Before 2020, the supply chain may have been something of an afterthought for the owners andleaders of many small- and medium-sized businesses. Organizational leaders knew thecompany’s key suppliers, kept an eye on monthly purchasing costs and may have helpedresolve delays or other minor disruptions that popped up from time to time. But for the mostpart, so long as everything was running smoothly — and it usually was —logistics were not a top concern for the C-suite. It was the domain of operations andwarehouse managers (or, increasingly, third-party logistics partners).
Of course, that all changed last year when widespread shortages and delays affectedbusinesses around the world and across industries. Since then, the supply chain has become afront-and-center issue at the highest levels of a business. More recent issues like agrounded container ship blocking the Suez Canal and winter storms in Texas have emphasizedthe point.
For a growing business, the impact of not having inventory to sell or materials tomanufacture goods can be devastating — the Federal Reserve estimates the pandemicknocked out 200,000 businesses in 2020. These organizations can’t match the cashreserves of large enterprises, so the effects of a problem can be more immediate and severe.
Leaders are acutely aware of the need for a clear strategy to reduce risks in their supply chain, and theyshould also know they must continuously evaluate and improve upon thatstrategy. We consulted supply-chain experts to develop a clear picture of the risks businessleaders need to consider when assessing their suppliers, what they can do to mitigate thoserisks and how technology can assist in these efforts.
What Are Supply Chain Risks?
Supply chain risks encompass economic, environmental, political, ethical, and cybersecuritythreats that can disrupt the flow of goods and services within a supply chain network. Theserisks include supplier bankruptcies, economic downturns, natural disasters, politicalinstability, ethical concerns like child labor, and cybersecurity threats. To mitigate theserisks, businesses can employ strategies such as supply chain mapping, weighted ranking,Value at Risk (VaR) assessment, supplier segmentation, diversification, inventory managementadjustments, scenario planning, and building strong supplier relationships to ensureresilience and continuity in their supply chain operations.
Key Takeaways
- The COVID-19 pandemic and other recent disruptions have highlighted the critical role ofsupply chains in business operations, making it essential for leaders to prioritizesupply chain risk management.
- Supply chain risks fall into four main categories—economic, environmental,political, and ethical—with examples including supplier bankruptcies, naturaldisasters, political unrest, and ethical concerns like sourcing from companies with poorlabor practices.
- Businesses should assess supplier risks by using techniques such as supply chainmapping, weighted ranking, Value at Risk (VaR) analysis, and supplier segmentation tounderstand and quantify potential vulnerabilities.
- Mitigating supply chain risks involves diversifying supplier bases, adjusting inventorymanagement strategies, considering scenario planning, and building strong supplierrelationships to enhance resilience and minimize disruptions.
Supply Chain Risks Continue Mounting
Most of the risks that could disrupt your operations fall into four broad categories:economic, environmental, political and ethical:
- Economic issues are a supplier going bankrupt, a recession or a work stoppage at a keymanufacturing partner.
- Environmental problems include natural disasters like a flood, earthquake or drought.
- Political risks could be civil unrest and a new leader who implements steep tariffs orputs restrictions on exports.
- Using child labor, forced labor or sourcing raw materials from a company that fails togive its workers the necessary protective equipment would be ethical concerns.
These are not new issues, though many of them have become more prevalent: For example, datafrom international disaster database EM-DAT shows the frequency of natural disasters hassteadily increased over the past 20 years. At the same time, concerns that could be broadlyclassified as environmental, social and governance (ESG) have come into focus.
Take for instance the provenance of products: A growing group of consumers wants to knowwhere goods originated and that they were made with sustainable and ethical practices.Similarly, environmental risks now extend beyond natural disasters to sustainability. If acompany is dumping waste in waters or releasing harmful toxins in violation of localregulations, that could lead to a fine or even a forced shutdown.
Additionally, cybersecurity has become a much bigger threat in a business environment thatrelies heavily on technology to coordinate and manage activities, said Steven Melnyk, aprofessor of supply chain management at Michigan State University. For smallercompanies, protecting against cyber threats comes down to choosing software vendors thatfollow leading cybersecurity practices.
