How to mitigate supply chain risk: 5 steps to consider
What is supply chain risk?
Risk in the supply chain refers to anything that can go wrong in the supply chain and compromise product or service delivery, increase costs or damage a company’s reputation.
Businesses typically break supply chain risk into two types: known risks and unknown risks.
Companies can anticipate known risks and measure and manage them over time. Known risks could be cybersecurity threats, which organisations can monitor and plan for, or supplier unreliability, which they can assess based on their financials and performance history.
Unknown risks are those that an organisation can’t realistically foresee, such as highly unusual natural disasters. Although organisations can’t necessarily anticipate these risks, responding quickly when they happen can lessen the harm they cause.
Categories of risk in supply chains
There are two types of financial risks associated with supply chain risk.
External financial risks include conditions an organisation can’t control, like unfavourable exchange rates or inflation. External financial risks can also include problems with trading partners, like if a supplier goes out of business or files for bankruptcy.
Internal financial risks are those an organisation can control and prevent, like overspending or unplanned changes that require additional funding.
Schedule-related risks include anything that disrupts a project timeline, like delayed materials, missed milestones, poor project management, or equipment failure. Longer than expected timelines drive up costs and tie up resources, which may prevent companies from taking on new projects.
If an organisation can’t find skilled employees to complete their work, this shortfall can jeopardise timelines and output. Labour shortages can be especially problematic for companies that experience seasonal surges in demand.
Legal risks include issues like contract disputes with suppliers or patent infringement, and product liability lawsuits. Legal risks may also be internal, such as failing to provide employees their minimum entitlements.
Environmental risks include natural disasters that cause widespread damage. These events can have devastating impacts on production facilities and delivery timelines.
Environmental supply chain risk can also include harmful emissions or improper waste disposal by a company or its suppliers. Poor business practices will eventually impact the bottomline.
How to assess your supply chain risk
Supply chain risk management starts with mapping out your suppliers. This list should include:
who the supplier is
what they provide
where the supplier is located
where they fit into the supply chain.
This list may also need to include your suppliers’ suppliers.
Update your supplier lists regularly, adding new partners and removing those you no longer work with. Supply chain software makes it easy to keep track of this information and account for every link in the chain.
Weighted scoring assigns a “weight” to each potential risk based on its level of importance. For instance, if supplier performance is a larger risk than natural disasters, that risk will have more weight.
After listing the risks and their respective weights, assign each supplier a score of 1–5 for each risk (with 1 as the lowest risk level and 5 as the highest), then calculate the weighted average.
Once all suppliers have a weighted average, compare their scores. Weighted scoring makes it easy to identify where supply chain risks are more likely to happen, and which partners are the most reliable.
Calculate value at risk
Another way to evaluate risk in supply chain is to use The Association for Supply Chain Management’s (ASCM) value at risk (VAR) metric.
Like weighted scoring, this process starts with putting risks into categories. Then, determine the likelihood of each risk occurring and how much the affected product would be worth. Multiply the two to understand the value at risk. For example:
A supplier has a 20% chance of going out of business and is the only company supplying a specific component.
The value of the product you make with that component is $2 million.
To find the VAR, multiply the chance of risk (20%) by the product value ($2 million).
The value at risk = $400,000 (0.2 x $2,000,000 = $400,000).
Companies use the VAR to make strategic decisions about their supply chains. In this scenario, the company may bring on an additional supplier or order backup inventory so they can continue making their product if the original supplier shuts down.
Risk mitigation in supply chain processes
If you’ve identified suppliers that are especially vulnerable to risk, diversifying — adding trading partners that offer the same parts or materials — makes for a more resilient supply chain. For instance, if a supplier in China is susceptible to shipping delays, adding a domestic supplier that doesn’t rely on overseas shipping mitigates that risk.
Keep in mind that onboarding new suppliers can take weeks or months, so you may want to ask multiple suppliers how quickly they could formalise a partnership with your company.
Many organisations have a just-in-time inventory (JIT) strategy, where the right amount of inventory arrives right at the time they need it, and the company keeps only a small amount of safety stock on hand as a buffer. But that buffer might not be enough to offset shipping delays.
A just-in-case (JIC) inventory approach, on the other hand, keeps more stock on hand in case of inbound material delays. It’s a more cautious stocking strategy for mitigating supply chain risk.
Another modification to consider is risk pooling, which adjusts for demand fluctuations by centralising safety stock in a warehouse that can supply two or more locations. Pooling resources lowers the amount of safety stock you need while still meeting higher-than-expected demand without going out of stock.
3. Build relationships
Building relationships with existing suppliers is an effective way to mitigate supply chain risks without requiring any operational changes. Get to know your main point of contact to turn a transactional relationship into a strategic partnership that benefits both parties.
This strategy is especially beneficial when a risk in the supply chain emerges. When an issue arises, your supplier is far more likely to alert the person who knows their name and talks to them often than a person they merely consider a buyer.
4. Create layers of defence
Organisations can build layers of defence into their processes that help mitigate risks. That could mean using software to reduce the risk of human error. For example, if an inventory manager submits a digital purchase order, software can generate an alert for the person who needs to approve the purchase.
Regularly reviewing supply chain risks and mitigation efforts is critical to maintaining a resilient, high-functioning supply chain. Create a risk committee composed of employees that have distinct perspectives on supply chain risk, such as accountants and warehouse managers. Discussing risk as a committee improves transparency across the supply chain process.
Reduce your supply chain risk with MYOB
Another way to reduce your supply chain risk is to digitise and automate key workflows, such as purchase order management. With MYOB’s business management platform you can connect your supply chain, finances, customers, employees, projects, accounting and tax so you can gain visibility across all areas of your business, while improving the speed and accuracy of your business processes to benefit both your suppliers and your customers.
Disclaimer: Information provided in this article is of a general nature and does not consider your personal situation. It does not constitute legal, financial, or other professional advice and should not be relied upon as a statement of law, policy or advice. You should consider whether this information is appropriate to your needs and, if necessary, seek independent advice. This information is only accurate at the time of publication. Although every effort has been made to verify the accuracy of the information contained on this webpage, MYOB disclaims, to the extent permitted by law, all liability for the information contained on this webpage or any loss or damage suffered by any person directly or indirectly through relying on this information.