Paul Hopkin. Fundamentals of Risk Management

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Supply chain management

Importance of the supply chain

Many organizations outsource major parts of their operations and support services. This can

range from the use of contract cleaners through to transport, communications and manufac-

turing outsourcing. Many leading suppliers of fashion goods design the products and supply

the ﬁ nished items through franchised retail stores. All manufacturing and distribution activi-

ties are frequently outsourced to third-party providers in different parts of the world.

Because of these developments, supply chain management has become vitally important.

Managing the supply chain in an increasingly globalized and competitive world can be very

challenging. Uncertainties in supply and demand, globalization of marketplaces, shorter

product lifecycles and rapid changes in technology have led to a higher exposure to risks in the

supply chain.

All kinds of uncertainties can cause problems in the supply chain and this has increased the

importance of risk management. It is impossible to eliminate risk entirely, but adequate atten-

tion to risk management matters can reduce the likelihood and magnitude of any disruption

to supply. As the trend towards obtaining components and ﬁ nished goods continues to lead to

greater use of manufacturing facilities overseas, the corporate social responsibility issues also

tend to increase.

Take the example of a sports club that has decided to outsource the procurement of merchan-

dise sold to fans of the club. The expectation of fans is that merchandise will be desirable,

available, distinctive and of appropriate quality and will represent value for money. The club

itself will require that merchandise is of an appropriate quality and high availability, desirable,

proﬁ table and ethically sourced. The risks associated with the supply chain and the risks of

managing conﬂ icting stakeholder expectations need to be assessed.

The conflicting stakeholder requirements of value for money and profitability have led

the club to take the decision that merchandise will have to be procured from a low-cost

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Supply chain management 215

manufacturer, probably based in a country with lower employment costs. However, the

club may have also decided that it will not procure directly from a manufacturer, but will

use a third-party procurement agency. The requirements then placed on the procurement

agency will include the goods being of appropriate quality and obtained at the lowest cost

available from an ethical supplier.

There are many risks associated with the course of action that the club has decided to take.

There may be quality and availability issues that could cause dissatisfaction amongst fans and

result in reduced sales. There are also questions of corporate social responsibility that need to

be addressed. It is likely that the decision to use a third-party importer will reduce these prob-

lems, because the importer should be in a better position to establish and monitor corporate

social responsibility standards.

Scope of the supply chain

Because of the increased use of outsourcing, there is an increasing interest in the risks associ-

ated with reliance on third parties. Outsourcing of operations is normally undertaken because

it is assumed that costs can be reduced and risks transferred. A careful evaluation of the balance

between risk and reward should be undertaken before any supply chain outsourcing decisions

are taken.

The organization should be aware of the fact that outsourcing means that the organization will

not only have to focus on its own risks but should also look at the risks associated with other

links in the supply chain. Supply chain management and risk management are interrelated.

Supply chain considerations are becoming more common, as well as much more complex.

Outsourcing of the various components of the infrastructure of an organization is only part of

supply chain management. Successful management of the supply chain will rely on strategic

partnerships and may also extend to joint-venture arrangements. Supply chain issues also

extend to simple outsourcing decisions, such as the appointment of cleaners and caterers.

There was a strong trend in the 1980s to the outsourcing of many types of facilities manage-

ment within buildings.

In summary, the scope of the supply chain can extend to strategic partnerships, joint ventures,

support services and outsourcing of facilities’ management activities. Many organizations also

choose to outsource the transportation component of their business. It is not unusual for

chains of retail stores to outsource warehousing arrangements and the delivery of goods to the

individual shops.

The box below is a summary of the supply chain considerations that affected Nike in the

mid-2000s. The company took actions to address the ethical sourcing issues that had been

raised. In order to protect its reputation, NIKE took rapid and decisive action in response to

critical reports.

216 Risk and organizations

Nike supply chain

Nike has said that it has been facing a lot of problems with manufacturing in China

with suppliers giving falsiﬁ ed documents, underage workers and unpaid wages topping

the list. The sneakers and sportswear manufacturer, in what is believed to be its ﬁ rst

country-speciﬁ c supply chain report, has said that the company has been trying to get

the Chinese suppliers to follow its code of conduct and Chinese law.

It is reported that the company’s difﬁ culties are a reﬂ ection of the depth of some of the

problems faced by manufacturing businesses in China, which reportedly is Nike’s

largest single sourcing country, with around 180 manufacturers and about 210,000

employees, at a time when prices are rising and the legal environment is stiffening.

The report, which was posted on Nike’s website, said: ‘As China continues to develop

we see progress and best practices emerging. But like our partners in any other

country, the factories we contract with in China continue to face challenges as well.’

According to the report, the company faced several labour-related problems, which

included falsiﬁ cation of payroll records (entry of age in particular), hiring practices

and the absence of a proper grievance system for workers.

