- After a stream of supply-chain issues, business leaders have realized the strategic importance of supply chains to the overall health of their organizations.
- We walk through a few techniques companies can use to pinpoint the risks that their suppliers present, assess the degree of risk and determine how much those threats matter.
- Beyond diversifying suppliers, growing businesses might mitigate these risks by increasing on-hand inventory for certain products. They should also focus on tightening relationships with their supply chain partners.
Before 2020, the supply chain may have been something of an afterthought for the owners and leaders of many small- and medium-sized businesses. Organizational leaders knew the company’s key suppliers, kept an eye on monthly purchasing costs and may have helped resolve delays or other minor disruptions that popped up from time to time. But for the most part, so long as everything was running smoothly — and it usually was — logistics were not a top concern for the C-suite. It was the domain of operations and warehouse managers (or, increasingly, third-party logistics partners).
Of course, that all changed last year when widespread shortages and delays affected businesses around the world and across industries. Since then, the supply chain has become a front-and-center issue at the highest levels of a business. More recent issues like a grounded container ship blocking the Suez Canal and winter storms in Texas have emphasized the point.
“COVID has pushed all of these concerns up to the front of everybody’s mind, and it’s very boardroom-relevant now,” said Jim Yarbrough, a global intelligence program manager at BSI Group, who consult with businesses on reducing supply-chain risks. “The supply chain must be secure and resilient, and we need alternate suppliers; we need alternate routes.”
For a growing business, the impact of not having inventory to sell or materials to manufacture goods can be devastating — the Federal Reserve estimates the pandemic knocked out 200,000 businesses in 2020. These organizations can’t match the cash reserves of large enterprises, so the effects of a problem can be more immediate and severe.
Leaders are acutely aware of the need for a clear strategy to reduce risks in their supply chain, and they should also know they must continuously evaluate and improve upon that strategy. We consulted supply-chain experts to develop a clear picture of the risks business leaders need to consider when assessing their suppliers, what they can do to mitigate those risks and how technology can assist in these efforts.
For this article, we spoke with:
Jim Yarbrough, global intelligence program manager at BSI Group
BSI Group is a London-based trade and development firm that consults businesses worldwide on practices ranging from data management to handling supply chain risk.
Steven Melnyk, professor of supply chain management at Michigan State University
A long-time supply chain management professor, Steven Melnyk’s research focus includes supply chain risk and resilience, as well as strategic supply chain management.
Joe Sarkis, supply chain management professor at Worcester Polytechnic Institute
A professor of over 30 years, Joe Sarkis’s research is primarily in environmentally-focused operations, technology and supply chains.
Jack Cunningham, purchasing manager at a global consumer products company
Jack Cunningham handles purchasing and manages relationships with suppliers around the world.
Tony Nuzio, founder and CEO of ICC Logistics Services
ICC Logistics Services helps executives throughout the U.S. identify and erase inefficiencies in their transportation and logistics processes.
Peter Bolstorff, EVP of the Association for Supply Chain Management
As the world’s largest nonprofit association for supply chain, the Association for Supply Chain Management connects companies to thought leadership on all aspects of supply chain.
Supply Chain Risks Continue Mounting
Most of the risks that could disrupt your operations fall into four broad categories: economic, environmental, political and ethical. Examples of economic issues are a supplier going bankrupt, a recession or a work stoppage at a key manufacturing partner. Environmental problems include natural disasters like a flood, earthquake or drought. Using child labor, forced labor or sourcing raw materials from a company that fails to give its workers the necessary protective equipment would be ethical concerns. Political risks could be civil unrest and a new leader who implements steep tariffs or puts restrictions on exports.
These are not new issues, though many of them have become more prevalent: For example, data from international disaster database EM-DAT shows the frequency of natural disasters has steadily increased over the past 20 years. At the same time, concerns that could be broadly classified as environmental, social and governance (ESG) have come into focus. Take for instance the provenance of products: A growing group of consumers wants to know where goods originated and that they were made with sustainable and ethical practices. Similarly, environmental risks now extend beyond natural disasters to sustainability. If a company is dumping waste in waters or releasing harmful toxins in violation of local regulations, that could lead to a fine or even a forced shutdown.
Additionally, cybersecurity has become a much bigger threat in a business environment that relies heavily on technology to coordinate and manage activities, said Steven Melnyk, a professor of supply chain management at Michigan State University. For smaller companies, protecting against cyber threats comes down to choosing software vendors that follow leading cybersecurity practices.
Strategies to Assess the Risk of Your Suppliers
Small and midsize businesses need to know how the suppliers they work with directly, tier 1 suppliers, stack up in each of these categories. Leading organizations will look upstream to their tier 2 and tier 3 suppliers, but that often comes later. Achieving any level of insight is a big step in the right direction.
To reinforce their supplier networks, companies should first understand which types of risks various partners present and the degree of risk in each case. This is often not an easy nor fast exercise, but it’s critical.
