to impact paint production, leading to shortages or outages of various tints and paints according to CNBC. The paint disruption started in 2021 and will likely remain an issue as long as Russia and Ukraine remain in conflict. No one expected this issue once the war started, and it has become a geopolitical risk that has impacted many supply chains around the globe.
Operational Risks
Operational risks are risks related to a company's internal operations and processes, including known and unknown risks within the organization. They can include production issues, equipment breakdowns, human errors, or inefficiencies in the supply chain process.
Operational risks often lead to delays, increased costs, or quality problems. The supply chain head needs to review all the supply contracts to ensure that sufficient parts and services are available to address common issues. Also, having a stock of critical spare parts is vital to avoid downtime delays due to ordering new parts from a new supplier.
For example, I worked at a large company with a unique motor built for an attraction. The custom motor was well-engineered and was projected to have an operational life of 10 years. This item was identified as critical, but the company decided not to order a spare motor since the operational life of the original motor was expected to be 10 years.
After three years, the custom motor failed, and the attraction remained down for over 12 months as a new motor was fabricated. The lesson learned is that if a part is critical to the operation, it is better to have a spare than to lose revenue for months.
Natural Risks
Natural risks include disasters like earthquakes, floods, hurricanes, or environmental changes. These environmental risks can cause significant disruptions in the entire supply chain by damaging infrastructure, causing supply shortages, or halting transportation and logistics operations.
These larger natural environmental risks can impact a producing company or one of its raw materials suppliers. Although the impact of disasters cannot be predicted, all organizations need to have a continuity plan to continue operating after a disaster, especially if the business uses global supply chains.
For example, when the COVID-19 pandemic was at its peak, production worldwide shut down and companies shifted to remote work. Also, supply chain resilience suffered, leading to shortages in some retail stores. Many organizations struggled to cope with the disruptions caused by the pandemic.
Constructing a business continuity plan is helpful to ensure that an organization is ready for a natural disaster. It could also lead to a business gaining a competitive advantage as well.
A production organization should also require that its key suppliers have a continuity plan in place as well.
In addition, the head of the supply chain might adopt an 80/20 rule where any critical materials are be divided between two companies. One supplier would provide 80% of the required materials and the other supplier would offer 20% of the required materials.
This system creates two suppliers for critical items so that if one supplier experiences an unexpected issue that halts production, another supplier can increase its production to ensure that a company obtains critical items.
Many people have asked me why companies should bother with this strategy rather than giving one company all the business.
But having tried to bring companies up to custom production on short notice in the past, I’ve noted that it is rarely fast or effective. Many companies say they can quickly take on custom production, but few can achieve it.
Another alternative to an 80/20 split is to look at seeking companies that produce 3D-printed parts for development. By setting up more expensive production with a 3D-printed parts supplier, a company might also be able to use those parts as an alternative in case of production issues.
Economic Risks
Economic risks are associated with changes in the broader economic environment that can impact a supply chain, such as fluctuations in market demand, currency fluctuations, inflation, or economic recessions. Such risks can affect the cost of goods, the availability of financing, and consumer demand.
In many cases, paying more money can alleviate some of these risks. As material costs increase, it might be possible to find what is needed, but that may not be a price point the market will handle.
For example, the New York Times noted that there have been recent shortages of sriracha sauce. This popular sauce has been out of stock or in short supply. However, some people think this shortage is due to a shortage of sriracha peppers, but there is no sriracha pepper. Sriracha sauce involves a mixture of several peppers of specific heat and flavor to create the sauce. But there has been experiencing supply chain issues with raw materials from Mexico.
Siracha sauce also needs to hit a particular price point. For production companies, it can be a challenge to finding acceptable ingredients at the right price, which can lead to shortages.
