Risk management rarely gets to the root cause


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Large companies usually have internal risk management functions. Many are staffed by individuals with advanced degrees or even doctorates in fields such as mathematics, statistics, actuarial science, and more. The role of these individuals is to identify areas of financial risk and prevent or reduce the threat they pose to their employer. profitability. Supply chain risk is assessed and managed in this way.

During my career I have worked with risk management groups and in my experience they are staffed with very smart people. On the other hand, as I’ve seen with most corporate functions, they seem unwilling to question corporate strategies or practices that have already been decided at the executive level. . In other words, they know which way the wind is blowing and are reluctant to recommend an alternative strategy that would make them appear as a thug sect.

Instead, they recommend actions that they hope will mitigate the financial risks of companies’ specific business strategies. At least in the supply chain, my observation has been that their risk reduction efforts haven’t necessarily addressed the root cause. A perfect example of this is the supply management sourcing strategy of selecting suppliers almost exclusively on the lowest price per piece.

Pricing vs Agile Suppliers

When I was in charge of materials in the late 1990s, sourcing from foreign suppliers at low piece rates was the norm. Added to this strategy were the customer risks of an extended supply chain. The sales season for our division’s main products was three months. When you think about it, that’s how long it would take to change schedules and receive coins from sources in, say, China. This meant that with our Chinese suppliers, we wouldn’t have parts in time to adjust our schedule volumes or our SKU mix. in our sale season to compensate for forecast errors. The financial damage would then be lost sales, lower revenue, and leftover products that would not sell.

When I spoke about it at the VP level, my position was largely ignored: that suppliers should be selected based on their ability to support the demand dynamics of the market they serve. When I complained to a trusted colleague about being considered a rogue heretic, he gave me what I came to believe was sage advice:

“When you conquer the world, bet on the world”

I will say that my career would have been much less stressful if I had followed this advice. In the end, however, I suspect it wouldn’t have been so satisfying.

That’s not to say companies haven’t taken steps to reduce the risk associated with sourcing through long supply chains. For example:

  • They have strengthened their logistics services. And I mean “inflated”, going from a few individuals in the 1990s to large and expensive logistics empires today. This greatly increases the fixed costs of a purchasing function.
  • They’ve purchased millions and millions of dollars in software designed to help them track, step-by-step, the exact status and location of their shipments of purchased parts. When you think about it, though, it’s not worth much when they’re stuck in ships sitting outside the Port of Los Angeles.
  • Many have also significantly expanded their warehousing capacity to be able to store the additional “safety” stock they are likely to need to minimize the impact of supply shortages. Of course, this added more fixed costs since these inventory levels were based on forecasts which, as we all know, have errors.

As mentioned earlier, none of these actions addressed the root cause and should therefore only be seen as band-aids.

Neglecting the root cause

You don’t need a doctorate. understand that these band-aids have been ineffective in avoiding or mitigating financial risk. Again, to address the root cause, vendor response capabilities must align with market dynamics and historical forecast error levels. And sometimes the best and most profitable overall approach is to accept a higher price per piece. This should have been the recommendation of my employer’s risk management function.

Read more articles on supply chain management from Paul Ericksen.

It should be pretty clear that the company’s actions to address the inherent risk of offshore sourcing are not addressing the root cause. Specifically, the longer a supply chain is, the higher the risk that something will negatively impact the transportation process or prevent the supplier from being able to react in time to support market changes.

I’m pretty sure “market dynamics” and “forecasting errors” haven’t been on the radar screens of most corporate strategic sourcing functions. In the future, progressive enterprise supply management functions will understand that there is no such thing as a “one size fits all” supply strategy.

In conclusion, a cartoon hug…

The newspaper I subscribe to publishes daily comics and a few months ago one caught my attention. It consisted of four panels, as described below:

Panel 1:

The woman asks the man: What’s been going on lately?

Man: I read that there were several problems in the supply lines

Second panel:

Man: But in all honesty, when it was decided to manufacture most of our products in Asia….

Panel three:

Man: And ship them across 6,500 miles of ocean.

Panel four:

Man: Who could have imagined that anything could go wrong?

I suspect the author of this comic didn’t have a Ph.D. in any of the areas listed above. Honestly, it’s a sad sign that corporate supply management strategies are now being mocked in the comics.

Paul Ericksen’s new book is “Better Business: Breaking Down the Walls of the Purchasing Silo.” Ericksen is IndustryWeek’s Supply Chain Advisor. He has 40 years of industry experience, primarily in supply management at two major OEMs.


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