Securing the Upstream Supply Chain: A Risk Management Approach

Abstract

Supply managers must manage many risks in their increasingly competitive environments. Traditionally this meant buffering against uncertainties, which sub-optimized operational performance. Risk management can be a more effective approach to deal with these uncertainties by identifying potential losses. This conceptual study proposes that situational factors- degree of product technology, security needs, the relative importance of the supplier, and the purchasers’ prior experience with the situation should be taken into consideration when determining the level of risk management in the supply chain. Doing so can avoid unforeseen losses and lead to better anticipation of risks.

Full text

Securing the upstream supply
chain: a risk management
approach
Larry C. Giunipero and Reham Aly Eltantawy
Department of Marketing, College of Business, Florida State University,
Tallahassee, Florida, USA
Keywords Risk management, Supply chain management, Marketing environment,
Risk assessment
Abstract Supply managers must manage many risks in their increasingly competitive
environments. Traditionally this meant buffering against uncertainties, which sub-optimized
operational performance. Risk management can be a more effective approach to deal with these
uncertainties by identifying potential losses. This conceptual study proposes that situational
factors- degree of product technology, security needs, the relative importance of the supplier, and
the purchasers’ prior experience with the situation should be taken into consideration when
determining the level of risk management in the supply chain. Doing so can avoid unforeseen losses
and lead to better anticipation of risks.
Introduction
A lot of firms have taken a good lesson from the 9/11 attack. They are re-examining their own
corporate security programs to determine whether they have avoided problems because their
programs are that good or because they’ve just been fortunate. Obviously, if you’re lucky, it’s
only a matter of time before your luck may run out. So the bottom line is that ...your security
controls need to be meaningful, strategically designed, and diligently maintained. And if
you’re not doing that, then you are unnecessarily exposing your company to internal and
external loss (Staff, 2003).
The above statement was made by Barry Brandman, president of Danbee
Investigations in Midland Park, New Jersey, in his interview with the Supply Chain
Management Review staff. It reflects that firms are confronted today with new risks.
Traditionally, businesses have been always faced with various risks that emanate from
the environment in which they operate. Risk is part of every business environment.
Today worldwide changes have created newer sources of risks. Protection against
threats of terrorism is now a cornerstone of the Department of Homeland Security’s
strategy. The movement of manufacturing to offshore facilities, particularly in China,
increases risks. For example, the effect of SARS virus on business has been widely
publicized and has had an effect on supply chains. Firms need to understand the value
of prevention and not merely the reaction to security risks. It makes far more sense in
terms of time, money, resources, and aggravation for firms to adapt their businesses in
order to dedicate their efforts to preventing problems from happening (Kendall, 2003).
Other more traditional risks that face firms include cost pressures that require
firms to constantly balance cost reduction targets with their objectives. For example,
a sluggish economy has left firms such as automotive companies with excess
The Emerald Research Register for this journal is available at The current issue and full text archive of this journal is available at
www.emeraldinsight.com/researchregister www.emeraldinsight.com/0960-0035.htm
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Received July 2002
Revised January 2003
Accepted March 2003
International Journal of Physical
Distribution & Logistics Management
Vol. 34 No. 9, 2004
pp. 698-713
qEmerald Group Publishing Limited
0960-0035
DOI 10.1108/09600030410567478

inventory. They have responded by offering consumers rebates and attractive
financing rates, in some cases as low as zero percent. Competition in most businesses
is intense and has forced firms to accept low profit margins. Increased reliance on
outsourcing creates a loss of control and a risk of losing proprietary information
shared between parties.
Traditionally, companies used to adopt strategies, which buffer against risks
present in their environment by using multiple sources for strategic items and
holding safety stock. These buffers restrict operational performances and can
negatively impact competitive advantage. New approaches involve risk
management, which is a formal process that involves identifying potential losses,
understanding the likelihood of potential losses, and assigning significance to these
losses. Supply chain management seeks to reduce these risks and enhance
competitive performance by closely integrating internal functions within a company
and effectively linking them with the external operations of suppliers, channel
members and final customers.
