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Supply Risk Management: Does Anyone Take It Seriously?

September 26, 2011

Last week IACCM ran an interview with Michael Held, a partner at Deloitte Consulting who had led research on the supply impacts of the Japanese tsunami.

In our conversation, we agreed that an increase in unexpected events is an inevitable consequence of extended supply chains – and therefore, by definition, of low-cost sourcing. Michael set out a thoughtful response to this when he introduced a concept called Risk Adjusted Pricing (RAP), which factors relative risk of supply chain disruption into price comparisons. He illustrated how this could be used to determine a truer sense of competitive cost comparisons and therefore lead to improved buying decisions.

One listener commented: “From the example given in the seminar, the in-country vendor is $11 (approx) more than the Chinese vendor.  Assuming the pricing to be FOB Destination (apples to apples comparison), the bottom-line here is that I am out $11 hard cash if I choose the in-country source.   Even though the RAP for China is $13 (approx) more.   That’s theoretical cash (funny money).

I go with China, I save $11 that goes to support my bonus goal and to my firm’s bottom line.

I go with in-country – I have a tough time coming up with $13 theoretical dollars to apply to my bonus goal and to my firm’s bottom line.

Short sighted, yes, but I think it’s more of a reality for most businesses.  It’s easier to blame a force majeure than spend more while your competitor is lucking out with the riskier supplier.”

The truth is that Procurement would prefer to have both a low price and low risk. But the weighting right now is strongly towards the former, at the expense of the latter. And in general, there is no tool or method to establish the value of paying a premium to reduce risks that are often unquantifiable for a single supplier or transaction.

The story may be a little different in a highly regulated industry such as aerospace and defense and this may indicate a re-balancing in other industries where regulatory pressure is increasing – for example, oil and gas, financial services. The cost of actual and reputational damages has to be sufficient to overcome the hunger for front-end savings.

And what about the role of the supplier in all of this? If someone wants to sell at premium prices because they offer superior management of risk, there are two important implications:

  1. terms and conditions must be adjusted to reflect that readiness to absorb customer risk (an implication that they will be recompensed if it occurs);
  2. data must be available to show the return on investment (ROI) that will typically be achieved from paying that higher price.
In the meantime, the difference between the ‘low risk price’ and the ‘high risk price’ is in a sense an insurance premium. Customers are, in general, betting that they can save more through low-cost supply than they will pay out due to supply chain risks.
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