The Growth Potential in Managing Supplier Risk


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From Supply Chain Management Review - Sept/Oct 2010 issue:

The downsides of a supplier failure are pretty obvious. Less clear are the advantages to be gained by aggressively managing and mitigating supplier risk.Two supply chain management executives from DHL tell how their company transitioned from a reactive to a proactive approach to supplier risk. This approach not only results in greater supply continuity but also serves as a building block for future growth.

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The Growth Potential in Managing Supplier Risk

  1. 1. LEADERSHIP SKILLS CONTINUITY RESPONSE FRAMEWORK The Growth Potential in Managing SUPPLIER RISK T By Wayne S. Evans and Sven Blawatt he global economic downturn changed some fun- damentals in nearly every industry, geography, and area of business—from nance to operations, from The downsides of a supplier failure compliance to procurement. The global reces- are pretty obvious. Less clear are the sion may be dissipating, but its effects and les- advantages to be gained by aggressively sons learned will have a signi cant impact on our approach to risk as we dust ourselves off and begin managing and mitigating supplier working in a recovering economic environment. As procure- risk. Two supply chain management ment professionals, perhaps the biggest change we see pre- to executives from DHL tell how their post-recession is the increased importance and focus on risk. Furthermore, we’ve witnessed an evolution in viewing this area company transitioned from a reactive more holistically from risk management through risk mitigation. to a proactive approach to supplier risk. The downturn moved risk from a good practice to a must This approach not only results in greater do, best practice. For us at DHL, like many other companies, the eye-opener came when a number of suppliers started show- supply continuity but also serves as a ing very weak nancials with some Dun & Bradstreet scores building block for future growth. indicating a high probability of near term business failure. As a consequence, supply chain risk management was abuzz again in C-Level suites and corporate boardrooms. The Aberdeen Group, an independent research rm, con- ducted a study on supplier risks before the downturn. The report, “Supplier Risk Increasing While the Market Stands Wayne S. Evans ( is Head of Procurement, Americas and Sven Blawatt ( is Regional Procurement Category Manager-Transportation, both at DHL Global Business Services. 30 S C M R · S /O
  2. 2. John Labbe Still,” provided a glimpse into a more laissez faire atti- nies competing in the global economy will face increased tude about supplier risk, with 49 percent of companies pressures and risks to their operations. As companies surveyed reporting that they did not have a developed emerge from the downturn there will be a continued supplier performance and risk management program in effort toward leaning the supply chain and outsourcing place.1 Even then, many of these same companies, 62 areas when there is a compelling value proposition. This percent of them, reported that they expected supplier brings about reliance on suppliers who can proactively risks to increase signi cantly over the next three years manage risk more dependably and on lower risk suppli- due to factors such as the globalization and disburse- ers in areas such as logistics. There will also be increased ment of their supply base. Enter the global recession responsibility on purchasing professionals to proactively and, combined with existing trends, supplier risk man- manage and mitigate risks by choosing optimal suppliers, agement has skyrocketed in importance. monitoring them, and ultimately balance risk and return. Even as we enter an economic recovery, most compa- Going into the recession, we needed to prepare S C M R · S /O 31
  3. 3. Supplier Risk for supplier failures as decreased demand increased competition and drove revenues A New Definition down. On the way out, demand could again of Supplier Risk be a problem; this time we need to prepare for constrained resources. For example, as the recession deepened we noticed that some of H istorically, supplier risk management has represented those processes that a company employs to limit unforeseen supply disruptions. Recent events have expanded this definition to include the larger print companies were taking presses practices that protect the business from supplier events that can off line and, in some cases, destroying them— have an impact on the company operationally, legally, and financially. thus reducing capacity in line with demand. While techniques to guarantee materials and services continue to Similarly, the airlines started taking planes out drive supplier risk management programs, the definition has evolved of service to match demand. These strategic to include methods and technologies that limit the level of exposure business moves lead to capacity constraints, of the business to regulatory, brand, or legal risks. and as the economy recovers this will lead to an A successful supplier risk management program can become a impact on delivery, price and quality. Also dur- continuous supplier improvement program—enhancing the quality, ing the recession many edgling suppliers went speed, reliability, and costs at which suppliers deliver. out of business, which again will add to supply risk and pricing pressures. Although the economy may be seeing improvement, was cost reduction. One of the most effective models this heightened demand pressure alone, will lead to was to send out “cost reduction” letters to the key sup- additional supply and quality risks as suppliers attempt pliers asking for a rm percentage discount. As we move to increase capacity. Therefore, we must be proactive towards a sustained economy our focus is shifting to sup- and provide contingencies for these risks going forward. plier