Tackling Supply Chain Vulnerabilities

Tackling Supply Chain Vulnerabilities

Before 2020, supply chain management was often an afterthought for many small- and medium-sized business owners and leaders. They were familiar with their key suppliers, monitored monthly purchasing costs, and occasionally resolved minor disruptions. As long as operations ran smoothly—and they typically did—logistics remained a concern primarily for operations and warehouse managers, or outsourced to third-party logistics partners.

However, the landscape shifted dramatically last year. Widespread shortages and delays disrupted businesses globally, making supply chain management a priority at the executive level. Incidents such as the Suez Canal blockage and winter storms in Texas have further highlighted the critical importance of a robust supply chain strategy.

For growing businesses, the consequences of inventory shortages or lack of manufacturing materials can be severe. The Federal Reserve estimates that the pandemic forced 200,000 businesses to close in 2020. Unlike large enterprises, these organizations often lack substantial cash reserves, making them more vulnerable to disruptions.

Business leaders now recognize the urgent need for a comprehensive strategy to mitigate supply chain risks. They must continually assess and enhance this strategy to remain resilient. To provide a clear understanding of the risks and mitigation strategies, we consulted supply chain experts. Here, we outline the key risks businesses should consider when evaluating their suppliers and explore how technology can aid in mitigating these risks.

Understanding Supply Chain Risks

Supply chain risks refer to a variety of threats that can disrupt the flow of goods and services within a supply chain network. These risks encompass economic, environmental, political, ethical, and cybersecurity challenges. Examples include supplier bankruptcies, economic recessions, natural disasters, political instability, unethical practices such as child labor, and cybersecurity breaches.

To mitigate these risks, businesses can adopt several strategies to ensure resilience and continuity in their supply chain operations. These strategies include:

  • Supply Chain Mapping: Creating a detailed map of the entire supply chain to identify potential vulnerabilities and bottlenecks.
  • Weighted Ranking: Prioritizing risks based on their potential impact and likelihood, allowing businesses to focus on the most critical threats.
  • Value at Risk (VaR) Assessment: Quantifying the financial impact of potential supply chain disruptions to better allocate resources for risk management.
  • Supplier Segmentation: Categorizing suppliers based on their risk profiles and importance to the business, enabling targeted risk mitigation efforts.
  • Diversification: Reducing dependency on a single supplier or geographic region by diversifying the supplier base.
  • Inventory Management Adjustments: Optimizing inventory levels to balance cost efficiency with the ability to respond to supply chain disruptions.
  • Scenario Planning: Developing and testing response plans for various disruption scenarios to improve preparedness.
  • Building Strong Supplier Relationships: Fostering collaborative partnerships with suppliers to enhance communication, trust, and mutual support during crises.

By implementing these strategies, businesses can better navigate the complex landscape of supply chain risks and maintain a steady flow of goods and services even in the face of unexpected challenges.

Key Takeaways

  • The COVID-19 pandemic and other recent disruptions have underscored the vital importance of supply chains in business operations, necessitating a strong focus on supply chain risk management for leaders.
  • Supply chain risks can be broadly categorized into four main types: economic, environmental, political, and ethical. Examples include supplier bankruptcies, natural disasters, political unrest, and ethical issues such as poor labor practices in sourcing companies.
  • To effectively assess supplier risks, businesses should employ techniques such as supply chain mapping, weighted ranking, Value at Risk (VaR) analysis, and supplier segmentation. These methods help identify and quantify potential vulnerabilities within the supply chain.
  • Mitigating supply chain risks involves several strategic actions, including diversifying supplier bases, optimizing inventory management strategies, engaging in scenario planning, and fostering strong relationships with suppliers. These measures enhance resilience and minimize the impact of disruptions, ensuring smoother and more reliable supply chain operations.

Mounting Supply Chain Risks: A Closer Look

Supply chain risks, which can severely disrupt business operations, broadly fall into four categories: economic, environmental, political, and ethical.

  • Economic Risks: These include scenarios such as a key supplier going bankrupt, economic recessions, or work stoppages at crucial manufacturing partners.
  • Environmental Risks: Natural disasters like floods, earthquakes, and droughts pose significant threats to supply chain continuity.
  • Political Risks: Civil unrest, regime changes leading to new tariffs, and export restrictions can all create significant disruptions.
  • Ethical Risks: Issues such as the use of child labor, forced labor, or sourcing from companies that neglect worker safety and protection standards fall into this category.

