Risk management is the process of identifying, assessing, and controlling risks arising from operational factors and making decisions that balance risk with offsetting benefits.
It is a systematic approach used to identify, evaluate, and reduce or eliminate the possibility of an unfavorable deviation from an expected outcome.
Nowadays, supply chain risk management is becoming a top priority in procurement, as companies lose millions because of supply disruption, cost volatility, non-compliance fines and incidents that cause damage to both: the organizational brand and reputation. All the following factors can cost your organization tens of millions in sales and hundreds of millions in brand damage. While reputation may only be important for name brands, cost volatility and supply disruption affect all manufacturers.
The Business Continuity Institute researchers have calculated that supply chain disruption doubled in priority relative to other enterprise disruptions (48% of firms are concerned or extremely concerned). In the same study, 14% had losses from supply chain disruptions that cost over €1 million.
About Supply Disruptions
Business experts define supply disruption as any unforeseen event that disturb the normal flow of goods and materials in a supply chain. Such disruptions can have major negative consequences for the management of operations. For example, they can result in production disruptions and hampered productivity and capacity utilization.
In the longer term supply disruptions can negatively affect the shareholder price and a company’s long-term financial performance. For a purchasing organization, a supply disruption can also mean the inability to meet demand and satisfy customers.
Supply disruptions can come from a wide variety of sources, including physical damage at production facilities, natural disasters, strikes and labor disputes, capacity issues, inventory problems, incorrect forecasts and delays.
Identifying specific risks is the first step in any risk management process. Let’s look at some of the more common categories of risk to consider:
1. Financial risks
These risks can range from an unexpected or unfavorable change in exchange rates all the way to a supplier’s bankruptcy.
Some examples of financial risks include budget overruns, finding the limitation, constructive changes, and missed milestones requiring additional funding. Financial risks also encompass unexpected cost overruns that may be linked to other risk factors such as changes in the scope of work required to successfully complete the activity.
2. Scope of schedule risk
Largely a result of poor project definition or a poorly worded statement of work, these are primary risks that threaten the timeline, but as noted previously, they can also have cost implications.
Schedule changes are often the result of a natural disaster such as hurricanes, fire, or flood, or as a result of noncompliance issues generated by the supplier. Scope risk can occur as a result of changes that are required when the initial statement of work (SOW) becomes unworkable or due to technological changes generated by the market.
3. Legal risks
Legal and contractual risks are often related to disputes or different interpretations of contractual obligations, or from not meeting the requirement included in the terms and conditions. Use or misuse of intellectual property can also be considered as a legal risk, especially when patent infringement is a possibility. We can also include in this category violation of laws, as well as civil lawsuits.
4. Environmental risk
In the sourcing process, it is critical to evaluate the risk to the environment created by your supplier or contractor. Environmental risk includes the organization’s negative impact on water, air, and soil as a result of discharges, emissions, and other forms of waste.
5. Sociopolitical risk
When the regulatory environment changes in response to a new government or to increasing awareness of inequitable social conditions, many existing institutions experience difficulty in adapting. Sourcing efforts, especially those in low-cost countries, must consider the impact of these changes on the culture and business operations within that environment. Stability comes with a price.
6. Project organization risk
These are generally a result of not having the right people or equipment in the right place at the right time. You might also consider this as a planning risk.
7. Human behavior risk
Not surprisingly, human behavior risks are the most difficult to assess.
Sometimes the project or activity may be put in danger due to an illness or injury or due to the departure of key personnel. Sometimes, it may be the result of poor judgment or bad decisions.
In addition to the categories just outlined, our assessment should identify if the risks to be considered are internal risks (related to our own operations) or external risks – related to conditions outside of our organization, such as market factors, political climate, regulatory environment, economic circumstances, etc. More specifically:
- Internal risks are risks that you can control or influence. They include cost estimates, staff assignments, schedule delays, and product design.
- External risks are risks that you as a contract manager can’t control or influence. External risks include governmental actions relating to taxes that could affect a financial contract, whether delays that could affect a construction contract, and a change in currency rates that could affect the value of an international contract.
Understanding supply risks can enable purchasing organizations to take effective action in response to those risks. Risk management should form an integral part of good purchasing and supply practice. It is essential to address the right risks and use the right strategies.
A number of techniques and tools may be useful in helping you identify risks. Supply risk management activities can involve process improvement, buffer strategies, forming strategic alliances and developing suppliers. In our next article, we’ll reveal the top secrets on how to effectively deal with all the possible procurement risks.