As the global economy recovers, organisations face a dilemma: Should they invest in supplier risk management considering the high rates of supplier financial failures? Or can they go back to “business as usual”? The rise of complex, integrated supply chains has increased the likelihood of critical suppliers facing supply disruptions and financial distress. Do organisations learn to live with the increased risk? CPO Agenda asks Frank Omare.
How did the economic downturn test supplier risk management?
In the past, a supplier in financial difficulty might have displayed warnings or signs during six, nine or even 12-month intervals. An organisation would have had many opportunities to identify, evaluate and react to what would have been an isolated situation, either by providing short-term assistance to the supplier or implementing a contingency plan.
But during the recent economic downturn, business conditions were far from typical and some suppliers suffered failure in a matter of weeks or even days. This presented a challenge in supplier risk management for organisations across various sectors. CPOs were forced to balance the need for cost savings with ensuring the health of suppliers. They also learned they could not always rely on traditional indicators to predict supplier failure.
Historically, the focus of the CPO was on large suppliers of strategic, critical items. Yet now, CPOs had to accept that smaller strategic suppliers could have a significant impact if they failed to deliver key products or services. CPOs learned that putting in place contingency suppliers was time consuming. Organisations questioned how well they knew their suppliers.
Did some organisations have a narrow escape with supplier vulnerability?
The rise of complex, integrated supply chains, along with the global downturn, increased the likelihood of critical suppliers encountering supply disruptions and financial duress. The consequences – from failing to deliver on promises to customers, to losing access to a supplier’s intellectual property – could be catastrophic.
Supplier risk management captured the attention of the C-suite during the downturn. Suppliers failed at an increasing rate and traditional methods of predicting supplier failures, such as medium-term cash flow and share-price tracking, became obsolete. Some organisations were caught off guard, while some had narrow escapes.
What consequences did those organisations that suffered supplier failures face?
Not every organisation suffered a supplier failure. But where they did, executive management teams fast understood the potential consequences of such a failure. These spanned a number of areas including costs, reputation and revenue, resulting in loss of sales, or adverse publicity.
During the worst of the downturn, the president of a global automotive manufacturer told the American Auto Taskforce that the company had “real concerns” about the health of 30 of its key suppliers. In another example, a global airline introduced a ‘supplier watch’ scheme in what appeared to be a trend to increase the scrutiny of suppliers. A June 2009 poll by Ernst & Young found that 14 per cent of executives had lost key suppliers to bankruptcy (up from nine per cent in January 2009) and 43 per cent were moving to lock suppliers into longer-term contracts.
Another trend we observed was the blurring of roles and responsibilities between procurement and finance. The relationship between a CPO and CFO can be strained at the best of times. However the levels of financial turmoil during the downturn fell outside the parameters of most risk models and supply chain processes, which created additional tension. Typically, the CFO has responsibility for risk management while a CPO is responsible for developing and managing the supply base. But analysing the supply base is a critical part of risk management. During supplier failure, procurement and finance overlapped as organisations strove to reduce the impact and to develop contingency plans.
Is identifying supplier risk still a high priority in recovery?
Organisations have turned their attention back to top-line growth. The new agenda for procurement is to collaborate with suppliers to develop new products and reduce the time to market. Supplier risk management continues to be a priority as organisations work more closely with strategic suppliers in current markets or develop operating models for new suppliers in new markets.
Where global organisations are relying on emerging markets for growth and using local suppliers in order to support corporate initiatives such as diversity, robust supplier risk management ensures a stable supplier base is set up and that risks are measured on an ongoing basis.
Meanwhile some organisations are rationalising their supply base to reduce costs and to develop closer partnerships with fewer suppliers. It is vital that suppliers are assessed for risk as part of the criteria for remaining in the streamlined supplier base.
As organisations seek to reduce costs even further, let us not forget low-cost country sourcing (or “BRIC sourcing”) and the risks that this brings to an already complex supply base. In summary, organisations are narrowing their supplier base or extending their supply chains in response to a business agenda which can increase exposure to supplier vulnerability. In our view, there has never been a better time to demonstrate to the board that supplier risk is a timeless concern.
Should we now retrofit to avoid risks?
Organisations should now be either strengthening or implementing supplier risk management mechanisms to protect themselves against potential future disruptions. Organisations should immediately review monitoring practices to determine if their early-warning screening system sufficiently identified suppliers that were in financial distress. But this is not all about the retrospective numbers – a longer-term look is also required, which demands a very different set of skills. Multifunctional teams must assess the extent of the risks and begin mapping a broad range of contingencies. Prudent management teams have taken note of the high rate of failed suppliers and are taking action to assess and mitigate potential near-term supply risks by:
• Revisiting risk models and related early-warning troubled-supplier identification systems
• Developing more detailed assessments of suppliers already in trouble or at risk
• Refining skills related to assisting suppliers, including re-sourcing, acquiring or investing, or managing through bankruptcy or administration.
There is still much uncertainty as to when there will be a full economic recovery, so procurement being able to mitigate and manage the potential impact of supplier failure remains of strategic importance. Historically, the pre-qualification of suppliers focused on safety, health and environment and did not include supplier risk ratings. But new ways need to be found to include supplier risk management in the pre-qualification stage – the challenge is to do this retrospectively for the existing entire supplier base. One solution is to apply a “light model” to current suppliers while introducing a more detailed review for new suppliers. New models also need to be developed for a new process for the categorisation of the identified risks. These models need to be standardised across all geographies and entities of the organisation.
Alternatively where supplier pre-qualification schemes/models already include supplier risk management to some extent, there is an opportunity here to enhance them.
So what have we learnt?
Supplier risk management captured the attention of the C-suite during the downturn. However as the global economy continues to recover and the supply base becomes more stable, organisations now need to recalibrate their supplier risk management. Organisations that were caught off guard are investing heavily in supplier risk management; others are redeploying their resources to face the challenges of increased demand for products or services posed by a recovering economy.
However, organisations would be advised to develop appropriate early warning systems and to deploy the right level of resources to manage the identified risks. Rather than revert to ‘business as usual’, organisations should learn from their experiences or from those of other organisations.
Proactively putting in place systems for monitoring supplier stability and risk mitigation processes will enable organisations to identify suppliers in distress and take appropriate action.
Frank Omare is a director, supply chain and operations at Ernst & Young’s advisory business, based in London