Supply Chain Disruption

Supply_Chain_Risk_Management_An_Emerging_Disciplin..._----_1._Supply_Chain_Risk_Management_Setting_the_Stage.pdf

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1 Supply Chain Risk Management Setting the Stage

Floods,. earthquakes,. tsunamis,. tornadoes,. and. billowing. clouds. of. ash. from.obscure.volcanoes.all.share.something.in.common..Over.the.last.sev- eral.years.these.events.have.been.featured.prominently.in.the.news—and. each.has.had.the.inevitable.effect.of.disrupting.the.supply.chains.of.entire. industries..But.these.kinds.of.disruptions.were.not.on.the.minds.of.Astellas. Pharma.executives.when.thieves.stole.a.trailer.from.a.truck.stop.containing. $10.million.of.the.company’s.pharmaceutical.products..What.followed.was. a.lesson.in.supply.chain.risk.that.felt.like.a.swift.punch.in.the.gut.

When.the.accountants.had.completed.their.final.tabulations,.they.found. that.the.stolen.products.represented.only.a.fraction.of.the.losses.suffered. by. Astellas.. Based. on. a. recommendation. from. the. U.S.. Food. and. Drug. Administration,. the. company. contacted. every. party. in. its. supply. chain,. ranging.from.wholesalers.to.hospitals,.warning.them.of.the.stolen.drugs.. As.a.preventive.measure.the.company.withdrew.from.the.marketplace.all. drugs.with.the.same.lot.numbers.as.those.that.were.stolen..Some.of.the.sto- len.pharmaceuticals.required.strict.climate.control,.something.the.thieves. (who. were. eventually. caught). were. not. too. concerned. about,. making. a. return.of.these.products.a.necessity..The.loss.of.this.trailer.eventually.cost. the.company.$47.million,.wiping.out.a.large.chunk.of.its.North.American. profit.for.that.quarter.1

Welcome.to.the.sometimes.unpleasant.world.of.supply.chain.risk.man- agement..This.chapter.starts.our.journey.into.this.evolving.discipline.by. setting.the.stage.for.important.concepts.that.appear.throughout.this.book.. We.begin.by.providing.various.definitions.and.perspectives.of.this.thing. called. risk.. Next,. we. present. reasons. why. a. focus. on. supply. chain. risk. management.has.become.a.necessity.rather.than.a.luxury..This.is.followed.

Schlegel, Gregory L., and Robert J. Trent. Supply Chain Risk Management : An Emerging Discipline, Taylor & Francis Group, 2014. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/apus/detail.action?docID=1680353. Created from apus on 2021-06-09 03:04:17.

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2 • Supply Chain Risk Management: An Emerging Discipline

by.an.explanation.of.various.risk.terms.and.concepts,.a.categorization.of. risk,.and.a.presentation.of.generic.risk.management.approaches.

the COnCept Of RiSk and RiSk ManageMent

A. logical. place. to. start. is. to. explain. what. we. mean. by. risk,. particularly. since.this.concept.can.be.defined.in.various.ways..One.common.perspec- tive. simply. says. that. risk. is. a. situation. involving. exposure. to. danger. or. loss..Another.perspective.takes.this.a.step.further.by.adding.that.risk.is.the. probability. or. threat. of. damage,. injury,. liability,. loss,. or. other. negative. occurrences. that. are. caused. by. external. or. internal. vulnerabilities. and. that.may.be.avoided.through.preemptive.action.2.Another.view.states.that. risk. is. the. effect. of. uncertainty. on. objectives.. Risk. can. also. be. viewed,. at. least. partly,. as. the. inability. to. capitalize. on. an. opportunity.. For. our. purposes. we. define. risk. as. the. probability. of. realizing. an. unintended. or. unwanted.consequence.that.leads.to.an.undesirable.outcome.such.as.loss,. injury,. harm,. or. missed. opportunity.. Warren. Buffet. once. observed. that. risk.comes.from.not.knowing.what.you.are.doing.

Most.risk.observers.believe.that.when.a.risk.becomes.a.reality,.something. bad. usually. happens.. Not. surprisingly,. supply. chain. managers. almost. always.look.at.risk.in.terms.of.something.to.be.avoided..And.to.say.that. most.supply.chain.managers.are.generally.risk.averse.would.be.an.under- statement..Conversely,.entrepreneurs.look.at.risk.through.a.different.lens.. They.view.risk.in.terms.of.upside.opportunities.and.missed.opportunities. when.failing.to.act..To.those.individuals,.creative.risk.taking.is.essential. to. any. goal. where. the. stakes. are. high.. Thoughtless. risks. are. destructive,. of. course,. but. perhaps. even. more. wasteful. is. thoughtless. caution,. which. prompts.inaction.and.promotes.failure.to.seize.an.opportunity.3

Aswath. Damodaran,. a. professor. at. New. York. University,. writes. that. every.major.advance.that.civilizations.have.made.involves.someone.will- ing.to.take.a.risk.by.challenging.the.status.quo..He.further.states.that.the. most.successful.firms.in.any.industry.actively.seek.out.and.exploit.risk.to. their. own. advantage.4. He. states,. “Successful. firms,. over. time,. can. attri- bute. their. successes. not. to. avoiding. risk. but. to. seeking. out. and. taking. the. “right”. risks.. This. perspective. views. risk. as. an. event. or. activity. that. may.have.an.impact.on.an.organization’s.ability.to.achieve.its.objectives.

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Supply Chain Risk Management: Setting the Stage • 3

or. may. cause. a. missed. opportunity.. The. single-.minded. view. that. risk. is. all.about.avoidance.is,.in.his.view,.narrow.and.constraining..It.can.also.be. quite.paralyzing.

Damodaran’s. review. of. risk. supports. three. conclusions. that. align. well. with.the.philosophy.of.this.book..The.first.is.that.while.some.risk.defini- tions. focus. strictly. on. the. probability. of. an. event. occurring,. richer. per- spectives.extend.this.to.incorporate.a.valuation.of.the.consequence.of.that. event..In.other.words,.risk.is.multidimensional..Throughout.this.book.we. will. present. techniques. that. consider. probability. and. consequences. and. model.them.accordingly..A.second.conclusion.is.that.in.some.disciplines.a. clear.distinction.is.made.between.a.risk.and.a.threat..With.this.perspective. a.threat.is.thought.to.be.a.lower.probability.event.while.risk.is.regarded.as.a. higher. probability. event.. Finally,. some. definitions. of. risk. focus. only. on. the.downside.of.risk,.whereas.other.perspectives.are.more.expansive.and. consider. all. variability. as. risk,. including. lost. opportunities.. A. company. that.has.more.demand.for.its.products.than.what.it.is.capable.of.producing. appears.to.have.a.welcome.problem..In.reality,.the.strains.placed.on.that. company.as.it.struggles.to.satisfy.demand.can.affect.customer.satisfaction,. brand.reputation,.profitability,.and.even.survival.

