Supply Chain Interruption

We now live in a world in which the largest shoe producers don’t actually make footwear, but only design and market it. In this world, the largest direct seller of personal computers assembles computers from components sourced elsewhere. In one industry after another, supply chains have been stretched farther than they ever were stretched in the past; at the same time, lean, just-in-time production schedules have made the consequences of a supply chain break more severe.

With operations scattered around the globe, companies face a host of new perils: political and currency risks, cyber attacks, failed communications with suppliers, just-in-time delivery strategies. They face dramatic, unpredictable risks associated with terrorism, not to mention non-compliance with attendant anti-terrorism trade and shipping guidelines. Also, companies face traditional property-related risks to their supply chains such as fire, natural disasters, power-grid blackouts and equipment breakdowns.

Financial executives around the world have identified supply chain risk as having the greatest potential to disrupt their top revenue driver, according to a recent study conducted by FM Global entitled Managing Business Risks in 2006 and Beyond (available for download at www.protectingvalue.com).

SURMOUNTING RISKS

Companies need not accept these new supply chain risks as insurmountable, to be guarded against by simply purchasing larger insurance policies. While some view insurance as a primary component of supply chain risk management, it more properly functions as a last line of defense.

One of the most effective ways to manage supply chain risks is to prevent threats from becoming realities. The challenge today is to extend that effort to a supply chain that may stretch around the globe. Contemporary supply chains include a vast array of independent suppliers, shippers and other vendors over whom your company has no direct control, and which, in every instance, add new layers of risk to your supply chain.

It is possible to protect your supply chain. It begins with taking the time to identify key products, revenue drivers, core business processes and locations in the supply chain–from procurement of raw materials to delivery of finished goods–as well as the types of events that could disrupt them. Then, take steps to prevent these “pinch points” from squeezing shut.

For example, think of the way companies traditionally sought out locations for manufacturing facilities: in addition to taking into consideration the availability of an adequate labor force and reasonable proximity to raw materials and customers, companies typically favored sites that weren’t exposed to flooding or windstorms, had good access to transportation networks, and were in countries with stable governments and reliable legal systems.

Today, companies that are looking to add a supply partner or outsource manufacturing to a third party can apply the same standards across geographies when deciding where to look for them. Similarly, if companies follow strict safety standards in their own facilities, they can choose suppliers that do the same. If your business is important enough to a supplier, that provider may even allow you to audit its facilities or agree to make safety or security changes to achieve preferred supplier status. Companies that are truly committed to this process sometimes go so far as to look at the suppliers of their suppliers.

PLANNING FOR DISASTER

Unfortunately, many companies rush to revamp their supply chains without giving much thought to the consequences. As they outsource to developing countries, they often unknowingly take on greater exposure to natural disasters, lower safety standards and less reliable legal systems.

The message isn’t that companies should never outsource to lesser-developed, high-exposure territories. Rather, companies should factor the existing risks into the decision-making process and weigh those risks against the potential rewards. Where the risks are deemed unacceptable, look for ways to prevent or control them.

That said, it would be a mistake to focus only on trying to manage catastrophic supply chain disruptions. Yes, one major disaster can wipe out a company or product line. But so can a series of minor disruptions. If, for example, companies are consistently a week late meeting customer demand, or if retailers’ shelves are not routinely stocked with their products, the chances of staying in business fall precipitously. In short, good supply chain management considers more than costs, it also considers customer satisfaction.

Fortunately, globalization provides opportunities to manage risk. It allows companies to locate facilities in safer locations, tap into educated overseas workforces and set up production centers closer to sources of raw materials. Also, by opening the door to using vendors and suppliers from around the world, globalization increases exponentially the number of vendors and suppliers that companies can tap to fill gaps in their supply chain. It’s important to make certain your organization’s alternate suppliers are truly divorced from the risks borne by their suppliers. A key tool, the supplier contract, can be used to specify a wide variety of performance and risk management standards. This is particularly effective when paired with appropriate oversight controls.

When catastrophic supply chain disruption occurs, a quick response can help minimize the consequences. This requires companies to have two measures in place before the disruption occurs.

The first is a business continuity plan. The second is an insurance program with ample and stable capacity that can reimburse a company for operational and financial losses directly attributable to an interruption of business activities.

A business continuity plan should be both broad and deep, covering a wide range of contingencies:

* disaster recovery,

* safety of employees,

* retrieval of backup business data,

* emergency communications,

* possible relocation of business operations to an alternative location, and

* sourcing of goods from alternative suppliers.

Ironically, the biggest hurdle to developing such a plan is not usually human ingenuity or industry, but lack of imagination.

Numerous catastrophes during the past decade have shown that organizations routinely underestimate–or simply ignore–the degree to which disasters can disrupt businesses and the supply chains on which they depend. The problem in planning for disasters of such magnitude is that our expectations tend to be colored by our past experiences– and few have lived through a major fire, much less a major earthquake or hurricane. Similarly, few have much experience managing supply chain risk across oceans and continents.

By working with business continuity experts, companies can better understand the risks they face and better prepare themselves to prevent, control and mitigate them however unlikely they might seem at first glance.

Companies often fail in the planning phase by looking at risks too narrowly – such as planning simply for IT continuity, for example – and not inoculating the business built around it to the same degree. And when it comes to your insurance program, it pays to know how your policy will respond, should you ever have an insurable loss.

OFFSETTING COSTS

To be sure, managing supply chain risk can add costs. But if these precautions prevent or minimize a supply chain disruption even once, companies might easily earn back their investment many times over.

In the meantime, companies can take solace in knowing that the costs of developing a good risk management program can be offset by lower insurance premiums — not to mention increased capacity and higher limits — for property, casual
ty and business interruption insurance. An effective supply chain risk management program really does reduce the chance a company will suffer a catastrophic business disruption.

Can your company afford to operate without such a safety net?

www.canadianunderwriter.ca* August 2006