Risk Scenario

Don’t Break the Chain

A risk manager for a manufacturing company argues for a supply chain assessment. Will stakeholders agree it's the right move?
By: | June 11, 2013
Risk Scenarios are created by Risk & Insurance editors along with leading industry partners. The hypothetical, yet realistic stories, showcase emerging risks that can result in significant losses if not properly addressed.

Disclaimer: The events depicted in this scenario are fictitious. Any similarity to any corporation or person, living or dead, is merely coincidental.

Part One

The sailboats gliding in San Diego Harbor as seen through the board room window were distracting, but business is business.

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To help her focus on the meeting she was in, Jennifer Gage, the risk manager for Charing Corp., a San Diego-based plastics manufacturer, raised her warm, almost full paper coffee cup and inhaled deeply.

Then Mark Lacy, the director of operations, said something that negated her need for caffeine.

“With the current profusion of new oil production sources domestically and globally, we think we can find feedstock cost savings out there. Substantial amounts, we think,” Lacy said.

Lacy added that his department was well on its way to identifying low-cost oil alternatives on a number of continents.

Jennifer got it. So did everyone else in the room. In its battle to stay competitive, Charing Corp., which used petroleum as a feedstock to manufacture plastic housings for household appliances, had to keep a sharp eye on the cost of raw materials.

But as Mark Lacy discussed different global sourcing locations, Jennifer started making notes.

Under the word risks, underlined three times boldly on her notepad, she started a list:

1) Reputational – What threats did any new suppliers represent from a reputational perspective? Human rights, etc.

2) Political – Where were these countries on the political spectrum? How impacted were they by recent political unrest for example? Run this down.

3) Logistical – What ocean passages or other transportation networks were these potential new suppliers dependent on? What recent geopolitical events made some channels more at risk than others? Bottom line, where were the bottlenecks? Which suppliers were more likely to suffer an event that would disrupt the flow of feedstock?

4) Nat/CAT – Which of the potential new suppliers were more exposed from a natural catastrophe perspective? Storm surges, coastal locations, etc.  Anything Gulf of Mexico-related.

As Lacy talked about locations in Southeast Asia, Latin America, the United States and Europe, Jennifer wrote, “Shorten the chain, strengthen the chain,” under her list of risks.

Later on, Mark Lacy was heading down the corridor away from the board meeting and Jennifer set off after him. He looked like he had places to be going, but so did everybody.

“Hey Mark,” Jennifer said. “You got a couple of minutes?”

Mark smiled.

“Sure, what’s up?”

“I wanted to talk to you about your feedstock sourcing plan, just wanted to go over a few things,” she said.

“Sure thing. I’ve got a little chunk of time before my next meeting,” Mark said affably.

In Mark’s office, Jennifer laid her cards right on the table. She and Mark had a good working relationship, so she had no need to hedge her comments.

“Looks like you’ve got a lot of support for your cost-cutting move,” she said.

“If I can pull it off,” he said.

“I think you can pull it off. But I want to work with you on it,” Jennifer said.

“What do you mean?” Mark said.

Scenario Partner

Scenario Partner

Jennifer laid out the plan that had started forming in her brain during the meeting.

Jennifer had done her reading. She knew that it was almost a “classic” supply chain risk management challenge to convince company stakeholders to conduct a supply chain risk assessment.

The cynics said it was just too tough to convince other executives to do it. The risk was so vast and hard to understand. Even if you were successful in convincing your team to conduct one, there was still the matter of convincing second and third-tier suppliers to tell you enough about their operations to assess the risk. Not too many of them were apt to do that.

The worst fight was usually between procurement and risk management. Procurement thrives on low cost and speed. Risk management urges caution; not exactly a good mix.

But here, with Mark and Jennifer, procurement and risk management were in the same room already. There was no place for cynicism here. This was a time to take advantage of an opportunity.

“I think our insurance carrier can help us with a risk assessment of the locations you’re considering,” she told Mark.

“Straight-up raw materials cost is one thing, and it’s a big thing, I’m not underestimating that,” she said.

“But if we can show Brad (the CFO) and Dax (the CEO) a risk benefit analysis that can establish a metric between the cost of the feedstock and the risks involved in procuring it, then we’re adding value, identifying the true upside of whatever move you make,” she said.

“This is a bottom line issue, not a top line issue,” she said.

“It is. But we’ve never done this before,” Mark said.

“But we should do it, shouldn’t we?” Jennifer asked.

“Yes, I think we should,” Mark said.

“The problem is we don’t have tons of time.”

Part Two

Jennifer gets in touch with her insurance carrier, based in New York.

Scenario_DontBreakTheChainWith the carrier, Charing Corp. has a property policy. Given the potential supplier changes, the carrier recommends that Charing Corp reconsider the existing contingent business interruption (CBI) coverage to make sure it’s adequate given any potential developing risks. The carrier agrees that a supply chain risk assessment would provide the necessary insight.

The carrier’s internal risk engineering team, led by Harry Reynolds, is on the same page. Harry agrees a comprehensive assessment will have great value. He explains that a supply chain risk assessment can not only identify the client’s supply chain exposures but also recommend risk mitigation strategies and actually help the carrier assess the risk, structure and price the CBI cover for the client. He also agrees with her in terms of the factors that will need to be studied to assess the supply chain risk presented by any new suppliers.

“Reputation is a big one,” he says. “This building collapse in Bangladesh has got everyone’s attention. When it comes to suppliers, it’s getting just like a retail real estate purchase out there. Everybody’s talking location, location, location. And its connection to reputation,” he said.

“Price is one thing,” he says. “But these days, with rampant Internet commentary, who can afford the reputation hit?”