Each.day.every.company.and.human.being.face.risk.situations..At.the. individual.level,.did.you.drive.a.car.or.fly.in.a.plane.today?.Did.you.cross. a.busy.street.or.share.the.road.with.cars.while.riding.a.bike?.Did.you.eat. food.at.a.restaurant.where.you.did.not.see.how.the.food.was.prepared?.Did. you.walk.down.a.flight.of.stairs?.Did.you.step.into.the.shower?.Do.you.have. money.in.the.stock.market?.Did.you.take.an.exam.without.studying?.If.the. answer.to.even.a.few.of.these.questions.is.yes,.you.have.exposed.yourself. to. risk,. just. like. everyone. else. on. the. planet.. The. challenge. becomes. one. of.not.allowing.a.fear.of.risk.to.paralyze.us.from.pursuing.opportunities. that.are.important.to.our.personal.and.professional.advancement..Risk.is. something.we.need.to.manage.

defining enterprise Risk Management

It. is. important. to. differentiate. between. enterprise. risk. management. (ERM).and.supply.chain.risk.management.(SCRM),.distinctions.that.are. central.to.this.book..Almost.all.corporate.executives.are.aware.of.ERM,.a. concept.that.has.been.around.for.decades..Using.a.definition.developed.by. the.Aberdeen.Group,.ERM.is

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4 • Supply Chain Risk Management: An Emerging Discipline

the.process.for.effective.identification,.assessment,.and.management.of.all. significant.risks.to.an.entity..This.includes.not.only.the.traditional.areas.of. financial. and. hazard. risk,. but. also. larger. operational. and. strategic. risks.. ERM.refers.to.the.people,.tools,.systems,.and.structures.that.are.part.of.a. broader.framework.of.Governance,.Risk,.and.Compliance.5.

Chapter 9. will. highlight. several. ERM. frameworks,. including. the. then. COSO. (Committee. of. Sponsoring. Organization. of. the. Treadway. Commission). framework. and. the. ISO. (International. Organization. for. Standardization). standards. relating. to. risk. as. well. as. Governance,. Risk,. and.Compliance.

Corporate.executives.have.been.concerned.with.enterprise.risk.for.years,. particularly. at. publicly. traded. companies.. The. Securities. and. Exchange. Commission. (SEC). requires. publicly. traded. companies. to. identify. the. material.risks.they.face.at.the.corporate.level.in.Section 1A.of.their.com- pany’s.10-K.report..Failure.to.identify.these.risks.can.result.in.claims.by. shareholders.that.the.company.did.not.adequately.warn.them.of.potential. risks,.which.could.present.some.liability.to.a.company.

Risk.identification.within.the.10-K.reporting.requirements.is.an.impor- tant.part.of.the.ERM.process..Historically,.the.vast.majority.of.risks.iden- tified.in.the.10-K.report.related.to.financial.and.legal.risks..Operating.and. other.supply.chain.risks.simply.were.not.perceived.as.important.enough. to. be. addressed. at. the. ERM. or. 10-K. level.. Unfortunately,. the. world. has. changed.and,.from.a.risk.perspective,.not.for.the.better.

Table 1.1.identifies.the.enterprise.risks.identified.in.Apple’s.10-K.report.. More.than.one.third.of.the.key.risks.identified.by.Apple.have.supply.chain. connections. or. implications. (those. risks. are. designated. with. a. check. mark);.something.that.is.becoming.increasingly.prevalent.as.supply.chain. risks. earn. the. dubious. “honor”. of. making. the. enterprise. risk. list.. While. supply.chain.managers.have.been.asking.for.increased.attention.at.the.cor- porate.level.for.years,.increasing.the.number.of.supply.chain–.related.risks. on. the. 10-K. report. is. probably. not. what. they. had. in. mind.. Watch. what. you.wish.for.

ERM. is. traditionally. the. responsibility. of. finance,. treasury,. insurance,. and. legal. groups. at. the. corporate. level.. In. fact,. a. survey. by. Accenture. revealed.that.at.the.corporate.level,.98%.of.organizations.have.what.they. consider.to.be.a.chief.risk.officer..And,.according.to.Accenture,.96%.of.risk. management.owners.report.to.the.CEO.6.With.that.said,.the.chief.risk.offi- cer.is.often.a.dual.position..At.General.Motors,.for.example,.the.chief.risk.

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Supply Chain Risk Management: Setting the Stage • 5

taBle 1. 1

Apple.Enterprise.Risk.Factors:.10-K.Report

•. Global.economic.conditions.could.materially.adversely.affect.the.company. •. Global.markets.for.the.company’s.products.and.services.are.highly.competitive.and.

subject.to.rapid.technological.change,.and.the.company.may.be.unable.to.compete. effectively.in.these.markets. .✓ To.remain.competitive.and.stimulate.customer.demand,.the.company.must. successfully.manage.frequent.product.introductions.and.transitions. .✓ The.company.faces.substantial.inventory.and.other.asset.risk.in.addition.to.purchase. commitment.cancellation.risk. .✓ Future.operating.results.depend.upon.the.company’s.ability.to.obtain.components.in. sufficient.quantities. .✓ The.company.depends.on.component.and.product.manufacturing.and.logistical. services.provided.by.outsourcing.partners,.many.of.whom.are.located.outside.of.the. United.States. .✓ The.company.relies.on.third-.party.intellectual.property.and.digital.content,.which. may.not.be.available.to.the.company.on.commercially.reasonable.terms.or.at.all.

•. The.company.is.frequently.involved.in.intellectual.property.litigation.and.could.be. found.to.have.infringed.on.intellectual.property.rights.

•. The.company’s.future.performance.depends.in.part.on.support.from.third-.party. software.developers. .✓ The.company.depends.on.the.performance.of.distributors,.carriers,.and.other. resellers. .✓ The.company’s.retail.segment.has.required.and.will.continue.to.require.a.substantial. investment.and.commitment.of.resources.and.is.subject.to.numerous.risks.and. uncertainties.

•. Investment.in.new.business.strategies.and.acquisitions.could.disrupt.the.company’s. ongoing.business.and.present.risks.not.originally.contemplated. .✓ The.company’s.products.and.services.may.experience.quality.problems.from.time.to. time.that.can.result.in.decreased.sales.and.operating.margin.

•. The.company.is.subject.to.laws.and.regulations.worldwide,.changes.to.which.could. increase.the.company’s.costs.and.individually.or.in.the.aggregate.adversely.affect.the. company’s.business.

•. The.company’s.success.depends.largely.on.the.continued.service.and.availability.of. key.personnel. .✓ The.company’s.business.may.be.impacted.by.political.events,.war,.terrorism,.public. health.issues,.natural.disasters,.and.other.circumstances.

•. The.company’s.business.and.reputation.may.be.impacted.by.information.technology. system.failures.or.network.disruptions.

•. The.company.may.be.subject.to.breaches.of.its.information.technology.systems,. which.could.damage.business.partner.and.customer.relationships,.curtail.or. otherwise.adversely.impact.access.to.online.stores.and.services,.and.could.subject.the. company.to.significant.reputational,.financial,.legal,.and.operational.consequences.

continued

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6 • Supply Chain Risk Management: An Emerging Discipline

officer.is.also.the.company’s.general.auditor..At.other.companies.the.chief. risk.officer.may.be.the.chief.financial.officer.(CFO)..And.at.some.compa- nies.the.chief.risk.officer.may.be.part.of.the.insurance.group.

defining Supply Chain Risk Management

Now. that. we. have. a. working. knowledge. of. ERM,. what. is. supply. chain. risk. management. (SCRM)?. The. definition. partly. reflects. someone’s. professional. discipline. or. where. they. reside. in. the. supply. chain.. In. the. information. technology. space,. the. National. Institute. for. Standards. and. Technology.defines.supply.chain.risk.management.as.a.“multidisciplinary. practice.with.a.number.of.interconnected.enterprise.processes.that,.when. performed.correctly,.will.help.departments.and.agencies.manage.the.risk. of.using.information.technology.products.and.services.”7.MITRE,.a.pri- vate,. not-.for-.profit. corporation. that. provides. engineering. and. technical. services. to. the. federal. government,. defines. SCRM. as. “a. discipline. that. addresses.the.threats.and.vulnerabilities.of.commercially.acquired.infor- mation.and.communications.technologies.within.and.used.by.government. information.and.weapon.systems..Through.SCRM,.systems.engineers.can. minimize.the.risk.to.systems.and.their.components.obtained.from.sources. that. are. not. trusted. or. identifiable. as. well. as. those. that. provide. inferior. material.or.parts.”8.A.third.perspective,.and.the.one.that.most.closely.aligns. with.our.philosophy,.says.that.supply.chain.risk.management.(SCRM).is. “the. implementation. of. strategies. to. manage. everyday. and. exceptional.

taBle 1. 1 (continued)

Apple.Enterprise.Risk.Factors:.10-K.Report

•. The.company’s.business.is.subject.to.a.variety.of.U.S..and.international.laws,.rules,. policies,.and.other.obligations.regarding.data.protection.