While these risks are not new, their prevalence has increased. Data from the international disaster database EM-DAT indicates a steady rise in natural disasters over the past two decades. Concurrently, environmental, social, and governance (ESG) concerns have gained prominence.

For example, product provenance has become a critical issue for consumers who increasingly demand transparency about the origins of goods and the sustainability and ethics of their production processes. Environmental risks now encompass not just natural disasters but also sustainability practices. Companies found dumping waste or releasing toxins in violation of regulations face fines or shutdowns.

Cybersecurity has also emerged as a major threat in the technology-driven business environment. Steven Melnyk, a professor of supply chain management at Michigan State University, emphasizes the importance of selecting software vendors with robust cybersecurity practices, especially for smaller companies.

To navigate these mounting risks, businesses must adopt comprehensive strategies that address each category, ensuring resilience and continuity in their supply chain operations.

3 Strategies to Assess Supplier Risk

For small and midsize businesses, understanding the risks associated with their tier 1 suppliers is essential. Leading organizations extend this scrutiny to tier 2 and tier 3 suppliers, but gaining any level of insight into the supply chain is a crucial first step.

To strengthen their supplier networks, companies must identify the types of risks their partners present and the severity of these risks. Although this process can be time-consuming and complex, it is vital for maintaining supply chain resilience.

To assess supplier risks, consider these three strategies:

1. Basic Supply Chain Mapping

Before evaluating suppliers (and potentially their suppliers), it is crucial to map out who they are, what they provide, and where they are located. Collaborate with colleagues across your organization to ensure no suppliers are overlooked, especially those providing seemingly minor items. You can create a basic map using a spreadsheet or specialized supply chain software. Regularly update this map as you add new partners and discontinue relationships with others.

2. Weighted Ranking

Use a system that assigns weighted importance to various risk factors such as economic or political disruption, financial stability, credit history, and natural disasters. According to Jack Cunningham, a purchasing manager at a global consumer products company, you can score each supplier on these factors from 1 to 5 (with 5 representing the highest risk). Calculate the weighted average of these scores to determine a supplier’s total risk and compare this across different partners.

3. Value at Risk (VaR)

The Association for Supply Chain Management (ASCM) offers a Value at Risk metric as part of its Supply Chain Operations Reference (SCOR) model. This method involves evaluating the probability of various risks—such as political unrest, weather events, or ethical practices—and their potential impact. For instance, if there’s a 10% chance of a hurricane hitting a region where your sole supplier of a critical component is located, and the value of the affected product is $3 million, the Value at Risk is calculated as 0.1 x $3,000,000 = $300,000. Based on these calculations, you might consider shifting orders to less risky areas or increasing inventory to cover potential disruptions.

Segmenting Suppliers

When using these techniques, consider the importance of different suppliers to your business. Segment suppliers into groups similar to an ABC inventory analysis. A partner in the A segment might produce a key component for a top-selling product, while one in the C segment might supply easily replaceable items. This ranking should not be based solely on sales volume; a critical supplier in a low-risk area still demands significant attention due to the potential revenue impact if they fail to deliver. Conversely, sourcing non-critical components from high-risk regions may not be a significant concern.

By implementing these strategies, businesses can effectively assess and mitigate the risks associated with their suppliers, ensuring a more resilient and robust supply chain.

4 Effective Strategies to Mitigate Supplier Risks

1. Diversify Your Supplier Base

After assessing the risks associated with your supply chain partners, one of the most effective strategies to build resilience is to diversify your supplier base. This involves identifying multiple suppliers for key components and materials located in different regions. For instance, having suppliers spread across various geographical areas ensures that a hurricane or other regional disaster won’t completely halt shipments of critical materials. Additionally, consider sourcing from partners closer to home—perhaps not within the same country but on the same continent—to reduce potential disruptions.

According to experts, the process of identifying and onboarding new suppliers can vary significantly in duration. Bringing on a new supplier for a commodity item like a ball bearing might take as little as a week. However, for specialized parts, particularly those used in highly regulated industries like medical devices, the process could extend to a year or more due to rigorous standards and testing requirements. Tony Nuzio, founder and CEO of ICC Logistics Services, emphasizes that while onboarding new suppliers for commodity items is relatively quick, highly regulated products necessitate a much longer timeline.

Diversifying your supplier base not only mitigates risks but also enhances the overall stability and flexibility of your supply chain, ensuring continuity and resilience in the face of unforeseen disruptions.