Previous research has focused on:
.the risk assessment process (Zsidisin et al., 2000);
.proactive risk management practices (Smeltzer and Siferd, 1998); and
.factors that influence management’s perceptions of supply risk (Zsidisin, 2003).
However, a research gap still exists in the supply management literature on providing
guidelines for managers on the situational factors that may influence the level of
investment in risk management systems. Therefore the purpose of this conceptual
research is to provide a categorization of these situational factors.
Most previous research in this area addressed the “sources of risk” in the supply
chain rather than the influential forces on the “level of investment in risk
management”. These two are not mutually exclusive. However, we argue that the
situational factors affect the level of investment in risk management. We explore four
of these factors. These include:
(1) degree of product technology;
(2) need for security;
(3) importance of the supplier; and
(4) the purchasers’ prior experience.
Prior to discussing these four factors we first present the sources of supply
management risks identified in literature. Second, we compare risk buffering activities
to risk management strategies. Third, we discuss a situational approach to risk
management. From this, we develop a set of research propositions for four situational
factors and managerial implications of these factors. Figure 1 highlights the approach
taken in this research.
The changing world events have had an impact on the supply chain environment.
Traditional risk buffering approaches are no longer sufficient to deal with this new
environment. Risk management becomes necessary as purchasers move to adopt more
strategic supply management practices. The level of risk management depends on
situational factors. This research posits four important ones based on previous
research.
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Sources of supply management risks
Supply risk involves the potential occurrence of events associated with inbound supply
that can have significant detrimental effects on purchasing firms (Zsidisin et al., 2000).
As previously mentioned, there are numerous factors present in the world environment
that affect supply management professionals perception of risk. One of the potential
consequences of the war in Iraq is higher oil prices and its effect on logistics costs.
Another is the instability of the relations between Pakistan and India. Also, threats
from North Korea could affect purchases of items in South Korea and China. To
safeguard themselves from such risks, companies will have to develop supply
managers who understand these issues and prepare strategies to mitigate their
consequences. Supply managers must understand the business context in which their
company’s corporate strategy was developed (Arminas, 2003).
In addition to world political events, there are several conditions that create risks in
a supply chain. These include product availability (Singh, 1998), distance from source
(MacKinnon, 2002), industry capacity (Lee et al., 1997), demand fluctuations (Singh,
1998), changes in technology (Iyer, 1996), and labor markets (Wiseman and
Gomez-Mejia, 1998), financial instability (Larson and Kulchitsky, 1998) and
management turnover (Wiseman and Gomez-Mejia, 1998).
Increased distance adds uncertainty to supply continuity through longer lead times
and potential transportation disruptions. Supplier capacity constraints result in the
inability to supply the quantities demanded by purchasers. Fluctuations in demand
may tax a supplier beyond its abilities through insufficient utilization of equipments
and employees (Lee et al., 1997). Other capacity risks include volume/product mix
requirement fluctuations that result from the increased customers’ sophistication and
Figure 1.
The framework for risk
management
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the unpredictability of demand and process technological changes. Also, if a supplier
cannot implement technological changes in the long term, that supplier may not be able
to produce items to necessary demand level and at a competitive price.
Additionally, supply chain professionals are faced with business risks associated
with the financial instability of a supplier. With the increased reliance on outsourcing
financial stability of suppliers, who influence a major portion of firms’ costs, becomes
more critical (Larson and Kulchitsky, 1998). If suppliers are unprofitable, they become
a greater risk. Particularly when there are no alternative sources and new sources must
be found and developed. This risk is especially critical within industries that are
consolidating, utilizing partnerships and alliances. Finally, management tenures are
shrinking with all the downsizing actions taken by corporations. This results in
increased uncertainty of labor skills and a reduction of management talent in many
organizations. In such an environment, there is a need to manage these uncertainties in
the supply chain.