Strategic partnerships

When setting up arrangements to outsource part of its operations, an organization will need

to consider very carefully the selection of each strategic partner. For example, the production

of an in-house magazine will be outsourced by many organizations. Depending on the impor-

tance placed on this magazine, an organization may wish to set up a strategic partnership with

the publisher.

Supply chain considerations become even more important when production activities are

involved. When a supermarket sets up an arrangement for the supply of manufactured goods,

there are many considerations. The ability of the supply chain partner to deliver the required

goods on time and within the agreed cost on a sustainable basis will be key considerations.

In order to secure exclusive supply, the supermarket may wish to enter into strategic partner-

ships with its suppliers. These strategic partnerships will result in the supermarket receiving

priority treatment in the event of potential disruption to supply. The beneﬁ t to the supermar-

ket of this arrangement is that continuity of supply is guaranteed and costs will be reduced.

For the supplier, the beneﬁ ts will be a secure market for their goods and a long-term contract.

The disadvantage for the supplier is that the price may be ﬁ xed, even though the supplier

could obtain a better price on the open market from time to time. There is a further disadvan-

tage that the supplier may be dependent on orders from only one customer.

Supply chain management 217

With increased focus on cost and use of ‘just in time’ delivery, single supplier arrangements

may increase the risk of business interruption. Although organizations will wish to limit

potential losses by purchasing insurance, it is unlikely that traditional insurance will ade-

quately protect the reputation and market share of the organization in these circumstances.

Therefore, organizations will need to look at business continuity strategies and developing

strategic partnerships.

Joint ventures

Securing priority status from suppliers may be part of the arrangements for an organization to

secure its supply chain. However, for very critical components or support operations, priority

status may be insufﬁ cient. Many organizations, therefore, explore the possibility of setting up

joint ventures with their suppliers in order to ensure priority supply status.

Setting up joint ventures also allows the organization to have some management control over

the operation of that supplier and eliminate the possibility that the supplier will deliver goods

to a competitor in difﬁ cult market conditions. Joint-venture arrangements may also be an

appropriate way of responding to competitor activities by denying the competitor access to

the products produced by the joint-venture partner. Joint ventures may also be a successful

way of responding to technology changes in the marketplace, because the organization will

not need to ﬁ nd all of the funding required to embrace the new technology.

These sorts of changes in the supply chain may be very signiﬁ cant. In fact, it may be beyond

the resources of existing organizations operating in the marketplace to respond to these

changes. Joint-venture operations can ensure continuity of supply chain and also, if correctly

executed, deliver competitive advantage.

Outsourcing of operations

Outsourcing of non-core operations can also give rise to supply chain exposures. Table 24.1

sets out a list of considerations when setting up a contract for the supply of outsourced support.

It is important that organizations consider the scope of the outsource arrangements and the

range of services to be supplied. Various other features of the outsourced agreement will need

to be addressed.

In many countries, there is legislation covering the protection of employees when an opera-

tion is outsourced. For example, if an organization decides to transfer the catering or the

cleaning services to an outsourced company, the employment rights of staff previously

employed by the organization may be protected. This can be a signiﬁ cant obstacle to the out-

sourcing of certain facilities’ management and other activities and obtaining the cost reduc-

tion that would result.

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Table 24.1 Risks associated with outsourcing

As a minimum, the agreement between the organization and the out-sourced service

provider must address the following issues:

scope of the arrangement

•

duration of the agreement •

services to be supplied •

pricing and fee structure •

service levels and performance requirements •

transfer/implementation arrangements •

audit and monitoring procedures •

business continuity management •

conﬁ dentiality, privacy and security of information •

default arrangements and termination provisions •

dispute resolution arrangements •

liability and indemnity •

restrictions on sub-contracting •

insurance requirements •

The box below considers some of the beneﬁ ts of outsourcing. Outsourcing is often undertaken

to save costs, but it may also be undertaken so that the work is fulﬁ lled by a specialist company.

For example, a mortgage lender may outsource property surveys to a company with great

resource and more expertise.

Beneﬁ ts of outsourcing

Most businesses outsource certain functions, but this is a major decision and the bene-

ﬁ ts can be difﬁ cult to deﬁ ne. Outsourcing can cut costs by reducing overheads and

having a professional perform the operation. Although this beneﬁ t is attainable, it should

not be the only reason a company decides to outsource.