•. The.company.expects.its.quarterly.revenue.and.operating.results.to.fluctuate. •. The.company’s.stock.price.is.subject.to.volatility.

.✓ The.company’s.business.is.subject.to.the.risks.of.international.operations. •. The.company.is.exposed.to.credit.risk.and.fluctuations.in.the.market.values.of.its.

investment.portfolio. .✓ The.company.is.exposed.to.credit.risk.on.its.trade.accounts.receivable,.vendor. nontrade.receivables,.and.prepayments.related.to.long-.term.supply.agreements,.and. this.risk.is.heightened.during.periods.when.economic.conditions.worsen.

•. The.company.could.be.impacted.by.unfavorable.results.of.legal.proceedings. •. The.company.could.be.subject.to.changes.in.its.tax.rates,.the.adoption.of.new.U.S..or.

international.tax.legislation,.or.exposure.to.additional.tax.liabilities.

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Supply Chain Risk Management: Setting the Stage • 7

risks.along.the.supply.chain.through.continuous.risk.assessment.with.the. objective.of.reducing.vulnerability.and.ensuring.continuity.”9

One.way.to.view.supply.chain.risk.management.is.to.think.of.it.as.the. intersection. of. supply. chain. management. and. risk. management.. One. thing.we.know.about.SCRM.is.that.no.standard.definition.exists..This.is. one.indicator.that.SCRM.is.still.an.evolving.discipline..Risk.is.embedded. within.so.many.business.disciplines.that.it.should.come.as.no.surprise.that. different.groups.perceive.this.concept.differently.

Why fOCuS On Supply Chain RiSk ManageMent?

Anecdotal.accounts.of.why.supply.chain.risk.management.must.become.a. corporate.concern.are.not.hard.to.come.by..In.fact,.we.will.present.dozens. of. examples. that. reveal. the. downside. of. risk.. While. natural. disasters. like. hurricanes.and.floods.grab.the.headlines,.the.reality.is.that.supply.chains. face.a.whole.range.of.risks.that.most.observers.believe.only.to.be.increasing.. A.survey.by.American.Productivity.and.Quality.Center.(APQC).revealed. that.75%.of.responding.companies.indicated.they.were.hit.by.a.major.supply. chain.disruption.during.the.two-.year.period.prior.to.the.date.of.the.survey.

A. classic. example. of. supply. chain. risk. involves. a. fire. that. destroyed. an. electronics.supplier.in.New.Mexico.that.supplied.Nokia.and.Ericsson.with. critical. components. for. their. phone. businesses.. The. response. to. this. risk. event.shows.the.strategic.implications.of.effective.(or.ineffective).risk.man- agement..Nokia’s.ability.to.quickly.secure.components.from.other.sources,. compared.with.Ericsson’s.lack.of.preparation.for.responding.to.this.event,. resulted.in.a.dramatic.industry.shift..Ericsson’s.supply.disruption.not.only. cost.the.company.several.hundred.million.dollars.in.lost.sales,.but.it.essen- tially. ended. the. company’s. position. as. a. player. in. the. growing. wireless. phone. business.. Chapter 9. will. investigate. this. example. in. greater. detail.. Consider.some.other.supply.chain.risk.events:

•. A.U.S..producer.of.power.tools.was.surprised.to.find.that.the.Asian. supplier.it.contracted.with.to.produce.its.lower-.end.products.began. selling.those.products.under.its.own.label.in.Asia..The.U.S..company. was. further. surprised. to. find. that. the. supplier. shared. its. product. designs. with. other. Asian. companies.. The. U.S.. producer. eventually. found.itself.competing.in.North.America.with.its.own.products.

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8 • Supply Chain Risk Management: An Emerging Discipline

•. Some. German. thieves. developed. a. creative. way. to. steal. freight. on. highways..The.thieves.position.a.car.in.front.of.a.truck.to.slow.it.down. while.another.car.is.positioned.next.to.the.truck.to.prevent.it.from. passing. the. car. in. front.. Then,. a. third. vehicle. pulls. up. behind. the. truck.and.at.that.point.one.of.the.gang.members.opens.the.back.of. the. truck. to. remove. cargo.. Thieves. have. used. this. method. to. steal. cargo.more.than.50.times.10

•. Nylon-12.is.a.critical.resin.for.producing.fuel.lines.and.other.automo- tive.components..Unfortunately,.the.resin.supply.for.the.entire.world. is.essentially.produced.in.a.single.facility.in.Germany..What.is.even. more. unfortunate. is. the. explosion. that. ripped. through. that. plant,. taking.out.half.of.the.world’s.output.in.the.blink.of.an.eye..Within. hours. automotive. original. equipment. manufacturers. (OEMs). had. established.crisis.management.teams.to.scour.the.globe.for.new.sup- ply.sources.

•. Eight.heavily.armed.thieves.dressed.as.police.and.driving.two.police. vans.with.flashing.lights.drove.through.a.hole.in.the.perimeter.fence. of. the. Brussels,. Belgium,. airport. and. onto. a. runway.. In. less. than. five.minutes.the.thieves.opened.a.plane’s.cargo.door.and.unloaded. 120. packages. holding. $50. million. worth. of. polished. and. uncut. diamonds.. The. thieves. escaped. with. the. diamonds. and. are. forever. embedded.in.criminal.folklore.

We.could.go.on,.but.you.get.the.idea..Moving.beyond.anecdotal.accounts,. an.emphasis.on.supply.chain.risk.management.is.necessary.today.because. supply.chains.face.many.factors.that.result.in.higher.risk,.more.so.than.at. any. time. in. modern. history..Some. of. these. risk. factors.are. self-.inflicted;. others.are.not..IBM.researchers.have.identified.a.solid.set.of.factors.that. lead. us. to. a. clear. conclusion—supply. chains. are. becoming. more,. rather. than.less,.risky..Table 1.2.summarizes.this.important.set.of.factors.

Other. factors. inadvertently. expose. a. company. to. heightened. supply. chain. risk. through. unintended. consequences.. This. includes. just-.in-.time. delivery.and.lean.systems.that.result.in.little.to.no.buffer.inventory;.a.trend. toward.centralized.decision.making.that.may.reduce.response.times.and. flexibility.at.local.levels;.continuous.cost.reductions.that.may.affect.a.com- pany’s.ability.to.plan.and.respond.to.risk.events;.greater.use.of.single.sourc- ing,. which. often. leaves. a. company. with. few. supply. options. and. higher. supplier.switching.costs;.and.widespread.outsourcing,.potentially.leading. to.a.loss.of.supply.chain.control..Sometimes.we.are.our.own.worst.enemy.