3 Strategies to Assess the Risk of Your Suppliers
Small and midsize businesses need to know how the suppliers they work with directly, tier 1suppliers, stack up in each of these categories. Leading organizations will look upstream totheir tier 2 and tier 3 suppliers, but that often comes later. Achieving any level ofinsight is a big step in the right direction.
To reinforce their supplier networks, companies should first understand which types of risksvarious partners present and the degree of risk in each case. This is often not an easy norfast exercise, but it’s critical.
To assess the risks of your suppliers, consider these strategies:
Basic supply chain mapping
Before you can evaluate suppliers (and perhaps your suppliers’ suppliers), youneed tomap out who they are, what they provide and where they’re located. Collaboratewithcolleagues across your organization as you build this map to avoid overlooking a fewsuppliers, especially if they provide a few small items. You can create a basic mapof theselinks in a spreadsheet or certain supply chain software. It’s important toupdate themap regularly as you add partners and stop working with others.
Weighted ranking
You can use a basic system that assigns weighted importance to risk factors likeeconomic orpolitical disruption, financial dependence, credit history and natural disasters,said JackCunningham, a purchasing manager at a global consumer products company. If youchoose to usethis system, you’ll give each of those factors a weighted importance and eachsuppliera score of 1-5 for each (with 5 representing the highest risk). Then,you’ll calculate the weighted average (opens in a newtab) of those numbers to come up with a score thatrepresents a supplier’s total risk — and compare the scores of variouspartners.
Value at risk (VaR)
The Association for Supply Chain Management (ASCM) has a metric called Value at Riskas partof its Supply Chain Operations Reference (SCOR) model, and it’s another wayforbusinesses to compare the amount of risk that various suppliers present. A companywillconsider categories of risks — whether they be risks related to politics,weather,ethical practices, quality or other categories — and assign probabilities tothelikelihood of occurrence. For example, if there’s a 10% chance that ahurricane willhit a particular geography; and the supplier in that region is your only provider ofacertain component; and the value of the product affected would be $3 million, thenthe Valueat Risk is .1 x $3,000,000 = $300,000. Based on these calculations, your companymight shiftorders to less risky regions or carry enough inventory to cover typical recoverytimes.
A Note about Segmenting suppliers
When using any of these techniques, factor in the importance of various suppliers to yourbusiness. You can segment suppliers into groups, much like an ABC inventory analysis. Apartner in the A segment might make a key component for a consistent bestseller, while onein the C segment could offer an easily replaceable product. You shouldn’t necessarilybase this ranking on sales alone: A critical supplier in a part of the world with minimalrisk may still warrant lots of attention because you’d see a substantial revenue dropif that supplier weren’t able to deliver. At the same time, sourcing a fewnon-critical or easily replaced components in a high-risk area may not be a major concern.
4 Strategies to Mitigate Supplier Risks
Diversify your supplier base.
Once an organization has assessed the risk of its supply chain partners, the best waytobuild resilience is to diversify itssupplier base. That means finding redundant suppliers for keypartsand materials that are located in different parts of the world so, for instance, ahurricanein a certain region doesn’t halt all shipments of a crucial material. It couldalsomean finding partners closer to home — maybe not in the same country but onthe samecontinent.
Localizing YourSupplyChain (opens in a newtab): Understand the potentialbenefits,major coststo consider, potential barriers to relocation and steps to take ifyoudecide to onshore.
Identifying and onboarding a supplier could take anywhere from weeks to a year ormore,according to experts we interviewed. A new supplier for a commodity like a ballbearingcould be live in a week, while one that provides a specialty part for highlyregulatedproducts like medical devices could take a year or longer due to strict standardsandtesting, said Tony Nuzio, founder and CEO of consultancy ICC Logistics Services.
Modify your inventory planning and management strategy.
Modifying your inventory planning and management strategy is another way to increaseresilience. You’ve likely already considered this: Many manufacturers,distributorsand retailers are struggling to decide how much inventory to carry in light ofrecentsupply-chain snags. Over the past quarter century or so, many products-basedcompanies haveadopted a just-in-time (JIT) inventory strategy. Organizations practicing JIT attemptto stockonly materials and goods they expect to sell, along with a small buffer of safetystock, inan effort to reduce costs.