“If the network comes down to one supplier deep in the supply chain and that supplier goes down or that one arc or node goes down, the whole thing falls apart,” said Joe Sarkis, a supply chain management professor at Worcester Polytechnic Institute.
“If the network comes down to one supplier deep in the supply chain and that supplier goes down or that one arc or node goes down, the whole thing falls apart.”
To assess the risks of your suppliers, consider these strategies:
Basic supply chain mapping
Before you can evaluate suppliers (and perhaps your suppliers’ suppliers), you need to map out who they are, what they provide and where they’re located. Collaborate with colleagues across your organization as you build this map to avoid overlooking a few suppliers, especially if they provide a few small items. You can create a basic map of these links in a spreadsheet or certain supply chain software. It’s important to update the map regularly as you add partners and stop working with others.
You can use a basic system that assigns weighted importance to risk factors like economic or political disruption, financial dependence, credit history and natural disasters, said Jack Cunningham, a purchasing manager at a global consumer products company. If you choose to use this system, you’ll give each of those factors a weighted importance and each supplier a score of 1-5 for each (with 5 representing the highest risk). Then, you’ll calculate the weighted average of those numbers to come up with a score that represents a supplier’s total risk — and compare the scores of various partners.
Value at risk (VaR)
The Association for Supply Chain Management (ASCM) has a metric called Value at Risk as part of its Supply Chain Operations Reference (SCOR) model, and it’s another way for businesses to compare the amount of risk that various suppliers present. A company will consider categories of risks — whether they be risks related to politics, weather, ethical practices, quality or other categories — and assign probabilities to the likelihood of occurrence. For example, if there’s a 10% chance that a hurricane will hit a particular geography; and the supplier in that region is your only provider of a certain component; and the value of the product affected would be $3 million, then the Value at Risk is .1 x $3,000,000 = $300,000. Based on these calculations, your company might shift orders to less risky regions or carry enough inventory to cover typical recovery times.
When using any of these techniques, factor in the importance of various suppliers to your business. You can segment suppliers into groups, much like an ABC inventory analysis. (More on that in the next section.) A partner in the A segment might make a key component for a consistent bestseller, while one in the C segment could offer an easily replaceable product. You shouldn’t necessarily base this ranking on sales alone: A critical supplier in a part of the world with minimal risk may still warrant lots of attention because you’d see a substantial revenue drop if that supplier weren’t able to deliver. At the same time, sourcing a few non-critical or easily replaced components in a high-risk area may not be a major concern.
“I can point at a map and say, ‘You must be risky here because I see a lot of typhoons there’ or whatever, but you really need to understand ‘What is that supplier doing for our company?’” Yarbrough said. “How important are they to our bottom line and everything we aim to do?”
Strategies to Mitigate Supplier Risks
Diversify your supplier base.
Once an organization has assessed the risk of its supply chain partners, the best way to build resilience is to diversify its supplier base. That means finding redundant suppliers for key parts and materials that are located in different parts of the world so, for instance, a hurricane in a certain region doesn’t halt all shipments of a crucial material. It could also mean finding partners closer to home — maybe not in the same country but on the same continent.
Localizing Your Supply Chain: Understand the potential benefits, major costs to consider, potential barriers to relocation and steps to take if you decide to onshore.
Identifying and onboarding a supplier could take anywhere from weeks to a year or more, according to experts we interviewed. A new supplier for a commodity like a ball bearing could be live in a week, while one that provides a specialty part for highly regulated products like medical devices could take a year or longer due to strict standards and testing, said Tony Nuzio, founder and CEO of consultancy ICC Logistics Services.
Modify your inventory planning and management strategy.
Modifying your inventory planning and management strategy is another way to increase resilience. You’ve likely already considered this: Many manufacturers, distributors and retailers are struggling to decide how much inventory to carry in light of recent supply-chain snags. Over the past quarter century or so, many products-based companies have adopted a just-in-time (JIT) inventory strategy. Organizations practicing JIT attempt to stock only materials and goods they expect to sell, along with a small buffer of safety stock, in an effort to reduce costs.
Last year’s supply-chain disruptions and others since, however, could spark a shift to a more cautious stocking strategy.
“Agility lost out to lean, in my opinion, in the early ‘90s,” Sarkis said. “I think agility’s going to be coming back after COVID, but it doesn’t necessarily mean you’re inefficient. It’s just that you have opportunities to be able to minimize risk.”
Even if a just-in-case (JIC) inventory approach gains traction, JIT is not on the brink of extinction. The reason it became popular — it can lower purchasing and inventory carrying expenses — is the same reason it won’t go away. Any company that practiced JIT without factoring in changes in forecasts would have run into problems well before the past year, said Peter Bolstorff, EVP of the ASCM.
Procurement teams will and should continue to use the economic order quantity (EOQ) formula to calculate ideal order sizes, reorder point (ROP) to determine when to place orders and safety stock to figure out the right amount of buffer stock. There are far more advanced models, but these are the starting points for finding ideal inventory levels, or inventory forecasting.