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Supply Chain Risk Management: Setting the Stage • 9

A. study. by. the. Aberdeen. Group. identified. some. good. reasons. why. a. company.should.make.SCRM.an.embedded.part.of.its.corporate.culture.. First,.a.need.to.protect.an.organization’s.brand.and.competitive.advantage. is. a. strategic. necessity.. Risk. events. have. a. nasty. way. of. affecting. brand. value. quickly.. Simply. think. about. how. stories,. whether. they. are. true. or. not,. can. impact. the. value. of. a. brand.. Next,. the. increasing. volatility. of. the.global.economic.environment.and.markets.is.resulting.in.greater.risk. exposure.. Third,. corporate. mandates. to. institute. and/.or. improve. risk. management.and.governance.programs.are.only.going.to.increase..And,.a. growing.need.to.comply.with.new.or.changing.regulatory.requirements.is. forcing.a.greater.emphasis.on.risk.management..Finally,.constant.pressure. to. improve. shareholder. and. customer. confidence. while. trying. to. reduce. costs. may. result. in. actions. that. result. in. greater. risk. exposure,. such. as. searching.for.suppliers.in.untested.emerging.supply.markets.

A.range.of.surveys.and.studies.conclude.that.supply.chain.risk.is.grow- ing.. To. disregard. what. has. become. obvious. is. short-.sighted. and. danger- ous.. We. can. easily. cite. source. after. source. that. concludes. essentially. the. same.thing—supply.chain.risk.and.its.impact.on.corporate.performance. continues.to.grow..It.would.be.challenging.to.argue.that.supply.chains.are,. on.average,.becoming.less.risky.

taBle 1. 2

Factors.That.Make.Supply.Chains.Riskier

•. Increased.globalization.through.outsourcing,.which.stretches.end-.to-.end.supply.chains •. Additional.regulatory.compliance.imposed.by.government.entities,.further.

complicating.international.trade.(such.as.C-.TPAT.and.SEC.conflict.mineral. reporting.requirements)

•. Increased.levels.of.economic.uncertainty.and.market.volatility,.which.create. additional.variability.in.demand.and.supply.and.make.it.more.difficult.to. accomplish.demand–supply.planning

•. Shorter.product.life.cycles.and.rapid.rates.of.technology.change,.which.increase.the. risk.of.inventory.obsolescence

•. Demanding.customers.that.create.additional.time-.to-.market.pressures.by.requiring. better.on-.time.delivery,.higher.order.fill.rates,.and.improved.service.level.efficiencies

•. Supply.side.capacity.constraints,.making.it.more.difficult.to.meet.demand. requirements

•. Natural.disasters.and.external.environmental.events,.which.affect.global.supply. chains

•. Complex.networks.of.suppliers.and.third-.party.service.providers,.as.well.as.large. interdependencies.among.multiple.firms,.which.increase.the.need.to.coordinate.risk

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10 • Supply Chain Risk Management: An Emerging Discipline

Some SCRM Observations

Extensive.experience.and.research.enables.us.to.make.some.observations. about. the. state. of. risk. management.. (Chapter 2. will. provide. a. more. in-. depth. presentation. of. the. “as. is”. state).. Perhaps. most. importantly,. most. observers.have.concluded.that.the.potential.impact.of.risk.has.increased. over.the.last.15.or.20 years..In.one.survey,.almost.75%.of.risk.managers.say. that.supply.chain.risk.levels.are.higher.than.in.2005..More.than.70%.say. the.financial.impact.of.supply.chain.disruptions.has.also.increased.11.And,. there.is.no.question.that.supply.markets.have.become.more.volatile..The. size.of.fluctuations.in.commodity.prices.has.more.than.tripled.since.2005. compared.with.the.period.of.1980–2005,.based.on.International.Monetary. Fund. data.. If. you. really. think. about. this. hard. enough,. you. might. just. get.depressed.

We. can. also. conclude. that. too. many. firms. are. not. prepared. to. handle. the.supply.chain.risks.that.may.come.their.way,.even.though.most.manag- ers.understand.that.supply.chain.risk.is.a.growing.concern..While.ERM. has. been. at. the. forefront. for. many. companies,. SCRM. has. been. more. of. an. afterthought.. A. recent. study. revealed. that. for. firms. with. less. than. $500.million.in.annual.revenue.(which.is.the.vast.majority.of.companies),. only.25%.take.a.proactive.approach.to.risk.management.12

Another.observation.is.that.while.many.risk.categorizations.and.topol- ogies. exist,. a. convergence. appears. to. be. happening. around. the. key. cat- egories. of. supply. chain. risk—a. convergence. this. book. uses.. Finally,. as. it. relates.to.mitigating.or.lessening.the.impact.of.risk.events,.we.tend.to.see. the. same. set. of. standard. approaches. that. fail. to. reflect. bold. or. innova- tive. thinking.. While. “blocking. and. tackling”. will. always. be. important,. it.is.time.to.see.a.bit.more.creativity.and.sophistication.within.the.SCRM. arena..Later.chapters.will.look.at.some.more.advanced.SCRM.approaches.

Why aren’t We prepared for SCRM?

The.reasons.why.so.many.firms.are.not.prepared.to.manage.supply.chain. risk. effectively. are. varied.. We. cannot. ignore. what. is. perhaps. the. most. likely. reason. of. all—risk. management. has. simply. not. been. a. part. of. the. supply.chain.domain..Why.would.we.focus.on.something.that.is.not.con- sidered.all.that.relevant?.It.is.easy.to.view.the.efforts.put.forth.toward.risk. planning.as.a.big.exercise.in.busy.work..This.may.not.be.the.kind.of.work. that.gains.personal.recognition.and.promotions.

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Supply Chain Risk Management: Setting the Stage • 11

A.study.by.the.Supply.Chain.Council.(SCC).identified.a.set.of.barriers. that. affect. the. practice. of. supply. chain. risk. management.. One. barrier. is. the. tendency. of. senior. management. to. focus. on. risk. management. only. during.times.of.crisis,.something.that.needs.to.shift.from.responsiveness. to. prevention.. A. second. barrier. is. that. SCRM. requires. many. functions. to. cooperate,. something. that. is. challenging. even. on. a. good. day.. Third,. the. study.concluded.that.SCRM.responsibilities.are.typically.added.to.exist- ing. staff. responsibilities.. While. everyone. should. be. a. risk. management. stakeholder,. adding. responsibilities. to. existing. duties. clearly. creates. a. competition.for.resources,.a.competition.that.SCRM.will.often.lose..Next,. the. increasing. complexity. of. products,. divisions,. regions,. and. supply. chains.makes.a.coordinated.SCRM.effort.more.of.a.challenge..A.final.bar- rier.is.that.a.partial.effort.to.SCRM.dilutes.the.perceived.need.for.a.real. and.sustained.risk.management.effort..A.“close.enough.is.good.enough”. attitude.toward.SCRM.often.prevails..These.barriers.will.clearly.affect.the. state.of.SCRM.

SOMe iMpORtant RiSk COnCeptS

A.working.knowledge.of.some.important.risk.concepts.is.essential.when. talking. about. SCRM,. particularly. since. these. concepts. are. mentioned. repeatedly.throughout.this.book..We.also.do.not.want.someone.to.appear. ill-.informed. when. talking. about. risk. management. with. others.. Part. of. understanding. risk. management. is. having. a. working. knowledge. of. the. terms.and.concepts.that.populate.this.body.of.knowledge..The.following. presents.some.important.terms.and.concepts.that.will.help.you.speak.the. language.of.a.risk.manager.