development and supplier relationship management. Solutions include building up and engaging a diverse To be successful, we realize the continued improvement supply base and, through collaboration, establishing process can no longer be just focused on taking cost out. a consistent service offering that mitigates any poten- It also must focus on creating tighter relationships with tial drop in quality. Supplier relationship management, suppliers, which is a key factor in a continuous supplier which is based on the concept of collaboration, is one of improvement program. Establishing suppliers across indi- the key factors to secure a continuous service offering on vidual business units provides the opportunity to stan- a high level standard. dardize frame contracts, bundle volumes, and align targets The current risk environment is compounded as and expectations along the company’s long term strategy. companies and customers are globally distributed and Key strategic initiatives are focusing on, for example, car- dispersed, and driven by a desire to grow the top line bon ef ciency, equipment and machinery utilization, and and cut the bottom line. As worldwide supply chains are continuous process and ef ciency improvement. In the expanded, risk mitigation practices will help differenti- future our opportunities for cost reduction will rely on ate those that succeed from those that fail. Regulatory continuous improvement programs and driving down the requirements and accompanying pressures have cost of doing business. increased ten-fold. (With political leaders in Washington seeking to bolster regulatory and enforcement efforts to Procurement Can Lead in protect against another “Great Recession,” you can bet Mitigating Risk those requirements will increase.) Competition in most Most in the supply management profession would likely industries has dramatically intensi ed. These increased agree that supplier risk has become a heightened priority business pressures are driving an ever-greater reliance and that the C-suite’s interest in the topic has peaked. on understanding, monitoring and mitigating supplier Yet there is still work to be done in educating our organi- risk. Companies are under growing pressure not only to zations on the importance of supplier risk management. avoid supply chain disruptions and problems, but also to The procurement organization looks at risk more improve supplier performance and collaboration to miti- “holistically” than other parts of the typical global com- gate future risks—and to improve business value. This pany. (The accompanying sidebar offers our perspec- leads to improved bottom line results and product/ser- tive on what constitutes supplier risk today.) Although vice quality. it may seem somewhat counter-intuitive, purchasing Like most global companies, we took aggressive action professionals evaluate the buying process as more than to take costs out in the recession. And, as with most just about price. They are interested in Total Cost of enterprises, our primary focus in supply management Ownership (TCO). We have the perspective, data, and 32 S C M R · S /O
  4. 4. the tools necessary to help our colleagues—from nance cant risk related to poorly de ned SOWs. This makes to operations—understand that purchasing is more than resolution of issues with the supplier or service provider a cost-decision, and that supplier risk management is that much more challenging. Our experience has shown more than just avoiding pitfalls. We need to bring these that “non strategic sourcing” leads to inconsistent SOWs perspectives and data tools to bear as widely as possible with the same supplier. We’ve also found that without a if we are going to truly have an impact in mitigating risk solid statement of work, it is extremely dif cult to man- for our organizations. age the supplier and “hold their feet to the re.” Based on our experience at DHL, and in past posi- 4. Financial risk. All of these factors contribute tions at major consulting rms, we offer the following to nancial risks—from failure to leverage economies thoughts on what procurement brings to the table in of scale to contract leakage, from nancial exposure to terms of mitigating risks in key areas: legal or production issues. It is important to identify and 1. Compliance risks. Simply stated, the procure- mitigate nancial risk as early as possible. One potential ment organization has standardized processes for buying solution is to monitor risk or market intelligence indi- goods and services. When departments source without cators from third party providers. Dun & Bradstreet’s consulting procurement, there are likely to be problems documenting As we move toward a sustained the purchase process, which increas- es the risk of non-compliance and economy, our focus is shifting to supplier the risk of an audit. Our message development and supplier relationship management. internally to the more “independent” executives is simply, “cover yourself.” If you source on your own you’re opening yourself up to Supplier Evaluation Risk Rating, for example, is cre- potential compliance issues. Whereas, purchasing has a ated from statistical models to predict the likelihood of clear, compliant and auditable trail. a company ceasing operations without paying all credi- It is common practice for internal and external audi- tors under state/federal law over the next 18 months. tors to review the acquisition process for high dollar Information such as age of business, payment trends and items. We have all seen several instances where a sig- performance, nancial ratios compared with industry ni cant purchase made through the business did not fol- averages, sales and pro tability, and more all are taken low a rigid, fair, and transparent bid process and failed into consideration. A change in score of two or more, to meet the audit requirements. Furthermore, the doc- triggers an automatic email alert to procurement signal- umentation, if it existed, was dif cult to nd and not ing them to launch actions on replacement or backup stored in any central repository, leading to the percep- suppliers. This kind of alert mechanism allows procure- tion that there is a non-compliant process. This risk can ment to act rather than re-act on a potential risk. be mitigated by utilizing an electronic repository from an When executives in a business unit want to award eSourcing application. DHL uses these and the other business to a speci c company, they usually don’t real- robust capabilities in Emptoris Sourcing. ize what the broader relationship is with that company. 