Don't Let the Supply Risk Grinch Steal Christmas

This morning, I'd like to welcome Jim Lawton to Spend Matters. Jim is vice president and general manager at Open Ratings, a D&B company with a range of supply risk management solutions for automotive, aerospace and industrial manufacturers.

When Jason asked me to contribute a few thoughts on supply risk around the holidays, my immediate thought was to borrow a favorite tale from the season. For any company tapping the promise of low-cost country sourcing strategies, the element of risk is much like the Grinch on the mountaintop, threatening to spoil the best-laid plans of every (un-suspecting) Who down in Who-ville.

As we near the end of the holiday season and the year, some companies may be reflecting on what went wrong with their global sourcing initiative. While many companies escaped the path of the "Risk-Grinch," others might not have been so lucky.

When it comes to supply risk, there are actually multiple Grinches -- which can show up as distance risk, cultural and geopolitical risk, and legal and accounting risk. But the most insidious nature of these is that they're magnified when doing business with unfamiliar suppliers. I'll tackle each of these three types of risk below.

1) Let's start with distance risk. Especially for manufacturers where the supply chain is so critical to corporate success, distance magnifies the severity of risk. The best means for managing and mitigating risk is by creating close relationships with suppliers -- but in a global environment with thousands of miles between suppliers and manufacturers, it's much harder to keep a close eye on operations. If you’re working with a Chinese supplier and they start shipping parts at a higher parts per million defect rate (PPM), it could take weeks to identify the quality issue while the goods are floating on the ocean in transit.

In my earlier experience as a supply chain manager, it was certainly true that distance also makes supplier development more difficult. Using local resources and knowledge (not to mention overcoming language barriers) can require a huge ramp. In the past, when my supplier was literally down the road it was easy to parachute into their facility, stay for a few months and check out the scene. But today, "driving down the road to check in" often means hoping a 12+ hour flight, making it a bit harder to do a surprise check on supplier's health and stability.

2) When sourcing globally, I've found that business and ethical cultures can vary significantly from country to country. As a start, suppliers in developing regions -- typically those which are best suited for low-cost country sourcing programs -- have different expectations when it comes to sharing information and conducting business. While doing business with Chinese companies over the years, I've come to realize that suppliers are rarely willing to disclose financial information, or even share an export customer list until we invested the time to develop a relationship and started doing business with them.

I've also found it challenging to get Asian suppliers to sign non-disclosure agreements that protect the interests of a buying organization. The risk in this case is not so much intellectual property theft, but rather the chance that a supplier will do an end-run to a company's customer or its customer's customer with confidential information or lower costs.

3) Another issue that companies can overlook when engaging in low-cost country sourcing is inconsistencies in legal, government and accounting standards and practices. In low-cost countries, trust cannot be assumed. Trust is based on relationships and the quality of the last container shipped. You need to remember that laws and customs vary significantly from country to country. Remember when Cherry Automotive, a local Chinese company 20 percent owned by GM, produced a near identical copy of a GM model made in Korea without paying loyalties to GM?

Additionally, things we've come to rely on such as GAAP (Generally Accepted Accounting Principles) and FASB (Financial Accounting Standards Board) don't exist throughout much of the world. The risk in this is that companies need to look at data with a degree of skepticism. But worse than a lack of accounting standards and standard financial underpinnings is the chance that a supplier could be quietly owned by the government, or even nationalized overnight and refuse to honor existing commitments and contracts. Most often I've seen the former example happen in China, and the latter is prevalent in Central and South America. After all, that's why Business Week calls them the "red chips"!

In order to avoid the Grinch stealing Christmas this year, I would suggest that you take a long hard look at what risks are lurking within your supply chain -- and then outline a plan of action to avoid issues before a crisis strikes. While many organizations "claim" to take into account the risk factors, the reality is that few actually understand how potentially catastrophic risks can be to business and the bottom line. Even worse is that only a small minority of companies that source worldwide have a clear plan of action when something does go wrong -- very wrong. For companies like Airbus launching into a new region, I would suggest that it's best to do due diligence beforehand and keep a close watch on global suppliers throughout the relationship. Trust me, investing upfront in global supply risk management and mitigation strategies and systems upfront can save a whole lot more heartache down the road.

Spend Matters would like to thank Jim Lawton for taking the time to share his thoughts on supply risk with our readers.

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