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Managing Logistics Risks in Global Procurement

Author(s):

Joseph R. Carter D.B.A., C.P.M.
Joseph R. Carter D.B.A., C.P.M., Professor Purchasing and Logistics Management Program, Arizona State University, Tempe, AZ 85287-3706, 602/965-0931
Bruce G. Ferrin Ph.D.
Bruce G. Ferrin Ph.D., Assistant Professor Purchasing and Logistics Management Program, Arizona State University, Tempe, AZ 85287-3706, 602/965-0931

81st Annual International Conference Proceedings - 1996 - Chicago, IL

Abstract. Purchasing executives and their management teams in global business struggle each day with a plethora of commercial, political, organizational, and technological changes. These forces are having a profound effect on the types and complexity of risk purchasing organizations face each day. The speed of change is reducing reaction time and increasing supply management risk. There is a compelling need for a new paradigm of global supply management risk assessment and control for purchasing organizations of virtually every size throughout the world.

Introduction. The sheer number of risks purchasing organizations must deal with each day requires that purchasing managers develop an integrated approach to global supply management risk assessment, as well as, effective processes to reduce risks to an acceptable level. Purchasing organizations face obvious risks such as those inherent in the use of financial derivatives, or compliance with confusing and conflicting environmental laws and regulations.

However, global supply management risks are not always so visible. Global competition for sources of supply means that there is always a competitor ready to undermine a firm's supply base even though an organization believes that it has assembled a world class core of suppliers. Technological advancements are making products obsolete at an increasingly rapid pace. International currency, interest rate and especially commodity markets are more volatile than ever, and the availability of more sophisticated derivative instruments for managing those risks is not necessarily a comfort. Add political, social, environmental and other factors and one finds that the global economy is a very risky place in which to source products and services.

The question becomes, given the myriad of risks purchasing executive face each day, what is a purchasing organization's best strategy for exploiting global opportunities while minimizing and controlling risks?

Global Supply Management Risks. Global supply management risk is the threat that an event or action will adversely affect a purchasing organization's ability to achieve its sourcing objectives and execute its purchasing strategies successfully. The term financial risk is far too restrictive for the purposes of this definition. The term ?global supply management risk capture the comprehensive focus of the problem because it encompasses the entire spectrum of significant threats to a purchasing organization's success. In addition, global supply management risk arises as much from the likelihood that something good won't happen as it does from the threat that something bad will happen.

Each purchasing organization will certainly have its own unique set of constantly changing global supply management risks. Certain risks will be external to the firm and will be either difficult or impossible to control. Others will be internal, resulting from a firm's own purchasing organization structure, processes, purchases, contractual commitments or relationships with suppliers and partners. Examples of these might include technology (are we purchasing the latest or optimal?), information (is our information for decision making relevant, accurate, timely?), human resource (are our employees productive; do they represent us well to suppliers), and many other risks.

Symptoms of Poor Risk Management. How does the purchasing function know that its organization has effective processes for managing global supply management risks? There are several clear warning signs that an organization needs to increase its risk management focus. First, is there a clear linkage between risk and total cost? Risk impacts cost, not in some ethereal way but directly. For example, to guard against the risk of supply interruptions, a company might dual source some critical commodities or services. This dual sourcing can result in increased cost either through price differentials, added shipping, or increased inventories. These are explicit costs which must be reconciled against the reduced risk obtained through multiple sources of supply.

Second, does the organization make a concerted effort to anticipate the sources of global supply management risk? Global supply management risk evaluations need to keep pace with the ever changing global business environment. An ad hoc approach is just that---haphazard. The risk management structure should be formalized and active. Does the firm have a explicit requirement for purchasing managers to periodically assess supply management risks and the performance of risk controls?

Third, does the function have an integrated risk assessment framework? A firm needs to constantly evaluate its purchasing strategies. Which are effective and which are ineffective strategies? Environment and other assumptions should be examined when it becomes obvious that a strategy is not working. There needs to be a systematic approach for identifying, sourcing, measuring and monitoring global supply management risks and making risk management and acceptance decisions. In this way, a formal mechanism for evaluating and changing ineffective purchasing strategies will be in place. Also, having a formal risk management framework in place will make it clear to all that top-management sees global supply management risk assessment as a high priority. Consequently, employees and mid-level and lower-level managers will consider it important.

Finally, is the global supply management risk assessment process at the firm fragmented? Does finance/treasury worry about the risk of exchange rate fluctuations, does logistics worry about transportation problems, or does marketing concern itself with countertrade requirements? Functions and departments should not act independently as separate "silos". Global supply management risk is everyone's business. Communication is a key to effective risk management. Periodic, sporadic internal communications about supply management risk and control is inadequate. Such limited communication can only lead to sporadic control, after-the-fact, of arising problems.

A Model of Global Supply Management Risk Control. The role of risk control demands far more than simply an ad hoc approach to managing global supply risk. The breadth and magnitude of potential risks are too great for a purchasing management team to hope disaster won't strike. In today's dynamic global markets, the purchasing function must adopt an active and integrated approach to managing risk. Employees throughout the supply management organization must be engaged in the development of effective control processes and early risk identification systems to monitor changes in risk factors and continually reduce risk to acceptable levels.