Risk buffering practices in supply chain
Purchasing/supply management is expected to mitigate risk and, at the same time,
control costs and assure continuity of supply. Previous research findings lead to the
conclusion that relationships exist between risk, strong pursuit of objectives, early
supplier involvement, and careful development, evaluation and management of
suppliers (e.g. Zsidisin and Hendrick, 1998; Laios and Moschuris, 1999). However,
traditional strategies that were used to buffer risk implied that the purchasers’ main
role was to react to internal customer needs. Under this philosophy a purchase
requisition is received from another department and an order is placed with a supplier.
Purchasing is largely transaction-oriented and risk averse. Evaluations are based on
two major criteria (see Table I):
(1) administrative costs involved; and
(2) cost savings on material expenditures.
Historically, most purchasing professionals adopted policies that hedged against risks
after the events had already unfolded. They buffered against supply risks by
developing multiple sources of supply and carrying safety stock. Risk stimulated the
creation of safety buffers by increasing order quantities and subsequent inventories to
prevent poor supply chain performance. However, buffers often limited performance
and reduced competitive advantage, since these extra costs made the firm less efficient.
Supply professionals must realize that companies which cope best with uncertainty
posed by risks in their environments are most likely to produce competitive
bottom-line performances.
Today, supply chains are perceived as a source of competitive advantage.
Competitive advantage cannot be attained through the inefficiencies associated with
traditional buffering strategies. Buffering practices used in traditional purchasing
often meant having the wrong items. This leads to increased transaction costs, long
purchase order cycle times, poor productivity and an environment characterized by
rush orders. We propose that various strategies that deal with risks require a more
proactive risk management approach.
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Risk creators
Traditional risk buffering Risk management
Practices Potential problems Practices Potential problems
Material availability
Long distances
Insufficient capacity
Demand fluctuations
Technological changes
Financial instability
Labor instability
Management turnover
Extra inventory
Multiple suppliers
Expediting
Manual purchase orders
Frequent supplier changes
High transaction costs
Long purchasing ordering
cycle times
Low purchasing
productivity
Rush orders
Industry consolidations/
partnerships/alliances
E-procurement
Just in time deliveries
Small flexible supply base
Increased coordination
Early supplier involvement
Frequent commitment
Highly-trained supply
management professionals
Measuring total costs
Lower control over
supply-related risk
Magnification of problems
throughout the supply chain
Paying higher prices
Higher switching costs
Skill gaps in current
employees
Security of transactions
Table I.
Risk buffering vs risk
management strategies in
the supply chain
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Risk management practices in the supply chain
As stated above, the buffering approach worked when purchasing was more tactical.
As we move to more strategic approaches risk management becomes a desired option.
These purchasing practices include industry consolidations, e-procurement, just in
time deliveries, smaller supply bases, and a focus on total costs (Table I).
Risk management is a continual process that involves long-term dedication of
supply chain members. Ongoing risk assessment involves gathering, communication,
and evaluation of information that helps in developing appropriate risk management
strategies (Zsidisin et al., 2000). It is important to realize that there are risks with these
new supply chain strategies. For example, fewer suppliers and lower inventories mean
that a problem at one supplier can be magnified throughout the supply chain.
Similarly, a disruption in transportation services could quickly cripple the entire
supply chain since inventories are very low throughout the chain. Transportation risk
management contingency plans would provide for alternative modes of transportation.
Thus, if a trucking company failed, alternative modes such as air or rail backups would
be in place to guard against supply disruption.
In order to manage risk effectively, purchasers are moving to adopt closer
relationships with key suppliers. These suppliers are expected to provide solutions and
compliment or enhance the buying firm’s core competencies. Dell Computer is often
cited as an example of a firm that has implemented this close working arrangement
with its suppliers (Antonette et al., 2002; McWilliams and White, 1999). Suppliers are
treated as extensions of Dell’s operations and its purchasing personnel are extensively
involved in understanding their suppliers operations, products, and commodities. Such
long-term business relationships are expected deliver added value for buyers and
suppliers.