Risk event

An. important. distinction. exists. between. risk. and. risk events.. Every. day. we. face. hundreds. of. risks. with. various. probabilities. attached. to. them. (although.we.rarely.quantify.those.probabilities)..But,.and.this.is.impor- tant,.a.risk.is.relatively.harmless.until.it.happens..There.is.always.a.risk.that. someone.will.fall.off.a.roof.when.they.are.working.on.their.house..Until. that.person.actually.takes.the.plunge,.the.risk.of.falling.remains.simply.a. risk..If.the.person.falls,.the.risk.is.now.a.risk event..A.risk.event.is.simple.

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12 • Supply Chain Risk Management: An Emerging Discipline

to.conceptualize—it.is.a.risk.that.has.become.a.reality..Formally.defined,. a.risk.event.is.a.discrete,.specific.occurrence.that.negatively.affects.a.deci- sion,.plan,.firm,.or.organism.13

Risk. events. are. not. only. episodic,. temporary. occurrences.. Risk. events. can.be.continuous,.particularly.if.they.relate.to.operational.performance. problems.. Any. supply. chain. performance. problem. that. is. ongoing. pres- ents.continuous.risk.to.multiple.parties.in.a.supply.chain.

A.word.of.caution.is.in.order.here..A.tendency.exists.to.identify.a.grab. bag.of.risk.events.and.then.label.each.event.as.a.risk.category..This.is.gen- erally. an. unorganized. way. to. approach. risk. management.. Late. supplier. deliveries.or.supplier.quality.problems.might.comprise.two.such.catego- ries.even.though.they.are.risk.events..Risk.events.should.be.organized.and. placed. into. broader. risk. categories.. In. the. supply. chain. space. a. number. of.risks.might.relate.to.financial.risks,.for.example,.and.therefore.should. be. placed. under. a. financial. risk. category.. Subcategories. of. financial. risk. may.then.be.developed.that.include.supplier.financial.risk,.working.capital. risk,.or.currency.risk..A.later.section.will.present.risk.typologies.

Risk exposure and Vulnerability

Risk.exposure.involves.the.quantified.potential.for.loss.that.might.occur. as.a.result.of.a.risk.event..The.risk.exposure.value.is.often.the.outcome.of.a. comprehensive.risk.analysis.that.uses.algorithms.to.combine.risks.accord- ing. to. their. probability. of. occurring. against. the. potential. loss. if. the. risk. occurs..A.company.that.can.seamlessly.switch.production.between.mul- tiple.supplier.locations.has.less.risk.exposure.to.a.supply.disruption.com- pared. with. a. buyer. that. has. access. to. only. a. single. production. location.. Even.before.a.garment.factory.collapsed.in.Bangladesh,.killing.430.work- ers. in. the. country’s. worst. apparel-.industry. accident,. major. buyers. such. as. Walmart. and. Levi. Strauss. had. ceased. doing. work. with. vendors. who. operated.in.multistory.buildings..The.risk.exposure.from.these.operations. was.simply.too.great.14

For. our. purposes. we. view. risk. exposure. and. vulnerability. as. closely. related.concepts,.although.vulnerability.tends.to.be.a.less.quantified.con- cept.. We. are. vulnerable. to. something. if. we. are. susceptible. to. harm. or. injury..Anyone.who.has.built.a.house.on.an.earthquake.fault.will.grasp.the. concept.of.vulnerability.to.earthquakes..Or,.someone.traveling.to.certain. parts.of.the.world.without.getting.proper.vaccinations.should.appreciate.

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Supply Chain Risk Management: Setting the Stage • 13

being. more. vulnerable. to. diseases.. In. the. information. technology. (IT). world,.vulnerability.refers.to.the.security.flaws.that.allow.a.successful.sys- tem.attack.by.hackers.15.IT.vulnerability.is.an.important.concept.because. supply.chains.today.are.increasingly.information.enabled.

Risk Resilience

Risk.resilience.is.becoming.one.of.the.most.researched.and.discussed.top- ics. in. supply. chain. risk. management.. At. a. basic. level,. resilience. refers. to. the. ability. to. recover. from. or. adjust. to. misfortune. or. change.16. It. repre- sents. the. ability. of. a. company. and. supply. chain. to. “bounce. back”. after. an. event.. While. the. concept. of. resilience. has. been. studied. scientifically. in. development. psychology. and. ecosystems. for. many. years,. it. is. still. an. emerging. topic. in. SCRM.. Even. in. well-.developed. disciplines. the. defini- tions.of.resilience.are.often.contradictory.and.confusing.17

A.good.example.of.pursuing.resiliency.as.an.objective.comes.from.the. utility.industry..As.utilities.work.to.storm-.harden.their.networks.(a.form. of.risk.prevention),.some.are.also.investing.in.technology.to.recover.faster. from. outages. (risk. responsiveness. or. mitigation). through. an. approach. called.the.“smart.grid.”.New.systems.use.advanced.technology.to.pinpoint. problems,.reroute.power.around.problem.areas,.and.identify.where.repair. crews.need.to.go.first.to.get.the.most.customers.restored.the.fastest.18.One. emerging. technology. cuts. off. power. at. the. spot. where. a. tree. falls. into. a.power.line.and.then.reroutes.electricity.so.nearby.customers.still.retain. power.. Using. a. boxing. metaphor,. resiliency. means. being. able. to. take. a. punch.and.still.be.standing.

A.second.resiliency.example.involves.offshore.oil.exploration.in.the.Gulf. of. Mexico.. It. became. obvious. that. following. the. 2010. explosion. at. BP’s. Macondo. well. an. array. of. new. and. complex. regulations. would. emerge. addressing. offshore. drilling. safety.. And. that. is. exactly. what. happened.. Some. observers. predicted. that. drilling. in. the. Gulf. of. Mexico. would. not. recover. for. years,. if. ever.. But. that. does. not. seem. to. be. the. case.. In. the. words. of. one. analyst,. “Bottom-.line,. Gulf. of. Mexico. oil. production. is. in. considerably.better.shape.than.even.the.most.ardent.optimists.envisioned. following. Macondo.”19. Part. of. the. reason. for. such. optimism. is. the. oil. industry’s. resiliency. as. it. learns. to. live. with. stricter. safety. oversight. and. slower.permit.reviews..Estimates.indicate.that.by.2022.oil.output.from.the. Gulf.of.Mexico.will.be.28%.higher.compared.with.current.levels.

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14 • Supply Chain Risk Management: An Emerging Discipline

Risk appetite

Risk.appetite.reflects.the.degree.of.risk.that.an.organization.or.individual. is. willing. to. accept. or. take. in. pursuit. of. its. objectives.. This. can. be. mea- sured.in.terms.of.both.quantitative.and.qualitative.dimensions..Some.also. refer.to.this.concept.as.risk tolerance or.risk propensity,.a.topic.that.is.well. grounded.in.the.financial.community.

Finance.experts.view.risk.appetite.as.reflecting.the.type.of.risk.that.an. institution. or. individual. is. willing. to. undertake. in. pursuit. of. a. desired. financial.performance..Clearly,.someone.who.invests.in.derivatives.rather. than.guaranteed.government.bonds.(assuming.they.are.not.Greek.bonds). has.a.higher.appetite.for.risk..When.an.organization.or.individual.has.a. low.risk.appetite,.we.say.they.are.risk averse..As.it.pertains.to.supply.chain. risk,.we.can.safely.conclude.that.most.organizations.tend.to.be.risk.averse.. Remember,.the.typical.supply.chain.professional.looks.at.risk.in.terms.of. loss.or.harm.

