The New Supply Chain Challenge: Risk Management in a Global Economy

The following is excerpted from a white paper from FM Global. The entire white paper can be found on www.fmglobal.com

One of the trends that has increased supply chain risk—globalization—also provides opportunities to manage that risk. Globalization allows us to site facilities in safer locations, tap into educated overseas workforces, and set up production centers closer to sources of raw materials. Also, by opening the door to using vendors and suppliers from around the world, globalization often increases the number of vendors and suppliers that companies can tap as alternate suppliers to fill gaps in their supply chain.

The trick is to make certain that the alternate suppliers your company chooses are truly divorced from the risks born by their preferred counterparts. Suppose, for example, a company buys commodity semiconductor chips for use in one of its main products. Taiwan is the center of the commodity chip industry. If both the preferred and alternate suppliers are located there, the same earthquake, power failure or political upheaval could knock both out of commission at the same time.

Prior to Hurricane Katrina in 2005, companies whose supply chains were dependent upon access to the Mississippi River via the port of New Orleans might have imagined that contracts with multiple shippers inoculated them against transportation risk. After Katrina, one of the most devastating natural disasters in U.S. history, the fallacy of that thinking was exposed: Nothing was moving through New Orleans.

Choosing alternate suppliers prudently means taking into consideration a wide variety of factors. Do they get their electrical power from the same grid that serves your primary supplier? Do they rely on the same transportation systems? Do they buy their raw materials from the same place? The fewer questions like these that that can be answered in the affirmative, the more reliable the alternate supplier will be.

Where risks are deemed small enough to be withstood, or in those rare cases where they simply cannot be prevented with certainty, companies can nonetheless take measures to control them. For instance, companies might employ computer technology to more tightly integrate order and inventory systems with suppliers’ systems and guard against communications breakdowns that could disrupt the supply chain. Again, the goal is to limit the business impact should a supply chain disruption occur. A key tool: the supplier contract, which can be used to specify a wide variety of performance and risk-management standards. These are particularly effective when paired with appropriate oversight controls.

Mitigating damages When catastrophic supply chain disruptions occurs, a quick response can help minimize the consequences. This requires companies to have two measures in place before the disruption occurs. The first is a business continuity plan. The second is an insurance program with ample and stable capacity that can reimburse a company for operational and financial losses directly attributable to an interruption of business activities.

A business continuity plan should be both broad and deep, covering a wide range of contingencies: disaster recovery, the safety of employees, the retrieval of backup business data, emergency communications, the possible relocation of business operations to an alternative location, and the sourcing of goods from alternative suppliers. Ironically, the biggest hurdle to developing such a plan is not usually human ingenuity or industry but lack of imagination.

Numerous catastrophes over the past decade, from the Kobe, Japan, earthquake in 1995 to Hurricane Katrina, have shown that we routinely underestimate—or simply ignore—the degree to which disasters can disrupt businesses and the supply chains on which they depend. The Kobe earthquake killed more than 6,400 people, destroyed 100,000 buildings, closed Japan’s largest port for two months, and caused more than US$100 billion in damages. Among the companies forced to scramble for alternate production and transportation were several of the world’s major auto manufacturers. Toyota alone was unable to produce 20,000 cars on schedule after damage to plants left it short of critical components.

The problem in planning for disasters of such magnitude is that our expectations tend to be colored by our past experiences—and few have lived through a major fire, much less a major earthquake or hurricane. Similarly, few have much experience managing supply chain risk across oceans and continents. Deloitte, in its risk management study “Disarming the Value Killers,” found that many of the greatest market capitalization losses in the world were attributable to events that were considered extremely unlikely—and for which those companies seemingly failed to plan. Many of the companies cited in the study lost more than 20% of their market value in the month after the event, and it often took more than a year before their shares regained their original levels.

By working with business continuity experts, companies can better understand the risks they face and better prepare themselves to prevent, control, and mitigate them. Where companies often fail to fully plan is by looking at risks too narrowly, such as simply planning for IT business continuity and not inoculating the business built around it to the same degree.

And when it comes to your insurance program, it pays to know how your policy will respond should you ever have an insurable loss. Do you know whether your insurer has the financial strength to pay for your loss? Does your insurer have the stability, so that you can be confident it will be around should you have a claim? Additionally, does it have a history of paying claims promptly and fairly?

Likewise, does your company have enough coverage? Carrying too little insurance can have serious consequences in times of potential disaster. Thus, it is far better to ensure your insurance coverage is in sync with the actual replacement value of goods and materials. Also consider the advantages of seeking more coverage at a higher deductible than having low limits with a low deductible.

While all this may sound like common sense, it isn’t always common practice. It pays to check with your company’s insurance manager to see how your company’s program is structured, and whether insurance can make your company whole again in a worst-case scenario.

Ruud Bosman is executive vice president for Johnston, RI-based FM Global, a commercial and industrial property insurer.

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