Reynolds said his team can visit the most exposed supplier locations and assess their vulnerability to natural catastrophe exposures, conduct an assessment of any transportation bottlenecks those locations could face and the political and reputational risks for each location.

Depending on how much cooperation they can get from perspective suppliers, the carrier can also work with Charing Corp. to develop risk management plans which could include helping to identifying alternate trade routes and using engineering to strengthen production locations against natural catastrophe exposures.

It takes a few days, but Harry is able to drum up an estimate for what the risk assessment would cost.

Mark Lacy has been given six months to come to a decision on his new suppliers. Now, he and Jennifer need to make the case to the CFO and then the board, that a supply chain risk assessment should be conducted before that decision should be reached.

In the office of Brad Parks, the CFO, Jennifer and Mark make their case, together with Harry and the insurance carrier’s team.

“You think we can get this assessment done and still come to a decision in six months? I’d hate to push this decision back,” Parks said.

“I think we can get it done,” Mark says.

“As it stands we’ve got four new locations that we’re looking at,” he said. “They are in South East Asia, Latin America and the US,” he said.

On a price per unit standpoint, the supplier in South East Asia seems to be the most cost effective, with Latin America second. But a full risk assessment will tell Charing Corp. at what potential cost.

“This is such a hard thing to get a handle on,” Brad Parks said. “You never know where or how a supply chain is going to get hit.”

“But you have to look at it,” Jennifer said. “Here’s what happens if you don’t look at it.”

Jennifer hands Brad an article that showed what major auto manufacturers went through after the Tohoku earthquake in Japan on March 11, 2011. That April, Honda’s production was reduced by 81 percent, Toyota’s was down 78 percent and Nissan’s was down 49 percent.

The numbers speak volumes.

As events in Japan showed, a lot of the big auto manufacturers did not have sufficient insight into their supply chain exposures and it really cost them. Then that industry and others got hit again when flooding ravaged Thailand later that year.

Parks doesn’t need to pick up a calculator to see how the costs of those kinds of production losses at Charing Corp..

“I don’t think we can afford not to do this,” Mark says.

“Then do it,” Brad says.

Part Three

Nothing well done is easy, and even with the expert work done by Harry and his team, Charing Corp. still had some tough decisions to make.

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The risk assessment analysis from the insurance carrier’s engineering group indicated that increased storm surge levels in the Pacific basin meant that there was a material chance of the South East Asian oil producer suffering a storm-related business interruption in the next five years.

Other countries had their own problems. Unstable political environments in other locales, as an example, made relatively cheap oil look like a questionable bargain.

Closer to home, the factories located along the Gulf of Mexico represented substantial hurricane risk. But those suppliers had the advantage of being closer to Charing Corp’s operations in Southern California.

There was less to worry about there from a logistics standpoint.

In addition, working together with the carrier, Charing Corp. had identified alternate suppliers and suggested a timeline and process for switching suppliers in the event of any business interruption events.

It looked like the Gulf of Mexico suppliers were the best bets from a supply chain risk management standpoint. And the price of oil Charing Corp. would get from these suppliers was 7 percent less than their current suppliers; But the South East Asian and Latin American suppliers were even more cost effective on a per unit basis.

Even more research would be required if the board was going to be convinced to go in a different direction. Jennifer did some more reading and came up with the idea of researching the supply chains of two of Charing Corp’s toughest competitors to try and find the weak spots. This is something private equity investment companies do to identify supply chain weaknesses when betting against the market.

The carrier was willing to advise here, based on their market knowledge. As it turned out, Charing Corp’s competitors were using South East Asian and Latin American suppliers.

This analysis of the broader market’s supply chain risk exposures, along with the detailed supply chain risk management plan from the insurance carrier is what carried the day with the board. Based on the research done by Jennifer, Mark and the insurance carrier’s engineering team, the board backed the switch to suppliers in Latin America and the Gulf of Mexico, and agreed to enhance the CBI cover for additional protection.

It was three months after Charing Corp. had made the switch that a typhoon struck South East Asia. Two of Charing Corp’s biggest competitors suffered three weeks of contingent business interruption.

Adding to the competitor’s difficulties was that the South East Asia supplier wasn’t very transparent about how badly it had been impacted. This lack of transparency delayed the competitor’s finding alternate suppliers.

As its competitors struggled, Charing Corp picked up two lucrative contracts that were going unfilled due to their suppliers’ difficulties.

“I guess we got a little lucky,” Jennifer told Mark as they left a meeting where Dax Baxter, the Charing Corp. CEO, had led the room in applauding them for a job well done.

“We got lucky because we planned,” Mark said.

“Lunch is on me, needless to say,” he added.

Summary

A manufacturer based in Southern California realizes some significant business advantages by conducting a supply chain risk assessment before making a key procurement decision.

1. Know your subject: The lessons of the Tohoku quake in Japan in 2011 have been fairly well documented. Selling the need for a supply chain risk management assessment to stakeholders within your company should be accompanied by cold hard data about what your company can lose if it is not prepared for a business interruption event.

2. It’s not just about logistics: Supply chain risk management involves much more than just a study of transportation or supply flow charts. Studying such things as political risk, reputational risk and the impacts of natural catastrophes on contingent business interruption are all part of the to-do list in this discipline.

3. Ask for more from your carrier: Insureds should work closely with their insurance carriers who usually offer great expertise in terms of technical experience in supply chain risk management.

4. Ask for more from your suppliers: If your suppliers aren’t willing to work with you to help you make the most informed risk management decisions when it comes to your supply chain, then you may want to consider alternatives. Transparency all the way down the line is what will create business opportunities here.

Dan Reynolds is editor-in-chief of Risk & Insurance. He can be reached at [email protected]

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