2. Legal and contractual risks. Traditionally, Nor do they understand the competitive situation in the if procurement is involved, then legal is also involved. category. They usually have a preference because of an When procurement and legal are not brought to the existing relationship or good experience with that sup- table, contracts tend to lack consistent, favorable and plier. There have been instances where we already have compliant terms and conditions. In our experience, 30 percent of a category with one supplier company and we’ve seen contracts ended without proper termination a business unit owner wants to send a new piece of busi- provisions, liability issues without proper indemni ca- ness to that same supplier. This would result in putting tion clauses, and intellectual property disputes without more than 50 percent of that category with that one sup- protective language. On several occasions in our careers, plier, thereby creating the potential for increased risk by we have been brought into circumstances where pro- concentrating signi cant spend with a single supplier. curement was not initially involved in creating the con- tract but later asked to “clean up a mess” that could have Complex Sourcing: been avoided. A Top Priority for Risk Mitigation 3. Statement of work (SOW) risks. When busi- Over the past two years, purchasing has become increas- ness units operate independently in contracting with ingly involved in complex sourcing projects for transpor- suppliers and service providers, there is typically signi - tation services—across all operational business units of S C M R · S /O 33
  5. 5. Supplier Risk DHL. We have done this by offering our sourcing exper- perfect examples. As we move to a recovery and econom- tise, procurement tools, and a broader view across all ic expansion, procurement has a prime opportunity to business units in support of their internal requirements. engage in the management of complex sourcing events. As one may imagine, reducing internal transportation It’s possible to solidify this engagement by offering a pro- costs is signi cantly important to DHL—given that curement service as an SME. Potential support resourc- Deutsche Post DHL, is the world’s largest mail and logis- es include a dedicated team with standardized processes tics services group with more than 470,000 employees in utilized in place, and an array of sourcing technologies more than 220 countries and territories worldwide. We supporting the complexity of this commodity. see our involvement in this strategic area as an important Once engaged, these resources can address a variety sign of the relationship between purchasing and other of risks, including: strategic departments at DHL. By providing a service to Operational Risks: It’s often the most critical sup- those unit—not a barrier—we increase the value that plies and services that are sourced independently—or procurement brings to the table. The entire organization sourced without full procurement engagement. The has come to recognize that having procurement involved loopholes left in such statements of work (SOW) and as a subject matter expert (SME) can ensure proper due contracts can be signi cant, resulting in a great deal of diligence and governance. Moreover, it can ensure best disruption within the company if the right supplier or outcomes covering interests on a business unit and over- service provider is not selected. Historically at DHL, all company level. the sourcing of internal transportation was done with- The holy grail of strategic sourcing has long been the out our involvement. But with procurement’s exper- high-value, high-dollar, complex supplies and services tise it was possible to increase the transparency of the that are critical to a company’s operations, as with trans- transportation spend and to reevaluate and enhance the portation spend in our case. We refer to this as “complex supply base, providing additional quali ed carriers. This sourcing.” With the introduction of sourcing technolo- increase in the supply base has improved the company’s gies and e-auctions, the “low hanging fruit” was the logi- position in terms of providing better lane coverage and cal rst target for cost savings. As costs were wrung out more competitive pricing, hence leveraging volumes, of supply chains, and as technologies evolved, it became reducing the reliance on incumbents and providing true possible to leverage these solutions for complex events. market prices. Today, not only can sourcing technologies assist with Financial Risks: Complex sourcing categories are complex RFx’s but optimization technology is available also usually the highest value and the steepest priced for conducting complex sourcing events. Plus, the stan- categories and services. The risks associated with these dard “three bid and a buy” sourcing process becomes categories will have nancial impact not just for a busi- even more ef cient because the real-time feedback tech- ness unit, but straight down to a company’s bottom line. nology reduces the negotiation lifecycle. Leveraging our technologies and best practice, procure- The days of massive spreadsheets, teams of experts ment at DHL has been able to bring about signi cant and months-long processes are quickly vanishing. Today, changes in complex categories by promoting standard- the sourcing optimization technologies offered by the ized terms and