Complex.models.have.been.developed.to.identify.risk.utility.functions.. Utility.functions.transform.monetary.values.(payoffs.and.costs).into.util- ity.values.that.specify.preferences.for.various.monetary.payoffs.and.costs.. This. encodes. a. company. or. individual’s. attitude. toward. risk.. A. time-. consuming.step.when.developing.utility.functions.is.to.assess.a.company’s. or.individual’s.attitude.toward.risk..At.the.company.level,.this.assessment. is.part.of.a.dialogue.between.the.board.of.directors.and.senior.manage- ment.and.includes.factors.such.as.business.model.aspirations,.institutional. principles,.shareholder.expectations,.and.core.competencies.20

An.analysis.by.The Wall Street Journal.concluded.that.the.United.States. is.becoming.more.risk.averse.(i.e.,.a.lower.risk.appetite).as.a.nation.com- pared. with. previous. periods.. If. this. is. true. it. does. not. bode. well. for. the. longer-.term. growth. prospects. of. the. U.S.. economy. as. fewer. individuals. start.new.ventures..The.Wall Street Journal analysis.concluded.that.three. shifts. are. causing. Americans. to. become. more. risk. averse,. an. aversion. that.will.result.in.fewer.new.businesses.being.created.and.a.reluctance.to. change.jobs.or.move.to.take.advantage.of.new.opportunities..These.shifts. include.an.aging.population.(older.citizens.are.not.known.as.risk.takers),. the. emerging. dominance. of. large. corporations. in. many. industries. that. shuts.out.new.players.and.ideas,.and.a.reluctance.of.venture.capitalists.to. invest.in.new.opportunities..As.one.observer.says,.“The.pessimistic.view.is. we’ve.lost.our.mojo.”21.At.a.national.level.we.need.risk.takers.to.grow.the. economy.through.innovation.and.change.

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Supply Chain Risk Management: Setting the Stage • 15

Risk analysis or assessment

Risk. analysis,. also. called. risk. assessment,. is. the. process. of. qualitatively. and. quantitatively. assessing. potential. risks. within. a. supply. chain.. At. a. basic. level. risk. analysis. involves. identifying. risks. and. then. evaluating. or. mapping. these. events,. at. a. minimum,. across. two. dimensions.. These. dimensions.include.the.probability.of.a.risk.occurring.and.the.impact.if. the.risk.were.to.become.a.risk.event..Some.techniques.will.score.the.two. dimensions.and.multiply.them.together.to.arrive.at.an.overall.risk.score.. Chapter.13.will.discuss.some.validity.issues.related.to.this.approach.

In. the. financial. sector,. risk. analysis. refers. to. the. uncertainty. of. fore- casted.future.cash.flows.streams,.variance.of.portfolio.and.stock.returns,. statistical. analysis. to. determine. the. probability. of. a. project’s. success. or. failure,.and.possible.future.economic.states..Remember,.risk.analysis.(and. risk. management). is. far. more. evolved. in. the. financial. community. com- pared.with.the.supply.chain.community.

Risk Response plan

A.risk.response.plan.is.a.logical.extension.of.a.risk.analysis..The.risk.plan. is.a.document.that.defines.known.risks.and.includes.descriptions,.causes,. probabilities. or. likelihood. of. risk. occurrence,. costs,. and. proposed. risk. management. responses.. A. word. of. caution. is. in. order. here.. We. have. all. been. presented. with. (or. assigned. to. write). the. dreaded. 125-page. report. that.no.one.will.ever.read..In.the.old.days.this.report.would.sit.on.a.shelf. in. someone’s. office. collecting. dust.. Now,. these. reports. sit. in. electronic. directories.collecting.virtual.dust..A.risk.response.plan.should.be.a.crisp,. actionable.document.that.is.not.someone’s.idea.of.busy.work.

Risk Compliance

Risk.compliance.includes.the.internal.activities.taken.to.meet.required.or. mandated.rules.and.regulations,.whether.they.are.governmental,.industry. specific,. or. internally. imposed.. Companies. have. always. had. compliance. requirements. relating. to. financial. reporting,. environmental. compli- ance,.and.a.host.of.other.areas..At.an.organizational.level,.compliance.is. achieved.through.management.processes.that.(1).identify.applicable.laws,. regulations,.contracts,.strategies,.and.policies;.(2).assess.the.current.state. of. compliance;. (3). assess. the. risks. and. potential. costs. of. noncompliance.

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16 • Supply Chain Risk Management: An Emerging Discipline

against. the. projected. expenses. to. achieve. compliance;. and. (4). prioritize,. fund,.and.initiate.any.corrective.actions.deemed.necessary.22.While.com- pliance. reporting. requirements. have. been. around. for. many. years,. the. hazard. events. of. the. last. 15 years. have. brought. about. new. compliance. requirements,.particularly.in.the.area.of.international.supply.chains.

Risk governance

Risk. governance. includes. the. frameworks,. tools,. policies,. procedures,. controls,. and. decision-.making. hierarchy. employed. to. manage. a. busi- ness.from.a.risk.management.perspective..At.times.the.governance.struc- ture.includes.a.chief.risk.officer,.who.is.normally.identified.as.the.person. responsible. to. coordinate. and. oversee. the. risk. management. process. and. approve.reports.to.the.corporate.audit.committee.of.the.board.of.directors.. Chapter 3.will.address.the.pros.and.cons.of.designating.chief.risk.officer.

The. risk. concepts. presented. here. are. certainly. not. the. only. ones. that. comprise. the. vocabulary. of. SCRM.. They. are,. however,. the. more. impor- tant.ones..It.would.be.difficult.to.proceed.with.our.risk.discussion.without. having.this.working.knowledge.of.risk.terminology.

CategORizing RiSk

While. various. frameworks. categorize. the. domain. of. supply. chain. risk,. no.standard.agreement.exists.regarding.what.these.categories.should.be.. Any. categorization. scheme. should. identify. broader. risk. categories. and. then.place.specific.risks.within.those.categories..One.perspective.classifies. supply.chain.risk.into.nine.categories—design;.quality;.cost;.availability;. manufacturability;. supply;. financial;. legal;. and. environmental,. health. and.safety.23.We.think.that.a.more.simplified.approach.might.better.suit. our.needs.

Perhaps.the.most.logical.way.to.look.at.supply.chain.risk.is.to.consider. the. four. categories. that. define. enterprise. risk. management—strategic,. hazard,.financial,.and.operational.risks..While.some.frameworks.present. more.categories,.the.thriftiness.of.these.four.categories.is.a.virtue..The.fol- lowing.describes.these.categories.

Strategic Risk. For. something. to. be. strategic,. it. must. be. necessary. to. or. important. in. the. initiation,. conduct,. or. completion. of. a. strategy. or.

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Supply Chain Risk Management: Setting the Stage • 17

strategic.plan..Strategic.risks.are.those.risks.that.are.most.consequential.to. an.organization’s.ability.to.carry.out.its.business.strategy,.achieve.its.cor- porate. objectives,. and. protect. asset. and. brand. value.. Chapter 4. explores. strategic.risk.in.detail.

Hazard Risk. This. category. of. risk. pertains. to. random. disruptions,. some.of.which.involve.acts.of.God..This.category.includes.bellowing.ash. from.a.volcano.in.Iceland,.a.tsunami.that.devastated.Japan,.serious.floods. in. Thailand,. and. a. super. storm. named. Sandy. that. affected. the. eastern. United. States.. This. category. also. includes. fires. and. malicious. behavior. such.as.accidents,.product.tampering,.theft,.and.acts.of.terrorism..Hazard. risk.is.normally.what.we.think.of.when.we.purchase.insurance.as.a.form. of.risk.protection..Chapter 5.addresses.this.risk.category.

