Sunday, December 13, 2009

Managing Risk along the Supply Chain

Supply risk measurement is a field that has often been overlooked in manufacturing best practices and industry research. While plant managers and engineers concern themselves with operational efficiencies and throughput, financial exposure can be left out of the equation. As part of a balanced scorecard, financial risks should be measured, in terms that can be clearly monitored and evaluated.

First, all commodities should be evaluated for their potentially negative impact on EBIT (Earnings Before Interest and Taxes). The probability the occurrence of these negative events should be factored into preventative activities to stop the occurrence completely or limit their effect on earnings. These statistics should be reported to the COO and CFO on a quarterly basis to ensure cross-functional attention to risk assessment. Procurement problems with commodity purchases can directly affect a company’s EBIT. Supply risks that should be evaluated include additional costs for cancellation, transportation, or material obsolescence. Unexpected fluctuations in material prices due to allocation, yield problems or change of specifications must also be monitored. In addition, missing parts due to late delivery, quality defects, or political instability can result in delays and inefficiencies. Contractual and currency risks are also a major factor in protecting a company’s balance sheet from volatile market swings.

Companies can implement operational improvements and managerial tactics mitigate these risks. By investing in suppliers to increase their productivity companies, manufacturers can make their procurements more cost effective. Operationally, they can improve planning processes, find alternative transportation routes and make quality requirements more strict. In terms of financial modeling, managers should adjust forecasts to more accurately reflect market conditions.

Measuring financial risks in the supply chain has proven especially important for telecommunications companies that have very low margins, but large direct materials costs, as well as airlines that profit by hedging against fuel prices. By instituting a risk measurement process, supply-line managers are able to track the most critical risks, which can be masked by other indicators of productivity. The management mantra of many firms “what gets measured gets managed” is applicable here. Further, supply risk management facilitates dialogue between operations and upper management to reconcile issues and devise better solutions. A third benefit to engineers and supply chain managers is that warnings of supply problems can be detected earlier, are prioritized, and can be resolved more quickly.

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