Supply chains are becoming increasingly complex. Yet many procurement teams are not working to prevent and manage disruptions that could prove costly.
“As the supply chain gets longer and involves more players, countries, modes and logistics handoffs, it exposes more potential vulnerabilities,” said Thomas L. Tanel, president and CEO of the CATTAN Services Group in College Station, Texas. “That does not mean volatility is inevitable, but it does mean it is more possible.” Tanel serves as chair of the ISM Logistics and Transportation group.
In a recent webcast, “Preventing and Managing Supply Chain Disruptions,” Tanel described costs of disruption to the supply chain and explained why it’s important for procurement to learn to identify vulnerabilities and develop a plan to mitigate risk.
Referring to a study, “The Effect of Supply Chain Disruptions on Long-term Shareholder Value, Profitability and Share Price Volatility,” Tanel shows what the vulnerabilities can mean to an organization. According to the study, the average effect of supply chain disruptions in the year leading to the disruption includes a 107 percent drop in operating income, 7 percent lower sales growth, and 11 percent growth in cost. In addition, share price volatility in the year after the disruption was 13.5 percent higher than in the year before the disruption.
Procurement teams plays a key role. Of them, Tanel asked, “Do you want to prevent and manage supply chain disruptions or would you rather resolve them after the fact?”
While the response appears obvious, teams understandably can become distracted by other priorities. Tanel suggested procurement take the long view and focus resources on mitigating risk.
“Managing the risk provides the early warning systems that enable fight, flight, or cognitive processes to kick in,” he said. “The sooner procurement teams have information, the sooner they’ll be able to respond.”
In his presentation, Tanel used this definition of risk: Exposure to a hazard or the chance of loss.
Procurement teams can limit the impact of supply chain disruptions on the business by identifying the risks within the supply chain and developing a plan to mitigate them. As he sees it, there are two types of risk to consider: external and internal.
External risk consists of:
- Demand risk — caused by unpredictable or misunderstood customer or end-customer demand
- Supply risk — caused by any interruptions to the flow of product, whether raw material or parts within the supply chain
- Environmental risk — from outside the supply chain, usually related to economic, social, governmental, and climate factors, including the threat of terrorism.
Internal risk includes:
- Process risks – caused by disruptions of internal operations or processes
- Organizational control risks — caused by inadequate assessment and planning, which amount to ineffective management or caused by changes in key personnel, management, reporting structures, or business processes, such as the way procurement communicates with suppliers and customers.
Given that supply chains have become more complex — due to growth of such procurement initiatives as outsourcing and low-cost-country sourcing — organizations are seeing an increase in the vulnerability of their supply chains. Tanel used a Kairos Commodities risk management survey to illustrate three areas where organizations are experiencing an increase in risk:
- Macro-economic uncertainty. A single risk event can easily disrupt at least one of the supply chain flows. In most cases, the impact of disruption can be observed along the supply chain. Any hiccup will cause delays and even disruption. Recent incidents such as the Arab spring protests, the earthquake and tsunami in Japan, and the floods in Thailand show how such disruptions can severely affect even the most stable supply chain.
- Commodity price volatility. Commodity prices exploded from 2002 to 2011, with an average annual growth rate of 15 percent for gold, silver, oil, aluminum, copper, coffee, sugar, rubber, cotton, corn, wheat, lumber, and steel.
- Currency risk. In June 2008, Volvo Cars reported a 28 percent reduction in sales compared with the same period in the previous year, with the biggest loss of about 50 percent in its SUVs. Fredrik Arp, then CEO, stated that “the weak dollar reduces the revenue and it will further reduce opportunities for R&D.”
Procurement can limit the impact of supply chain disruptions on the organization by identifying risks within the supply chain and developing ways to mitigate them, Tanel said: “Make this part of your overall supply chain continuity plan.”
Tools that may help include:
- ISO 22301 and 22313:2012 Business Continuity Management, which specifies requirements to plan, establish, implement, operate, monitor, review, maintain, and continually improve a documented management system to protect against, reduce the likelihood of occurrence, prepare for, respond to, and recover from disruptive incidents when they arise.
- ISO 31000:2009 Risk Management provides principles, a framework, and process for managing risk, and can be used by any organization regardless of size, activity, or sector.
“Although prevention and being prepared go a long way toward ensuring supply chain continuity, disruptions can still occur,” Tanel said. “Creating a business response plan allows an organization to effectively manage the business’ immediate response if the supply chain is disrupted.
“An organization with a resilient and responsive supply chain,” he added, “will have a significant competitive advantage over other businesses.”
VUCA: Volatility, Uncertainty, Complexity, Ambiguity
VUCA, originating in the military and adopted by business, is a way to assess and provide for the changeability of events. Tanel sees VUCA as a tool for procurement, “a strategy for handling unavoidable changes.” The term is the acronym for:
Volatility. The nature and dynamics of change, and the nature and speed of change forces and change catalysts. Volatility is mitigated by vision, a clear cut master statement of where an organization is headed. When confronted with volatility, communicate clearly and make sure intent is understood, Tanel said.
Uncertainty. The lack of predictability, the prospects for surprise, and the sense of awareness and understanding of issues and events. Uncertainty yields to understanding, which is the deliberate ability to stop, look, and listen. In uncertain situations, make sure to get fresh perspectives and remain flexible, he said.
Complexity. The multiplex of forces, the confounding of issues and the chaos and confusion that surround an organization. Complexity is checkmated by clarity, the deliberate effort to make sense of the chaos. In complex situations, collaborate with others and don’t seek permanent solutions, Tanel suggested.
Ambiguity. This is the haziness of reality, the potential for misreads, and the mixed meanings of conditions. Ambiguity is matched by agility, the ability of supply chain professionals to communicate across people and organizations instantly and to move quickly in applying solutions. Listen well, think divergently, and set up incremental dividends, he said.
Susan Avery is Chief Editor at My Purchasing Center. She writes articles, blogs, and white papers and manages and creates other content for the online procurement and supply management publication. She produces and moderates webcasts. Susan has more than 25 years experience covering procurement and supply management for Purchasing magazine and Purchasing.com.