The beneﬁ ts of outsourcing can be divided into two types. First, there are the direct ben-

eﬁ ts of having a specialist company undertaking the outsourced activities. Then, there

are the indirect beneﬁ ts of giving greater focus to the core activities that remain in-

house. The direct beneﬁ ts of outsourcing are reduced costs, decreased cycle times and

improved customer perception and satisfaction, including:

focus on core competency; •

reduction in the cost of manufacturing and logistics services; •

Supply chain management 219

reduction in head count of hourly workers and management; •

improved accuracy; •

ﬂ

exibility and wider range of services; •

access to global networks and superior technology; •

improved service and quality; •

reduced capital investment and increased cash ﬂ ow. •

Risk and contracts

Risk management is clearly an important component when setting up supply chain contracts

or deciding to outsource certain activities. The need for a detailed contract between the organ-

ization and the suppliers of the outsourced service will depend on at least the following

factors:

level of the risk associated with the contracted service; •

value of the contract for supply of goods or services; •

duration and scope of the contract; •

level of skill required in the delivery of the contracted services; •

critical nature of the goods or services that are being contracted. •

The desire to achieve greater value for money and reduce costs has resulted in complex supply

chains that are far more fragmented than was previously the case. Many organizations will

contract out key parts of their activities, so that money can be saved and a greater level of spe-

cialist expertise is available from the outsourced company. Outsourcing also enables organiza-

tions to focus on their own core operations and competencies.

However, this has resulted in complex global supply chains that are more vulnerable to poten-

tial disruption through external sources such as terrorism, pandemics and natural disasters.

Organizations need to undertake a thorough risk assessment of their supply chain and out-

sourcing arrangements to ensure that the risks associated with these contracted services are

adequately managed. Remember that contracting out the supply of goods or services does not

transfer all of the risks.

Outsourcing arrangements should be introduced only when it is the cost-effective and efﬁ -

cient way of running the business. Outsourcing decisions based on a belief that risks are being

completely transferred to a third party may prove to be incorrect. Damage to reputation may

still be suffered if the outsourced manufacturing activity produces substandard goods.

220 Risk and organizations

For example, an organization that decides to have manufacturing undertaken in a lower-cost

territory may discover that the goods produced do not comply fully with safety requirements.

There have been examples of toys manufactured in one part of the world that were illegal in

the country where the toys were to be sold because of the use of lead-based paint.

It is possible that the cost of supply will be reduced, but the risks may actually be increased.

When contracting out services and supply, the organization needs to be satisﬁ ed that the risks

associated with this transfer are within the risk appetite of the organization, and also within its

risk capacity. Finally, evaluation should be undertaken to determine the actual risk exposures

that are associated with increasingly complex supply chain arrangements.

Case study

Hercules Incorporated – outsourcing logistics

Odyssey Logistics & Technology Corporation, a provider of outsourced logistics management

services to process manufacturers, today announced that Hercules Incorporated, a $1.7 billion

chemical manufacturer and marketer, has signed a ﬁ ve-year, multimillion-dollar contract to

outsource its North American import and export transportation and logistics operations to

Odyssey.

As Hercules’ contract transportation arm, Odyssey will provide all necessary services to ship

product from Hercules’ manufacturing plants and other shipping facilities to its global cus-

tomers. Hercules’ four divisions are focused on providing chemicals and other materials for

industrial manufacturers in markets such as pulp and paper, personal care products, paints,

carpets and adhesives.

In 2002, Hercules forged a renewed focus on its core business units and decided to outsource

its transportation functions for three compelling business reasons: to achieve more insight

into its global supply chain costs; to reduce its transportation costs by gaining increased lever-

age in negotiating rates with its multimodal carrier network; and to deploy its own expertise

in the business of manufacturing chemical products and meeting its clients’ needs.

Prior to outsourcing to Odyssey, Hercules worked with a variety of third-party logistics pro-

viders who were focused on one or two modes of transportation. Unlike Odyssey, they were

not connected to one another and could not provide Hercules with a holistic view of its multi-

million dollar transportation spend.

Odyssey’s transportation management solution interfaces directly with Hercules’ enterprise

resource planning application, incorporating the order management system directly into its

freight planning solution. The technology integration provides the critical link to allow Her-

cules senior executives to have one view of the transportation supply chain.

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222 Risk and organizations

Odyssey is a full-service third-party logistics provider with capabilities in all transportation

modes – truck, rail, ocean and air. The company has signiﬁ cant experience supporting the

requirements of the chemical industry where the movement of liquids and dry bulk are often

an important part of the product mix.

Odyssey Logistics & Technology Corporation 2008

Part 5

Risk response

Learning outcomes for Part 5

provide alternative deﬁ nitions of enterprise risk management (ERM) and identify the •

key features of an enterprise-wide approach;

describe the 10 steps in the implementation of a successful ERM initiative, as set out in •

more detail in Appendix B;

outline the importance of risk appetite as a planning tool in the implementation of a •

risk management initiative;

describe the relationship between risk appetite, risk exposure and risk capacity and the •

interface with operations, projects and strategy;

describe the risk response options in terms of tolerate, treat, transfer and terminate, •

and explain how these can be shown on a risk matrix;

describe the types of controls that are available, in terms of preventive, corrective, •

directive and detective (PCDD) controls;

explain how to determine whether controls are cost-effective, how controls change loss •

expectancy and how to learn from controls;

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