Financial Risk. Financial. risks. relates. to. the. internal. and. external. financial.difficulties.of.the.participants.within.an.integrated.supply.chain.. While.we.can.make.the.argument.that.all.supply.chain.risk.events.eventu- ally.have.financial.risk.implications,.we.categorize.a.risk.as.financial.when. the.primary.and.immediate.effect.of.the.risk,.rather.than.a.subsequent.or. secondary. effect,. is. financially. related.. Chapter 6. explores. financial. risk. in.detail.

Operational Risk. Operational.risk.arises.from.daily.operations..By.far. a.disproportionate.set.of.supply.chain.risks.will.be.categorized.as.opera- tional.since.this.category.includes.internal.and.external.quality.problems,. late.deliveries.anywhere.in.the.supply.chain,.service.failures.due.to.poorly. managed. inventory,. problems. related. to. poor. forecasting,. and. a. thou- sand.other.events.related.to.operational.performance.failures..Chapter 7. addresses.operational.risk.specifically.

Other Ways to look at Risk

A.somewhat.different.way.to.look.at.risk.is.according.to.a.three-.category. system.that.categorizes.risks.as.systemic,.event,.or.idiosyncratic.24.Systemic. risks. pertain. to. widespread. risks. that. impact. most. players. in. an. indus- try..Chinese.wage.inflation.and.currency.reevaluations.are.risks.that.will. affect.a.large.number.of.players.from.many.different.industries..Event.risks. include.narrow.or.localized.events.that.impact.participants.selectively..An. earthquake. in. Taiwan,. for. example,. may. selectively. impact. semiconduc- tor.foundry.operations..Or,.a.tornado.in.Oklahoma.only.impacts.directly. a. certain. part. of. the. United. States.. Idiosyncratic. risk. pertains. to. highly. localized.events.that.impact.very.few.players..A.delayed.truck.delivering.

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18 • Supply Chain Risk Management: An Emerging Discipline

goods.to.a.single.retail.store.is.an.example.of.a.risk.that.has.a.limited.affect. in.terms.of.its.impact.

Still.another.way.to.look.at.risk.involves.hard.versus.soft.risks..Hard.risks. are.easily.measurable.and.tangible,.such.as.risks.that.affect.assets,.inven- tory,. and. facilities.. With. hard. risks. a. company. can. identify. reasonably. precise.losses.if.a.risk.materializes.and.a.reasonable.history.of.occurrences. and.probability.exists..Soft.risks.are.more.difficult.to.measure.or.identify.

Because.soft.risks.are.usually.present.to.some.degree,.they.increase.the. overall.probability.of.risk.occurrence.but.in.ill-.defined.or.imprecise.ways.. An.analogy.here.involves.total.cost.models..Some.costs.are.easily.identifi- able. and. quantifiable. (transportation. costs. and. unit. price,. for. example). while.other.costs.are.“hidden”.and.difficult.to.calculate.(the.cost.of.com- munication.and.time-.related.problems.when.dealing.with.remote.Chinese. suppliers).. These. hidden. costs. (which. are. analogous. to. soft. risks). still. increase.the.true.total.cost,.although.in.ill-.defined.or.imprecise.ways.

Still. an. additional. way. to. think. about. risk. is. in. terms. of. known. and. unknown.risks..Known.risks.are.specific.risks.that.we.have.encountered. previously.or.can.foresee.or.anticipate.with.a.reasonably.good.estimate.of. occurrence..During.risk.analysis.and.planning.known.risks.are.good.can- didates.for.practicing. risk.prevention..Unknown.risks.consist.of.unfore- seen.combinations.of.outcomes.or.events.that.produce.a.risk..This.includes. unexpected. or. unanticipated. surprises.. Managing. unknown. risks. will. benefit.from.strong.risk.mitigation.plans.

geneRiC RiSk ManageMent appROaCheS

Literally. hundreds. of. activities,. tools,. and. approaches. have. the. potential. to.be.part.of.a.company’s.risk.management.portfolio..At.a.very.high.level. we.can.organize.these.approaches.by.their.primary.risk.objective,.which. includes.mitigating,.avoiding,.preventing,.accepting,.or.sharing.risk.

Risk Mitigation

Some.will.use.the.term.risk mitigation.to.describe.almost.everything.that. is. undertaken. in. the. name. of. risk. management,. including. preventive. actions.. According. to. its. most. basic. definition,. mitigate. means. to. lessen.

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Supply Chain Risk Management: Setting the Stage • 19

the. impact. of. something.. That. “something”. could. be. the. effect. of. a. risk. event.such.as.a.supplier.fire.or.supply.chain.quality.problem..In.a.broader. sense,.mitigation.can.also.be.the.result.of.action.taken.to.either.reduce.the. likelihood.of.a.risk.occurring.or.minimize.the.extent.of.its.impact..This. broader.perspective.is.why.many.sources.refer.to.just.about.any.risk.man- agement.initiative.as.risk.mitigation.

When.speaking.in.broad.terms.about.how.to.manage.risk,.we.will.use. the.term.risk management.rather.than.risk mitigation..We.view.mitigation. more. in. terms. of. responding. to. risk. events. rather. than. preventing. risk.. Prevention. is. a. risk. management. response. that. is. largely. separate. from. mitigation..Mitigation.or.risk.responsiveness.is.essential.when.unknown. risks.are.present..Not.everything.can.be.anticipated.or.prevented.

Risk avoidance

Avoidance.involves.exiting.those.activities.that.give.rise.to.a.risk..A.com- pany.may.decide.(and.many.have).that.sourcing.a.material.from.a.certain. supplier.is.too.risky,.so.it.avoids.that.supplier..Or,.a.certain.line.of.products. is.not.earning.enough.profit,.so.a.company.decides.to.stop.making.those. items. (or. sell. the. brand. to. another. company).. With. avoidance,. a. com- pany.has.made.a.conscious.decision.to.reduce,.perhaps.even.eliminate,.its. risk.exposure.

Risk prevention

Prevention.involves.taking.action.to.ensure.that.a.risk.does.not.become.a. risk.event.or,.if.it.does.become.an.event,.that.it.will.have.an.inconsequential. effect.. This. approach. to. managing. risk. is. often. preferable. when. dealing. with.known.risks..Prevention.is.different.from.avoidance.in.that.a.com- pany. did. not. exit. something. as. a. means. of. addressing. risk.. We. expect. a. greater. focus. on. prevention. as. supply. chain. managers. become. more. focused. on. anticipating. and. averting. risk. rather. than. experiencing. and. responding. to. risk.. We. have. heard. numerous. business. leaders. comment. that.their.firms,.while.good.at.responding.to.risk.events,.need.to.do.a.bet- ter.job.preventing.the.risk.event.in.the.first.place.

At. a. personal. level. most. of. us. understand. the. concept. of. prevention,. particularly.as.it.relates.to.our.personal.health..We.know.that.if.we.watch. our.weight,.exercise,.avoid.smoking.and.excessive.alcohol,.avoid.harmful.

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20 • Supply Chain Risk Management: An Emerging Discipline

drugs,. drive. prudently,. and. eat. correctly,. we. may. prevent. a. host. of. seri- ous.ailments.

We.will.clearly.differentiate.between.mitigation.and.prevention.activi- ties.as.we.try.to.anticipate.and.then.take.steps.to.ensure.that.a.risk.does.not. become.a.reality..A.primary.argument.put.forth.in.this.book.is.that.most. companies.are.conversant.or.even.qualified.in.terms.of.risk.responsiveness. (mitigation).but.not.nearly.as.advanced.when.it.comes.to.prevention.

