Industrial
The financial crisis began nearly 10 years ago, but businesses still feel its effects. One global industrial firm describes how, since the crash, it has been working to improve its measures of supplier risk – and ensure they provide business value.
The banking crisis of 2007-08 ripped through the financial services sector on both sides of the Atlantic. But a decade on, its effects have been felt across all industries, worldwide. Take, for example, a State of Flux client in the industrial sector.
A multi-billion dollar world leader in heavy industry and global top 20 manufacturing firm with industrial operations in 18 countries, like any business of this size, must measure supply chain risk to understand threats to the business.
As a result of the financial crisis it began to change its thinking, says its manager for operational risk management. “Like many businesses, we saw some suppliers that could have gone bankrupt and many big suppliers focus on their working capital,” he says.
Before 2015, it based these calculations largely on its operations and assets for the purpose of investor reporting. But over the past couple of years, it has been using innovation in
SRM to understand how the behaviour of suppliers can create risk across geographies and business units.
The result was a shift in how suppliers and the manufacturer managed risk, he says. “Big suppliers of electronic equipment reduced the guarantees and started keeping spare parts for five years instead of 10, so we had an obsolescence risk. Meanwhile, some big suppliers decided to outsource production to Asia and the Far East where we were concerned about quality issues. At the same time, customers were pushing us to hold stock for longer and only deliver on a just-in-time basis so that they could reduce their working capital.”
As it considered these risks, the manufacturer began to see that its calculations based on manufacturing asset or country were insufficient. It measured risk at the level of a single factory or product line. Small changes in the behaviour of a single supplier may not seem significant at that level, but if the supplier supports the business in many locations and across product categories, changes in behaviour could have a far-reaching influence on
risk.
Vertical Silos Hinder Global Risk Measures
"We are set up in vertical silos based on geography or product type. We discovered we don't have a global view of the total exposure to supplier risk, we only have a vertical view. We wanted to try to create a methodology we could use for understanding and managing supplier risk across the whole group,” the risk manager says.
The manufacturer’s risk team worked with State of Flux to set up a template for understanding supplier risk across assets and product types. The joint team started working with one of the company’s manufacturing plants in South America in 2015 to validate the template. During the site visit the team surveyed 14 of its stakeholders to understand the perceived maturity of its risk management processes.
The manufacturer did not only need to create and validate its risk methodology for internal purposes; the exercise was also important to insuring the business appropriately. It needed to ensure the financial markets could understand and use the risk data it was producing and to make sure it was insured according to the level of risk for each supply chain activity.
A Methodology with many measures
The risk methodology includes geopolitical stability, economic data and educational performance, as well as internal information about suppliers. It even used geological measures of risk to assess the likelihood of earthquake disruption. Using
supply chain data and information providers such as Dun & Bradstreet, it measured these risks five tiers down its
supply chain.
The
supply risk methodology also considered the demographic risk within a supplier: to probe whether suppliers can capture knowledge and learn from experience. Such qualities can be affected when companies decide to outsource production or services to off-shore locations, the risk manager says.
"When both you and a supplier have people retire, and younger people come in – perhaps in a third-party service provider – do you capture experience? If not, suddenly the problems you experienced 20 years ago can start to happen again. Costs go up, delivery times go up and production goes down. It is interesting to know the demographic changes taking place within a company, a country and an industry,” he says.
But the purpose was not only to make sure the risk was correctly understood and priced; it was to alter company and supplier behaviour to reduce risks. The objective is to align key performance indicators with the new methodology.
"In the industrial world, many people choose the wrong KPIs. They are bonus-driven, or achievement-driven around a person or a plant. They do not necessarily help the whole group,” the risk manager says.
Aligning KPIS with risk measure and business drivers
The manufacturer worked with State of Flux to understand the drivers of behaviour in the supply chain and ensure that internal KPIs were aligned to that picture.
“Then you can understand where you are, where the gaps are versus where you want to be and over time close those gaps. Quality will improve, and working capital will become more effective. Supplies will start to arrive just in time, as opposed to just too late, and you will not have tonnes of material sitting in a warehouse because you got the calculation wrong,” the risk manager says.
“If you can choose the right KPIs, defined by your understanding of suppliers’ drivers, then you can create stakeholder and enterprise value. You know which elements you need to work on, how to prioritise investment and you know what effect that will have. Over time you should be able to show how theoretical value creation becomes real with a supply chain that is more resilient and robust,” he says.
The manufacturer has calibrated the methodology in South America over the past year and is set to verify it in Africa next year. It is still early days for such a complex initiative.