2. Modify Your Inventory Planning and Management Strategy

Adapting your inventory planning and management strategy is essential for increasing supply chain resilience. Many manufacturers, distributors, and retailers are currently reevaluating how much inventory to carry due to recent supply chain disruptions. Over the past 25 years, many product-based companies have adopted a just-in-time (JIT) inventory strategy, which involves stocking only the materials and goods they expect to sell, along with a small buffer of safety stock, to reduce costs.

Despite the increasing interest in a just-in-case (JIC) inventory approach, JIT is not disappearing. Its popularity stems from its ability to lower purchasing and inventory carrying costs, which is why it remains a viable strategy. Companies that practiced JIT without adjusting for forecast changes would have encountered issues long before the past year, according to Peter Bolstorff, EVP of the ASCM.

Procurement teams should continue to use the economic order quantity (EOQ) formula to calculate optimal order sizes, the reorder point (ROP) to determine when to place orders, and safety stock calculations to maintain appropriate buffer stock levels. These foundational models are critical starting points for inventory forecasting and determining ideal inventory levels.

ABC Inventory Analysis

A straightforward ABC inventory analysis helps identify which products are most crucial for your business. The items generating the majority of your revenue or profit fall into the A category, the next biggest sellers are in the B category, and the least popular items are in the C category. Typically, A products represent 70-80% of all sales, B items 15-20%, and C goods just 5-10%. Jack Cunningham, a purchasing manager, notes that 20% of products usually account for 80% of sales, reflecting the Pareto principle, or “80-20 rule.” It makes sense to stock larger quantities of A products or their components because their absence would have the most significant impact on your business. Conversely, some C group items might not be worth selling if their costs exceed their profit.

Calculating Inventory Carrying Costs

Understanding carrying costs, or the expenses associated with maintaining inventory, is crucial. These costs include storage, insurance, taxes, labor, shrinkage, obsolescence, and more. Opportunity cost is also an important consideration, as funds tied up in inventory could be used for other purposes, such as marketing campaigns or hiring new employees. Since some products are more expensive to hold than others, managers need to know these costs at the item level to make informed stocking decisions. They can then balance carrying costs against the value of potential lost sales to determine whether the projected revenue justifies the expenses.

By modifying your inventory planning and management strategy, you can better navigate supply chain challenges and enhance your business’s resilience and efficiency.

3. Recognize the Potential of Scenario Planning

The importance of scenario planning has gained significant attention following the unforeseen disruptions of the past year. Organizations now strive to be better prepared for future disruptions, and scenario planning tools play a crucial role in this effort. These tools can project the financial effects of various scenarios, such as the loss of a key customer, a three-month hiatus in orders from two suppliers, or a sudden surge in demand.

By understanding the financial impact of best-case, worst-case, and average-case outcomes, businesses can make informed decisions about inventory levels. Instead of relying on best guesses, decisions are data-driven, enhancing preparedness and resilience against potential disruptions.

Recognizing the potential of scenario planning allows organizations to anticipate and mitigate risks more effectively, ensuring a more robust and responsive supply chain.

4. Treat Your Suppliers as True Business Partners

Your success is intricately linked to the performance of your suppliers, shipping carriers, and everyone else involved in your supply chain. As you work to strengthen your supply chain, it’s crucial to shift your perspective on suppliers from being mere vendors to strategic partners.

Building strong relationships with your suppliers is at the core of this approach. Take the time to get to know your primary contacts at each supplier. This investment in relationship-building can yield significant benefits in the long run.

Consider the impact of strong supplier relationships: If an issue arises, who is the supplier more likely to alert first—the person who merely submits purchase orders, or the one who regularly checks in and knows them personally? One procurement leader noted that the close relationships he built with Chinese suppliers were instrumental in keeping his business afloat during the pandemic.

To earn priority treatment, supply chain leaders should strive to understand their partners’ businesses and identify ways to be a great customer. A personalized approach to each supplier demonstrates that you value them and view the relationship as mutually beneficial. By treating your suppliers as true business partners, you create a foundation of trust and cooperation that can enhance the resilience and efficiency of your supply chain.

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Tackling Supply Chain Vulnerabilities
Article Name
Tackling Supply Chain Vulnerabilities
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Mitigate supply chain vulnerabilities with proven strategies for risk assessment and supplier relationship building.
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ABJ Cloud Solutions
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