Even if a just-in-case (JIC) inventory approach gains traction, JIT is not on thebrink ofextinction. The reason it became popular — it can lower purchasing andinventorycarrying expenses — is the same reason it won’t go away. Any companythatpracticed JIT without factoring in changes in forecasts would have run into problemswellbefore the past year, said Peter Bolstorff, EVP of the ASCM.
Procurement teams will and should continue to use the economic order quantity (EOQ)formulato calculate ideal order sizes, reorder point (ROP) to determine when to placeorders andsafety stock to figure out the right amount of buffer stock. There are far moreadvancedmodels, but these are the starting points for finding ideal inventory levels,or inventory forecasting.
Inventory Forecasting Formulas and Examples
Formula Sample Data Example Economic Order Quantity (EOQ) √ [(2 × Costs per order x Annual demand) / Annualholding costs] Order cost=$5,000, Annual demand=10,000 units, Holding costs=$3per unit EOQ = √ [(2 x $5,000 x 10,000) / $3] = 5,774 units Safety Stock (Maximum daily usage x Maximum lead time) – (Average dailyusagexAverage lead time) Max daily usage=100, Max lead time=20 days, Average dailyusage=70,Average lead time=14 days Safety stock = (100 x 20) – (70 x 14) = 1,020 units Reorder Point (ROP) (Number of units used daily x Number of days lead time) + Numberofunits safety stock Units used daily=70, Lead time=14 days, Safety stock=1,020 units Reorder point = (70 x 14) + 1020 = 2,000 units Even as businesses consider holding moreinventory, it doesn’t make financial sense to increase stockon-hand forevery SKU, nor is it feasible for most. Here are a few ideas to help youdetermine the ideal amount of buffer inventory to keep in yourwarehouses:
ABC inventory analysis
A simple ABCinventory analysis is a great way to find out which products pull themostweight for your business. Those select items that make up the majority of yourrevenue orprofit fall into the A category; the next-biggest sellers are in the B group; andthe leastpopular items are in the C group. Companies often find A products represent 70-80%of allsales, B items 15-20% and C goods just 5-10%. Cunningham, the purchasing manager,said thatin his experience, 20% of products usually account for 80% of sales, reflecting theParetoprinciple, or “80-20 rule.” It makes sense to carry larger quantities ofthose Aproducts, or the components needed to make them, because your business will take thebiggesthit without them. On the other hand, certain SKUs in the C group might not be worthsellingif it costs more to continue offering them than the profit they drive.
Calculating inventory carrying costs
It’s essential to have a strong grasp on carrying costs, or the expensesassociatedwith keeping items on-hand. There are a lot of expenses to consider when calculatingcarrying costs: storage, insurance, taxes, labor, shrinkage, obsolescence and more.Opportunity cost is an important consideration here, because money tied up ininventorycould have been spent elsewhere, like on a marketing campaign or a new hire. Butsomeproducts are more expensive than others to hold, and managers need to know thosecosts atthe item-level as they make stocking decisions. They can then weigh those carryingcostsagainst the value of potential lost sales and determine whether the projectedrevenuejustifies the expenses.
Recognize the potential of scenario planning.
Interest in scenario planning surged after so many organizations were blindsided lastyear.Companies want to be better-prepared for the next disruption, and scenario planningtoolscan help by projecting the financial effects of, say, a key customer leaving,receiving noorders from two suppliers for three months or a sudden surge in demand. Awareness ofthefinancial impact of best-case, worst-case and average-case outcomes can informdecisionsabout how much inventory to carry. Decisions are based on data rather than bestguesses.
: Get afullrundown on how to choose the scenario-planning framework that worksbestforyour team, as well as detailed examples.
Treat your suppliers like true business partners.
As should be clear at this point, your success is dependent on your suppliers,shippingcarriers and everyone else that plays a role in your supply chain. You need toremember thisas you strengthen your supply chain. It may require shifting the way you think aboutsuppliers, from simply “the person we buy something from” to a truestrategicpartner.
At the heart of this is the age-old art of relationship building. Wherever possible,take thetime to get to know your primary point of contact at each supplier.
