By K. Dunlop Scott
The entire issue of this magazine is devoted to understanding
the business risks with a focus on the supply chain. This
article addresses one of the most common sets of risks that
enterprises face: Operational and financial risk.
Every enterprise – private sector, government or non-profit – depends
on a number of suppliers who can be deemed “critical” to
the enterprise mission – if these suppliers do not
provide the components or services which the enterprise depends
upon, then the enterprise cannot fulfill its mission to its
Because supply chains have become lean and dependent upon
just in time or continuous delivery, major enterprises need
to understand where their risks lie, and then they must understand
any changes in the risk profile which could potentially interrupt
the expected flow of components and services from their critical
Operational and financial risk are just as real as other
major risks such as earthquakes and transportation disruptions – and
unlike those types of risk, we believe operational and financial
risks are largely predictable. Further, operational and financial
risks generally develop over a period of time, so that the
enterprise customer, if it pays attention, can see these
problems as they develop. Tracking developments in the critical
supplier base allows for some forward planning, to reduce
or eliminate the threat to continuous supply of the critical
components or services.
Virtually every major enterprise is aware of serious operational
and financial problems in several of its critical suppliers.
In many cases, senior supply chain executives in these enterprises
recognize that there are likely many other critical suppliers
suffering similar challenges – but because there is
no structured program for tracking and measuring risk in
the critical supplier base, the enterprise customer is not
yet cognizant of the problems.
Operational and financial risk boil down to this: Do the
enterprise’s critical suppliers have the management
and financial resources available to meet the changing demands
of the enterprise for products and services? In other words,
can the suppliers actually do what the enterprise expects
them to do?
In many cases, the enterprise customer may not be aware
of the capabilities of the critical supplier – the
supplier simply can’t meet demand, because it is operationally
or financially strapped. This leads to some of the most common
issues in the enterprise supply chain.
In simplest terms, operational and financial problems at
the supplier level manifest themselves in several ways:
- Lack of cash flow to fund current operations
- Inability to adapt to change because of inexperienced
or inflexible management
- Inability to grow because of capital constraints
- Turnover in key personnel may have a profound impact
on the supplier’s ability to meet even current enterprise
- Lack of scale may mean that profitability of the supplier
is too low, resulting in low reinvestment and a downward
spiral over time
Each of these manifestations of trouble can grow – if
left unchecked – into eventual bankruptcy or the demise
of the supplier. But many of these issues are rarely crises
of the moment – rather, they build over time – and
an enterprise can carefully watch its critical supplier base
and gain considerable time to plan for mitigating the risk.
In assessing the supplier base, one of the most important
questions an enterprise must ask itself is “Is there
something we are doing which is making it difficult for our
suppliers to thrive?” After all, the health of the
supplier base becomes essential, as the enterprise becomes
more dependent upon fewer, but more important critical suppliers.
Large enterprises often act in ways which seem logical to
a large entity, but which run counter to the health of the
supply chain. Several examples spring to mind:
- A large government customer places huge orders for components,
but only sporadically. Critical suppliers are faced with
scrambling to meet these orders, and then protracted
periods of no orders at all. Not a recipe for supplier
In fact, several large government customers have seen
their supplier bases wither – there are no producers
of certain components at any price.
- A major OEM is rolling out a new technology developed
by a small entrepreneurial company. The OEM is expecting
volumes go from hundreds of units to hundreds of thousands.
Both OEM and supplier now have a challenge – how
is the supplier going to get the management and capital
required to meet demand? Is there a credible path to
success for both OEM and supplier?
- A non-profit customer asks one if its key services suppliers
to take on a new outsourcing opportunity, requiring the
supplier to dramatically increase staffing. Both enterprise
need to assess the impact on working capital – if it
represents a strain on the supplier’s resources, then
the enterprise must be aware of this, and find some way to
assist. Using the enterprise’s normal payment terms
may not be adequate for the supplier, leading to potential
failure of the new effort.
Each of these problems can be foreseen and even solved.
But each requires that the enterprise be keenly aware of
its supplier base.
Developing a Critical Supplier Risk Map
We advocate that an enterprise undertake a four step process
to determine where its supply chain risk lies and what the
nature of that risk is:
- AUDIT: Analyze current risk management practices and
status within a particular program or supply chain;
existing process versus best practices; perform a gap
analysis versus best practice; develop a plan to implement
risk assessment process
: Determine what factors
and supply chain elements are considered critical for
the enterprise mission, and
identify all the suppliers in the supply chain; develop
monitoring risk, using best practices and program specific
metrics, if appropriate; then categorize suppliers
into criticality and risk quadrants, identify high risk
and evaluate overall risk
- MEASURE: Perform detailed risk analysis on high risk
critical suppliers; ascertain the sources and nature of
risk; develop closed loop feedback mechanism for monitoring
risk; develop strategies for mitigating each risk, including
replacement of suppliers
- MITIGATE: Where appropriate, seek to remediate supplier
What can an enterprise do to reduce risk on a forward-looking
basis? Once developing problems are identified, senior
enterprise executives have several paths for dealing with
operationally and financially troubled suppliers:
- Figure out how to stop doing business with that supplier.
This may require time, but with enough planning, it may
- If not, perhaps the supplier can be encouraged to combine
with another stronger supplier, providing comfort to
the enterprise customer.
- In some cases, an operational fix may be appropriate.
Several of the largest enterprises have operational skills
they provide to suppliers to assist them in improving
their capabilities. Or the supplier can be encouraged to
assistance from a third party.
- The enterprise can also determine if the issues could
be solved if more capital were available. In some cases,
where enterprise demand for the product or service is growing,
more capital may be the solution to assist the supplier
fund working capital and investment needs. Most enterprises
think using their own capital to fund suppliers is a good
use of funds – so a third party should be encouraged
to provide that capital.
Once an enterprise understands where the operational and
financial risks lie in its critical supplier base, then actions
can be taken to reduce those risks. The cost of developing
a process for measuring and monitoring operational and financial
risk is minimal – the cost of an interruption caused
by not knowing about a developing weakness can be devastating.
Dun Scott is President and Chief Operating Officer of Columbia
Partners, LLC, Investment Management. Columbia Partners manages
over $2.1 billion in capital from institutional and individual
clients and is interested in assisting enterprises determine
where their supply chain risk lies and in providing capital
to help solve enterprise supply chain challenges where appropriate.
we are not recommending ANYTHING, just educating our readers.
Thanks to the GR for their continued contributions.
ChainLink Research, Inc.