Risk acceptance

Acceptance. means. to. take. on. and. assume. a. risk.. SCRM. may. not. be. a. priority. at. a. company,. so. therefore. no. specific. risk. management. action. is. taken.. In. this. case. acceptance. occurs. essentially. by. default.. A. second. reason. for. risk. acceptance. is. that. a. cost/.benefit. analysis. reveals. that. the. cost.of.addressing.a.risk.outweighs.the.expected.impact.of.the.risk..A.third. reason. is. that. no. practical. way. exists. to. prevent,. share,. or. mitigate. the. risk..This.is.usually.an.acknowledgment.that,.at.least.in.the.short.run,.no. viable.action.or.alternative.is.available.that.will.effectively.address.a.risk.. No.practical.choice.exists.except.to.assume.the.risk.

Risk Sharing

Risk.sharing.involves.transferring.or.sharing.a.portion.of.a.risk.to.reduce. or.mitigate.it..Sharing.product.development.costs.with.suppliers.or.buying. insurance.is.a.risk-.sharing.method..We.all.practice.risk.sharing.when.we. buy.home,.car,.or.life.insurance..Financial.managers.enjoy.the.benefits.of. risk. sharing. when. they. engage. with. other. traders. to. hedge. commodities. and.currencies..And.supply.chain.managers.often.write.contracts.with.sup- pliers.that.feature.some.level.of.currency.or.commodity.risk.sharing.

Risk.pooling.is.an.important.form.of.risk.sharing..A.risk.pool.involves. insurance.companies.controlling.the.risk.of.insuring.against.catastrophic. events.or.extending.insurance.to.individuals.or.businesses.that.are.likely. to.create.sizable.claims..If.a.claim.arises.from.a.natural.disaster.or.cata- strophic.weather.event,.the.companies.spread.losses.among.all.members. of.the.risk.pool..Single.members.of.the.risk.pool.are.protected.from.large. claims.that.would.bankrupt.the.insurance.company,.leaving.their.claim- ants.with.nothing.25

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Supply Chain Risk Management: Setting the Stage • 21

prevention versus Responsiveness

Often.times.we.look.at.risk.simply.in.terms.of.trying.to.prevent.an.event. from.occurring.versus.responding.after.the.fact..While.prevention.sounds. like.an.ideal.way.to.approach.risk.management.(who.would.not.want.to.pre- vent.problems?),.not.all.risks.can.be.predicted.or.anticipated,.particularly. hazard.risks..What.we.see.today.at.best.practice.firms.is.a.combination.of. preventive.actions.wherever.possible.combined.with.responsiveness.plans. that. support. risk. resiliency.. The. bottom. line. in. the. prevention-.versus-. responsiveness. debate. is. that. an. increase. in. known. risks. favors. pre-.risk. preventive. approaches.. And. an. increase. in. unknown. risks. favors. post-. risk. response. agility.. How. a. specific. company. approaches. risk. manage- ment.will.be.affected.by.this.mix.of.known.and.unknown.risks.

COnCluding thOughtS

This. chapter. starts. our. journey. through. the. evolving. world. of. supply. chain.risk.management..Something.to.remember.as.we.progress.through. later.chapters.is.that.companies.that.are.effective.at.managing.risk.are.sup- ported.by.a.corporate.culture.and.a.foundation.that.promote.a.company- wide.approach.to.risk.management..A.culture.that.stresses.risk.awareness. and.management.must.then.be.supported.by.a.set.of.enablers.and.sophis- ticated.tools.and.techniques,.and.perhaps.most.importantly,.the.ability.to. quantify.the.value.of.risk.management.efforts..When.the.right.corporate. culture. is. supported. by. effective. tools,. techniques,. measures,. and. skills,. a.company.can.engage.in.thoughtful.risk.taking.rather.than.being.para- lyzed.by.an.irrational.fear.of.risk.

Summary of key points

•. One.common.perspective.for.defining.risk.simply.says.that.risk.is.a. situation. involving. exposure. to. danger. or. loss.. A. broader. perspec- tive.takes.this.a.step.further.by.adding.that.risk.is.the.probability.or. threat.of.damage,.injury,.liability,.loss,.or.other.negative.occurrences. that.are.caused.by.external.or.internal.vulnerabilities.and.that.may. be.avoided.through.preemptive.action.

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22 • Supply Chain Risk Management: An Emerging Discipline

•. It. is. important. to. clarify. the. distinction. between. enterprise. risk. management.and.supply.chain.risk.management..Almost.all.corpo- rate.executives.are.aware.(or.should.be.aware).of.ERM,.a.concept.that. has.been.around.for.decades..SCRM.is.an.evolving.discipline.

•. SCRM.is.the.implementation.of.strategies.to.manage.everyday.and. exceptional. risks. along. the. supply. chain. through. continuous. risk. assessment.with.the.objective.of.reducing.vulnerability.and.ensuring. continuity..One.way.to.view.SCRM.is.to.think.of.it.as.the.intersec- tion.of.supply.chain.management.and.risk.management.

•. An. emphasis. on. SCRM. is. necessary. today. because. supply. chains. face.many.factors.that.result.in.higher.risk,.more.so.than.at.any.time. in.modern.history..Some.of.these.risk.factors.are.self-.inflicted;.some. are.not.

•. A. working. knowledge. of. some. important. risk. concepts. is. essential. when.talking.about.SCRM,.including.what.is.a.risk.event,.risk.expo- sure.and.vulnerability,.risk.governance,.risk.resilience,.risk.appetite,. risk.compliance,.risk.response.plan,.and.risk.assessment.and.analysis.

•. While. various. frameworks. are. available. to. categorize. the. domain. of. supply. chain. risk,. no. standard. agreement. exists. regarding. what. these.categories.should.be..A.logical.way.to.look.at.risk.is.to.consider. the.four.categories.that.have.defined.enterprise.risk.management.for. many.years—strategic,.hazard,.financial,.and.operational.risks.

•. Literally. hundreds. of. activities. and. approaches. have. the. poten- tial.to.be.part.of.a.company’s.risk.management.portfolio..At.a.very. high. level. we. can. organize. these. approaches. by. their. primary. risk. objective(s),.which.includes.mitigating,.avoiding,.preventing,.accept- ing,.or.sharing.risk.

•. When. the. right. corporate. culture. is. supported. by. effective. tools,. techniques,.and.measures,.a.company.can.engage.in.thoughtful.risk. taking.rather.than.becoming.paralyzed.by.an.irrational.fear.of.sup- ply.chain.risk.

endnOteS

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. 2.. Accessed.from.http://www.businessdictionary.com/.definition/.risk.html..

. 3.. Blair,.Gary.Ryan..as.quoted.in.www.brainyquote.com..

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Supply Chain Risk Management: Setting the Stage • 23

. 4.. Accessed.from.http://people.stern.nyu.edu/.adamodar/.pdfiles/.valrisk/.ch1.pdf..

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. 6.. Teach,.Edward..“The.Upside.of.ERM.”.CFO,.November.2013:.44..

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. 11.. Favre,.Donovan,.and.John.McCreery,.“Coming.to.Grips.with.Supplier.Risk.”.Supply Chain Management Review,.12,.6.(September.2008):.26..Citing.statistics.from.Marsh,. Inc..and.Risk & Insurance.magazine..

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. 20.. Anonymous..“Institutions.Need.to.Better.Understand.their.Risk.Appetite.”.The RMA Journal,.92,.6.(March.2012):.38042..

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