Mergers and alliances are ways that companies expand their power and manage the
risk of uncertainty. Total mergers and acquisitions across all sectors worldwide totaled
more than $1.8 trillion through the first nine months of 1998 (Cavinato and Kauffman,
2000). By 1999 mergers taking place around the world were worth $3.43 trillion (Caulk,
2000). Industry consolidation, partnerships and alliances lead to greater overall
procurement efficiencies as newly formed companies leveraged their size and influence
to push suppliers for more services and lower costs. The demands of these larger firms
often create situations that lead to consolidation in the supply base to meet the
increasing demands of these large buyers.
Another form of investments in risk management is the use of e-procurement to
integrate supply chains. The emergence of e-procurement reduced transaction costs
from $40 to $400 (via a sales representative) to $2 to $5 (telephone) to $0.10 to $0.40
(Internet). While these firms are more efficient, there are concerns about security of the
information placed on the Internet. As a result, many larger firms have developed their
own buy side portals. Suppliers are required to enter theses private portals when doing
business with a large company. For its investment the buying firm is safe in knowing
its information is secure (Antonette et al., 2002).
Another area where e-procurement is being used is bid solicitation. However,
electronic reverse auctions technology that is being widely used by many buyers must
be carefully implemented. Electronic reverse auction involves having the buyer offer
its package of goods to many sellers who compete in a real time online auction format
(Antonette et al., 2002). It streamlines the traditional bidding process and provides an
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extremely competitive environment in which sellers must aggressively bid to receive
the business. While savings can be enormous there are risks in using this approach.
Suppliers feel that it awards business on a price basis and overlook other important
aspects of the relationship such as service, quality, and delivery issues.
Joint buyer-supplier efforts may reduce risks in the supply processes. Williams and
Stemper (2002) reported that collaborative supply management efforts increase
product reliability and reduces risks in product introduction. The key to successfully
managing risks in this process is to provide allowances for these risk variables. For
example, after the final reverse auction results are tabulated a percentage allowance is
given to a certified supplier and another percentage allowance is given to a supplier
with outstanding delivery performance. Quality-related risks can cause significant
detrimental effects on supply chain, with a cascading effect through the supply chain
to final consumers. Each link within a supply chain is dependent on the other links to
meet product or service requirements. Organizations using net markets to purchase
goods from distant sellers expose themselves to greater risk, as it is hard to assess
quality levels and specification requirements before shipment (MacKinnon, 2002). Data
quality problems such as wrong or out-of-date part numbers can mean the success or
failure of a supply chain. Quality failures can stem from failure of suppliers to maintain
capital equipment, lack of supplier training in quality principles and techniques, and
damage that occurs in transit.
Problems with risk management
Conversely, certain risk management purchasing practices can create new problems
and risks. Single sourcing, just-in-time deliveries, and reduced supply bases all have
the potential for disrupting supply chain processes. Reliance on e-procurement tools
also involves additional risks.
For example, security of transactions in an electronic environment is a potential risk
management problem (Kendall, 2003; MacKinnon, 2002). Information in the hands of a
“competitor” or a “hacker” could create major confusion for the supplier. Also,
shipments of material that can be used to make illegal items, such as pipe bombs and
biological, could wind up in the wrong hands. Recently, extensive publicity has been
given to the lack of security over the contents in shipping containers unloaded daily
from ships at major port cities in the USA. Finally, risk management skills, including
awareness of risk signals and developing risk management plans, are essential
requirements for supply management success today (Giunipero and Pearcy, 2000).
The above discussion indicates supply chain participants are using newer more
efficient strategies. These new strategies could increase firms’ susceptibility to supply
disruptions, which require a risk management approach.
Situational risk management
Risk is present to some extent in every supply chain. Each commodity, product, or
service purchased exhibits a different risk profile. With today’s uncertain conditions
and heightened awareness of supply threats it is particularly important for supply
managers to assess the degree of risk across their purchase categories. The
distinguishing characteristics of each purchasing situation are expected to have a
differential impact on the need for risk management. Further, the extent to which
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management invests in any risk handling strategy depends largely on the buying
situation.