This small investment of time and money could pay dividends down the road. If anissuearises, who is the supplier more likely to alert: the person that simply submitspurchaseorders or the one who knows their name and calls to check in every month? Oneprocurementleader said without the close relationships he built with Chinese suppliers, hisbusinesswould’ve been in serious trouble when the pandemic hit.
To earn priority treatment, supply-chain leaders need to make an effort to understandtheirpartners’ businesses and what they can do to be a great customer. Apersonalizedapproach to each supplier will make it clear that you value them and view this as amutuallybeneficial relationship.
How to Findthe Right Suppliers: As your supply chain becomesincreasingly intricate, look for certain traits in your partners to avertproblems down the line.
Your Complete Guide to Inventory Forecasting
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Which Supply Chain Technology Do You Need?
Many of the steps you can take to strengthen your supply chain depend on access toup-to-date, reliable information. A few critical systems can help you track all the nodes inyour supply chain, providing a real-time picture of your end-to-end operations.
To get started, growing businesses should invest in tools for inventory management andprocurement. Inventory management systems are essential in improving inventory planning andanalysis, especially as companies consider keeping more items on-hand. Procurement softwarecan help you keep tabs on all of your suppliers by showing the performance, contacts andtransaction history for each. Companies that manufacture will see quick ROI with amanufacturing solution that helps plan production runs and ensures they have enough capacityto meet demand. One other core piece is a demand planning application that can help forecastfuture sales based on historical sales data and other inputs from complementary systems.
Collectively, these systems are often referred to as supply chain management (SCM) software because they help businesses managethe entire flow of goods, from sub-suppliers through delivery to end users. Together theyrecord a great deal of information that can be culled into digestible dashboards andreports. For example, how often are supplier shipments arriving late? How fast are productsin a certain category turning, and at the current pace, when will you run out? Tracking thisdata will also reveal shifts in supply and demand that you can use to produce accurate,trustworthy forecasts so you’re prepared for the future.
SCM systems are typically integrated with an enterprise resource planning (ERP) platform that provides a global view ofyour business — not just operations but also finance, HR, sales and marketing andmore. The ERP allows leaders to see how changes or issues in their supply chain affect otheraspects of the organization, like cash flow and cost of goods sold (COGS). That level ofdetail is absolutely crucial for businesses that want to build a more resilient supply chainwithout straining their bottom line.
Minimize Supply Chain Risks With NetSuite
NetSuite’s supply chain management software aims to keep operationsrunning smoothly, ensuring that all workers and materials are available at the right timeand place. NetSuite procurement capabilities drive accuracy throughout the purchasingprocess while supporting collaboration with suppliers. In addition, integrated demandplanning, inventory management and predictive analytics optimize supply chainstrategies and streamline tasks to ensure that supply plans are executed without disruptionand products are delivered as promised.
The past 14 months or so illustrate why small and midsize business leaders can’t simplyhope for the best with their supply chains and turn their attention elsewhere. Theconnection between supply chain management and financial success, even solvency, is nowcrystal-clear.
Top decision-makers must be involved in efforts to strengthen the supply chain. They need torealize that risk and reliability are critical factors when making any decision related totheir supply chain and adapt accordingly. At the same time, they should recognize the valueof establishing trust and goodwill with new suppliers and strengthening relationships withexisting ones.
Supply Chain Risk FAQs
What are the risks of the supply chain?
Supply chain risks encompass a range of potential disruptions and threats, including economicrisks (e.g., supplier bankruptcies, economic downturns), environmental risks (e.g., naturaldisasters, climate change), political risks (e.g., political instability, trade policychanges), ethical risks (e.g., sourcing from companies with unethical practices), andcybersecurity risks (e.g., cyberattacks and data breaches).
What is causing supply chain issues in 2023?
Supply chain issues in 2023 are related to various factors, including global events,transportation challenges, labor shortages, and geopolitical factors, among others.
What are the US supply chain issues?
Supply chain issues in the U.S. can include challenges related to transportation andlogistics, labor shortages, disruptions caused by natural disasters, trade policies, andcybersecurity threats. These issues can impact various industries and sectors within theU.S. supply chain.
