“Although good CFOs never take their eyes off spending,” writes Jeffrey A. Burchill, FM Global’s CFO, “you need to be very careful about trying to wring too much cost out of your supply chain.”[1] Although that advice may sound strange coming from a CFO, Burchill is wisely taking the long view of a company’s bottom line. He explains:

“Many CFOs deploy Big Data analytics to drive out supply chain costs, and often they’re rewarded on that metric. Believe me, I love cost-cutting as much as the next CFO. But there’s a point of diminishing returns: If you drive your costs down to zero, your revenue could be zero, too. Cost-cutting techniques such as using sole-source suppliers, lowest-cost providers, and plants in countries where labor is cheapest can be recipes for disaster. As your supply chain costs fall, your risk can soar. If a brittle supply chain eventually snaps — an outage at a single site can halt your product flow — costs can go through the roof as you lose revenue, market share, brand value, and shareholder value.”

Burchill must have had his tongue firmly in his cheek when he wrote “if” rather than “when” a brittle supply chain eventually snaps. A brittle supply chain is not a good thing and it greatly increases the difficulty of implementing a supply chain risk management process. Virtually all supply chains suffer disruptions and only flexible supply chains successfully adapt when disruptions occur. That’s really the point Burchill is making. Bill Mongelluzzo (@billmongelluzzo) provides a few recent examples of such disruptions. “Recent harsh winters, equipment shortages and longshore labor disruptions,” he writes, “have taught beneficial cargo owners that supply chain plans of the past are inadequate in today’s unpredictable transportation environment if they do not include risk assessment and management.”[2] And it’s not just lengthy transoceanic supply chains at risk. Hurricane Joaquin proved that. The folks at Lean Logistics report, “We’ve all seen the news, and some of us are living through the nightmare of the 1000 year flood happening in South Carolina. The state is dealing with over a dozen reported fatalities, boil water advisories, displaced residents, dam breaches, and 70 miles of I-95 road closures. Hurricane Joaquin didn’t just affect domestic supply chains, either. An El Faro cargo ship sank in the middle of the Caribbean, having been stranded in the hurricane’s path. There’s more trouble ahead for South Carolina, and that is also true for our supply chains.”[3] Hopefully, affected supply chains are beginning to recover. They go on to explain that natural disasters aren’t the only source of supply chain disruptions; but, they are generally the most significant disruptions. “Disruptions happen all the time in transportation,” they write, “trucks breakdown, loads shift, and road construction or accidents cause traffic delays; even seasonal increases in demand can have a negative impact on operations. Most of these minor issues are easy to correct, but are you prepared for a major disruption caused by unforeseen, large-scale events, such as natural disasters?” Since disruptions “happen all the time,” it only makes sense to have a full-time supply chain risk management process in place.

Having read Burchill’s article, Mickey North Rizza (@MNorthRizza), Vice President of Strategic Services at BravoSolution, writes, “Think about it. If all you care about is lowering the cost you will consistently look for lower cost options. Outsourcing and low cost country sourcing are two such initiatives that have brought many corporations lower costs over the years.”[4] Good right? Rizza explains why such thinking is short-sighted.

“The efforts are superb for the financials but also leave you vulnerable to issues that can occur outside of your purview, ultimately negatively impacting revenue. While you have lowered your costs by removing the costs, you have also introduced complexity as you now must rely on another link in the supply chain to meet your required expectations. Failure at one of these links such as sources of supply, manufacturing or logistics issues can have a negative impact on your product availability in the market. Compliance to government regulations by all parties within your supply chain is critical to many brands and their customer perception of value. Quality of product, human rights conditions and trafficking, and sustainability initiatives are all important indicators of business social responsibility. Any one of these areas may have a hiccup, however small, and wham, your business market share, revenue, brand and shareholder value can all be negatively impacted.”

She calls that strategy being penny wise and pound foolish. Adam Brosch (@79Dragos), Director of Global Sourcing at Berlin Packaging, offers six other (not so obvious) things you should consider when establishing a supply chain risk management process (in addition to some of things noted above).[5] They are:

1. Quality levels and defects. Manufacturing processes aren’t perfect, so the industry typically accepts a certain quality level for products. Complexity and variability are part of any production process, and unfamiliar sources might not adhere to accepted U.S. defect levels. Choosing a non-U.S.-based sourcing firm can open up questions and disputes about which party is liable for defect percentages that rise above normal.

2. Time zones. Some U.S. firms experience issues when dealing with companies on the other side of the country — and never mind the 13-hour time difference between the United States and Asia. Waking and working hours do not coincide, which can be a challenge when a pressing issue arises. Waiting one day to clarify a product question or process change can often simply be too long for companies that are trying to run nimble operations.

3. Long-range logistics. Purchasing items at a delivered price is easy, but the shipment can be delayed. Whether it is a factory hold-up or transit problem, ignoring the complexity of long-range logistics can be a risk.

4. Accountability and compliance. Companies should consider social compliance every time they look at global sourcing. They need to conduct due diligence about child labor practices, acceptable working conditions, forced labor, and fair compensation practices. Barring the hiring of local staff members, however, there isn’t a surefire way to ensure social compliance from across the globe. Risk comes in the form of severe brand damage due to unfair or illegal practices that come to light.

5. Delays. To receive on-time product delivery, it is vital to have firm completion dates and shipping timeframes. An item that is globally sourced, however, is often just a piece of a bill of materials that must be on hand for product completion. Delays from a non-U.S. source can derail production and drive up related costs.

6. Language barriers. Global partners offer competitive pricing and efficiencies, but still often conduct day-to-day business in a different language. Managers will likely speak English, but their directions must be relayed to line staff, and your own words might be lost in translation. Errors are bound to happen when communications aren’t translated and interpreted perfectly.

As you can see, there are a number of things a company must consider when supply chain risk management is discussed. It’s not a part-time job. As Rizza concludes, “While lower operating costs is critical, so is reducing supply chain risk. Don’t be penny wise and pound foolish because managing the risk is just as important as lowering costs. Otherwise, while you manage the pennies, the pounds of complexity that aren’t managed well could end up costing you all your pennies.”

Footnotes
[1] Jeffrey A. Burchill, “Three Sources of Big Data to Curb Supply Chain Risk,” CFO, 6 October 2015.
[2] Bill Mongelluzzo, “Risk management: a new link in the supply chain,” Journal of Commerce, 8 October 2015.
[3] “Including Risk Management in Supply Chains,” Lean Logistics, 8 October 2015.
[4] Mickey North Rizza, “Balancing the Risk: Penny wise and Pound Foolish?” StragtegicSourcing.com, 8 October 2015.
[5] Adam Brosch, “6 Global Supply Chain Challenges To Ignore at Your Own Risk,” Inbound Logistics, July 2015.