conditions, SOW’s, and processes as well top software providers, such as Emptoris, are capable as greater transparency. A recent initiative for a business of simultaneously evaluating hundreds of different pro- partner focused on standardizing a supplier surcharge curement inputs. Such evaluations can take into consid- schedule across the business with expected, continuous eration the global market, speci c current supply chain savings of over $1 million annually. conditions, and individual supplier conditions. And Suggestive Bidding Risks: When organizations put importantly, they offer solutions that address the buyer’s out strict speci cations without allowing suppliers to and supplier’s goals in the best possible way. present alternative bids and solutions, something is lost This obviously has implications for mitigating risks. in the process. Not least are the supplier’s creativity and In fact, we have found that a focus on complex sourcing the ability to nd mutually bene cial common ground. events is the most important task a company can under- Managing this level of exibility is extremely dif cult take to mitigate both supplier risk and broader business with paper processes. Complex sourcing technologies, risks. As another procurement leader noted, “Where by contrast, allow for more exible bidding, and thus a there is complexity—especially complexity that is dif - broader set of supplier solutions. When you’re not allow- cult to measure—there is risk.” Too often, complex cat- ing suppliers to tell you about themselves and to be cre- egories of spend are not sourced at all and are treated as ative, you’re not getting best value—and there is risk sacred cows. Transportation, bene ts and marketing are inherent in that limited approach. 34 S C M R · S /O
  6. 6. Suggestive bidding, which is empowered by sourcing downturn—before, during, and after.) optimization technology, allows the carrier to create its own These realities and beliefs are all re ected in our pro- offer based on modules provided to them in a “sandbox” envi- curement mission at DHL. We continually ask ourselves ronment. Let us illustrate with another transportation sce- how we can advance the value we provide to the broader nario: Rather than strictly de ning routes, the buyer de nes organization. all required scheduled stops on a weekday basis and provides Getting cost out is not going to be as “simple” and them to the quali ed carriers. The carriers then create their “easy” as it has in the past. But the value is higher now, own routes based on their existing business and cross docks the risk greater and the consequences will impact overall in place. In doing so, they are able to provide a better price corporate competitiveness. As supply management pro- and eventually create their own discount structures. Such fessionals, we need to understand when strategic sup- an approach also supports supplier relationship manage- pliers are nancially strained, and learn how to support ment, as the carrier is ultimately more successful utilizing itsthem. We need to bring tools to the table to monitor full capacity. supplier risk proactively. We need to manage suppliers A centralized sourcing optimization technology in a different way, in a way that seeks mutual continuous ensures successful suggestive bidding, leading not only to improvement. In short, our organizations are expecting best price but also to best value. Further, such sourcing us, as supply management leaders, to move the organiza- practices help identify risks while helping ensure proper tion forward to a more secure, more prosperous place in compliance and governance. Optimization enforces a the future. consistent and fair bidding process—eliminating the risks Before jumping into speci c strategies and imple- related to inconsistency. menting solutions, the rst step in increasing the value proposition is to identify and isolate the one or two key Increasing the Value Proposition risk types within your business environment. Once you’ve In the recession, we’ve seen the business world move completed this exercise, you can customize your risk man- forward and increasingly recognize the importance of agement strategy towards monitoring these risks. strategic supply management. Senior executives can no Then, identify risk factors or indicators that can be longer afford to simply operate with their “price blind- continuously monitored—and develop and implement ers” on. Value can be delivered in myriad ways, not least a dashboard or alert functionality to keep you actively of which is through effective supplier risk management. updated on these indicators. Note, too, that supply base Coming out of the downturn we will experience supply intelligence and transparency go a long way to mitigat- risk, in ation, and continued business failure—all of ing long term risks. A potential vendor management which can be managed by a proactive procurement orga- database should include information on supplier history, nization. (Exhibit 1 depicts a timeline of activities and process compliance, bidding performance, and current opportunities associated with the various stages of the market intelligence (for example, via third party nancial risk scores). EXHIBIT 1 Finally, we believe that supplier col- Key Events in Downturn Cycle laboration can be a signi cant factor in mitigating supplier risk—and can help you steadily reduce your risk percentage in the Reverse Auctions long term. By identifying key players in your In ation supply base and sharing your organizational Net Value Lower Demand Approach Downturn goals and targets with them, customized solutions can be developed on both sides of the relationship, increasing ef ciency and Demand Management mitigating overall risks. Focus on Cost Reduction Supplier Relationship “Supply Chain Letters” Management Endnote: 1 “Supplier Risk Increasing While the Market Sacred Cow Initiatives Stands Still,” The Aberdeen Group, March “Complex Sourcing” 2007. Time 2008 2009 2010 S C M R · S /O 35