Supply Chain Risk Management Strategies
Supply chain risk management strategies are an essential aspect of supply chain operations. Ideally, supply chain managers should keep three important management strategies in mind:
- Diversify suppliers
- Build strong relationships with suppliers
- Use insurance and financial strategies
Diversifying Suppliers
It is necessary to diversify suppliers to mitigate supply chain risk and avoid over-reliance on a single supplier or region. Having multiple suppliers for critical components can mitigate the impact of a disruption in one area.
One method for diversifying suppliers is to use the 80/20 strategy. Another option is to use more of a 50/50 split. If one supplier has issues, then production would only be affected by 50% while the other supplier gears up to fill the increase in demand.
In addition, consider local or regional suppliers to reduce dependency on international supply chains. Although overseas pricing can be favorable to companies, remember that there will still be a long lead time and potential delays due to logistics disruptions.
Building Strong Relationships with Suppliers
Developing strong supplier relationships involves regular communication, collaborative planning, and shared risk management practices to address both internal and external risk factors.
It’s crucial to understand what new products or services can be bundled to maximize efficiency. The stronger the relationship with a supplier, the more likely an organization will be allowed to try new products or services.
Furthermore, implementing supplier performance monitoring systems ensures that suppliers meet standards and can reliably supply products or raw materials during disruptions. Understanding who are the most reliable suppliers will help companies to make strategic decisions that include external products or support.
Insurance and Financial Strategies
Companies should have insurance to protect against certain risks, such as natural disasters or supply chain disruptions. It’s not always possible to be protected against all disasters, but having insurance covering any rebuilding costs is important.
Furthermore, an organization can consider hedging against increased costs by taking a position on the raw material. If fuel is a significant cost driver, that company might want to take a position on crude oil to compete against increased costs. Furthermore, maintaining solid financial health to withstand potential disruptions allows the organization to recover more quickly.
Why Is It Important to Manage Supply Chain Risks?
Managing risk is always important to ensure business continuity. Controlling risks lies at the heart of supply chain risk management, including the mitigation of both internal supply chain risks and external supply chain risks.
Although minor risks might not topple an organization, it is possible that enough supply chain problems could mean the end of the organization. Many case studies have shown that chasing good people can lead to the collapse of an organization, so addressing risks is imperative to keep the business running smoothly.
Ensuring Business Continuity, Cost Efficiency, and Profitability
Disruptions in the supply chain, whether due to natural disasters, geopolitical tensions, or supplier insolvency, can halt production, affect product delivery, and lead to revenue loss. But planning for disruptions is the only way to prevent organizational failure.
Unanticipated supply chain disruptions can lead to increased costs due to expedited shipping, higher-priced last-minute suppliers, and lost sales. Freight costs can lead to numerous issues in order to maintain production, such as the need to switch from economical sea freight to expensive air freight.
Proactive risk management helps predict and mitigate these disruptions, ensuring cost efficiency. By optimizing inventory levels and avoiding rush orders, companies can maintain their profitability even when faced with unforeseen challenges.
Reputation and Customer Trust
In the age of social media and instant communication, a supply chain failure can rapidly escalate into a reputational crisis. No organization wants a social media frenzy about problematic deliveries.
Consumers and clients expect reliability and transparency, and a failure to deliver can damage a brand's reputation in the long term. Effective supply chain risk mitigation helps maintain customer trust by ensuring consistent product availability and quality, enhancing brand loyalty and reputation.
Using a Structured Approach to Manage Risks Strategically
Every organization is unique, so it’s necessary to build a structured risk management approach that leverages an existing supply chain strategy to mitigate risk, including known and unknown risk factors. For instance, a supply chain manager might want to increase inventory on-site to serve as a buffer against supply chain disruptions.
It is also helpful to review different insurance policies to ensure a company has suitable coverage to mitigate external risks, disruptions, or disasters. A company should also build a flexible continuity plan that will help keep the company operating, regardless of the issues that arise.
Ultimately, the supply chain head and company executives must build a structured plan to keep an organization operational despite issues, risks, disasters, or supply chain disruptions.
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