profit from procurement

Procurement, Supply Chain and Risk

17/12/2015

With every purchase, there is an associated risk.

Clearly the risk of buying easily substitutable items such as pencils is of considerably less risk than procuring a global ERP system. However, it is procurement’s responsibility to ensure that the risk is assessed so that it can be reduced and mitigated where possible.

The more business-critical the goods or services being procured are to the buying company, the more risk becomes an issue in which a cross-functional team, led by Procurement, should be involved in its assessment.

To understand the risk, it is no longer sufficient just to assess potential risk between the buying and selling organisations. It is critical to assess the risk along the whole length of the supply chain. i.e. the total risk.

This holds true, even if the buying organisation has no direct communication or involvement with any of its supplier’s suppliers e.g. imagine a Company W buys a bespoke component for the towel dispensers it produces from Company X.

Given that Company W’s towel dispenser sales generate 35% of the company’s profit, Company W conducted what they considered to be a thorough risk analysis of Company X.

Analysis showed that the risks were low and those that concerned them, were mitigated through contractual agreements e.g. assurance of supply was particularly important to Company W, so a clause ensuring that Company X would keep 2 months’ stock of the finished component was included in the contract.

Even more reassuring, the two companies were only 10 miles apart, so very short lead times were possible if needed. The deal was done.

All went well for the first 6 months, but things began to unravel when Company X were advised by their supplier, Company Y, that it would be unable to supply a critical part to Company X for at least 3 months, since their supplier, Company Z, which was based in China, had suffered a major fire which had closed their production line for the foreseeable future.

Given the bespoke nature of the component Company W bought from Company X, it was not possible to source an alternative before Company X’s 2 months’ stock ran out.

The consequences for Company W were clear: unable to fulfil orders, their profits fell, cost increased and their reputation with customers was damaged jeopardising both existing and future sales.

Despite having appeared to have done the right thing i.e. conducting a risk analysis of their supplier, Company W had not considered the risks associated with all the suppliers in their supply chain i.e. they had not considered the total risk their company was exposed to before committing to an agreement with Company X.

It was a fire at a supplier which ultimately exposed the weakness in Company W’s risk assessment, but it could have been many other things including:

• Exposure to exchange rate changes – how were Company W’s supply chain suppliers protected (or not) against fluctuations in exchange rates?
• What pricing/supply agreements (if any) did companies X have with Y and Y with Z?
• Shipping delays from China?
• Strikes at customs?
• Financial strength of Companies Y & Z – were they on the brink of bankruptcy?

Of course, there could be many other areas of risk, including issues relating to Corporate Social Responsibility (exposure to serious corporate reputational risk), but it is incumbent on Procurement to understand the nature of the risk associated with what is being procured and where it could occur throughout the supply chain.

Working with their colleagues/key stakeholders, Procurement should lead a cross-functional team to assess the risk and put in place measures which would reduce or mitigate it….then comes the management of it!

The above article addressed Procurement’s role in assessing risk in the supply chain, but of course, understanding your supply chain is also an opportunity for Procurement to identify and take out cost. This will be addressed in a further article.

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