Organizations use many different practices to control supply management risk. Unfortunately, control is all too often confused with budgeting, endless management reporting requirements, and a stream of useless information moving up and down the supply chain. Fast changing supply markets, flatter and thinner purchasing hierarchies, and the need for an expanding scope of authority at the local level are changing the manner in which purchasing organizations operate and rendering the old model of risk control obsolete.

Global supply management risks have become terribly interrelated and supply markets closely linked. Rather than treat global supply management risk control as a series of linear activities, it should be treated as a business process. Global supply management risk controls are processes specifically designed to provide assurance that vital purchasing business objectives (strategies) are identified and achieved. These processes can assist purchasing managers in avoiding, transferring, or otherwise reducing supply management risk to acceptable levels. Note well that the goal is not to eliminate all risk. Risk is unavoidable and in many cases quite acceptable. Playing it safe all of the time is not a possible or even good idea.

Elements of Supply Management Risk. A useful way to organize the universe of risks is under four broad headings: supply environment, economic environment, operational environment, and sociopolitical environment. These four categories of risk provide a broad foundation from which more specific risks can be identified and detailed. A fuller model of global supply management risk is provided in figure 1. As shown in the model each category and sub-category includes specific risks. Each supply management organization should develop a firm specific model that all employees can understand, internalize, and use to identify, source, measure and control supply management risks. Senior managers can quickly grasp the strategic importance of focusing on the entire array of supply management risks as they develop specific sourcing strategies to exploit new opportunities and world-class benchmarks to control and evaluate their organizations.

Supply environment risk arises when there are external forces the could change the fundamental assumptions that drive a purchasing organization's overall objectives and sourcing strategies. These forces include the actions of suppliers or supply markets, shifts in commodity availability or prices, changes in logistics channels or capacity, or other factors outside the purchasing organizations direct control.

Operational environment risk arises when purchasing processes do not function efficaciously. Some examples of poorly performing purchasing operational processes occur when purchasing strategies are not effectively aligned with overall business strategies, the purchasing process is ineffective in satisfying user needs, the purchasing process does not function efficiently, or the information technologies are not operating as intended or are compromising the availability and accuracy of needed information.

Economic environment risk occurs when purchasing fails to protect significant financial, technological, or supply market-based assets from unacceptable losses, risk-taking, technological obsolescence. A classic example is a purchasing organizations failure to identify and control the risk of exchange rate fluctuations in a global sourcing environment. Another example would be the failure of purchasing to identify new sources of global technological advantage before they are exploited by a competitor.

Sociopolitical environment risk arises from changes in the global social and political fabric. This risk encompasses governmental laws and regulations, cultural demographics factors, and the ethical issues involved in operating in different cultures and environments.

Risk and Sourcing Strategy Selection. Strategic sourcing is a decision making process that involves the analysis of internal capabilities and external environments of a firm in order to efficiently and effectively use resources to meet organizational goals. The strategic sourcing framework allows a purchasing organization develop its capacity to anticipate, as well as to efficiently implement change. The importance of adapting the sourcing function to its environment cannot be underestimated.

The sourcing strategy management process consists of three phases: sourcing strategy formulation, sourcing strategy implementation, and sourcing strategy control. Sourcing strategy formulation is a process in which the purchasing function defines its role in the business, evaluates internal and external capabilities, and selects specific sourcing strategies to accomplish its supply management objectives. But how can a company know which sourcing strategies to select and how to judge their effectiveness? The proper identification and management of global supply management risk is the key. Without a proper understanding of environmental risk, proper sourcing strategies cannot be formulated and implemented, and effective world-class benchmarks cannot be selected to measure the effectiveness of these strategies. In simple terms the goal of all sourcing strategies is to manage environmental risk. This relationship is the missing link a sourcing strategy development and management.

Summary. A fragmented or unfocused approach to managing global supply chain management risks is inadequate in these turbulent times. The forces of change, shifting customer needs and expectations, increasing competition from supply, new technologies, a complex legal and regulatory environment, worldwide financial instability, changing circumstances for employees placed in positions of trust, and global supply market volatility, all require an integrated and systematic approach to making informed decisions regarding global supply management risks.

Purchasing management's role requires that the following global supply management risk and control issues are raised and addressed as organizational change and development occurs.

  1. As we re-engineer and improve procurement processes, have we considered all relevant global supply management risks?
  2. As we source new technologies globally, how will we assess and control the new risks that arise?
  3. As we enter into more complex business transactions and relationships with global suppliers, how do we assess and control the supply management risks (e.g. the affect of global markets and competition, the use of derivatives, the threat of environmental liabilities, the exposure to litigation, the possibility of unethical acts by employees, etc.)?
  4. As purchasing organizations downsize, how do they insure that existing and presumably necessary controls are not compromised?
  5. As we develop and implement sourcing strategies, how can we link those strategies to specific global risks and benchmark these strategies effectiveness in reducing these risks to acceptable levels?

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