The supply professional should be aware of the cues that each buying situation
presents, so that they can invest in the appropriate level of risk management strategies
for each buying situation and, thereby, optimize their performance and minimize their
risk at the same time. As previously discussed Table I summarizes the sources of risk
and the traditional practices used to address these risks as well as the newer risk
management practices. The table also indicates that both risk buffering and risk
management practices have the problems associated with their implementation.
Therefore, companies need to strike a balance between the benefits gained through risk
management and the costs incurred by using these practices. The following section
addresses our main research question of: “When should management invest more
resources in risk management systems?” In other words: “What situational factors
determine the level of investment resources directed to risk management?”
Previous research has shown that four major parts of the supply chain are
important situational factors; the buyer, the supplier, the product bought, the
environment surrounding the purchase (e.g. Niraj et al., 2001; Mabert and
Venkataramanan, 1998).
Research propositions
Product technology
In his study, Zsidisin (2003) posited that there are numerous characteristics that affect
how supply management professionals perceive risk. Risk management should always
be conducted, but money and time spent on risk management should be rationalized to
vary according to the need. Managing expenses at each point in the supply chain can
produce greater returns. Management should be able to assess differentially risk
management depending on specific situations.
In an attempt to provide a classification of supply risk sources, most studies in this
area posited than “product technology” is an important determining factor of the level
of risk management needs. Zsidisin (2003) posited that item characteristics are the
major categories of supply risk. Also, Laios and Moschuris (1999) used the degree of
differentiation, technical complexity, specialized installation, and technical after sales
service, to assess the complexity of the item. In the same study, the authors posited that
these variables would affect the level of commercial uncertainty. In this study we
define product technology as the degree of change and complexity of product
applications and the competencies required for the product application and usage.
High-technology markets are characterized by a rapid pace of technology change
involves a high degree of uncertainty for buyers. An important source of uncertainty
stems from buyers’ lack of experience with product technology. Risks caused by the
rapid pace of technology changes. In markets where technology changes at a rapid
pace there are, usually, multiple discrepant product standards (Heide and Weiss, 1995).
Rapid technology changes makes difficult for buyers to evaluate suppliers’
performance and predict any likely problems that might arise in the production and
the delivery of the product.
This study’s predictions are that businesses developing high-technology product
face higher risks of failure than other businesses because of greater competency
demands and higher organization costs (Baker, 1995). In high-tech markets, the
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occurrence of frequent major technological changes often destroys existing
competencies and requires the redeployment of resources to develop capabilities
suitable for the new technological regime. Further, investments in risk management
activities, such as alliances and coordinating supplier relationships, moderate failure
risks. Its central prediction is that businesses developing high-tech products involve a
higher risk of failure – of ceasing operations and exiting their industry – than
businesses developing less technologically complex products. In considering alternate
explanations for the impact of technological complexity (Baker, 1995).
In such situations, buyers have to be involved in extensive risk management
activities. Buyers have to engage in an ongoing process of information gathering about
and assessment of suppliers’ production processes, costs and lead times, because
information gathered at a particular point in time may not be relevant for long. Also,
proper selection of suppliers can be an important key to managing risks in such
scenarios. As the relative pace of technology changes increases as well as the novelty of
the situation, the carefulness with which suppliers are selected should increase. That is:
P1. High-tech markets require more extensive risk management than other
low-tech markets with slower pace of technological changes.
Security needs
A second situational factor that is likely to affect the level of risk management is the
“need for security”. On the one hand, there a general increased need for security. On the
other hand, there are some supply chains purchased items that require greater security
precautions. This is true in a long supply chain, where there are three or more supplier
tiers and/or when the products are globally bought, processed, and/or transported. In
such situations, nearly every container load represents a point of vulnerability in the
pursuit of security. In the USA, each day 17,000 cargo containers enter 361 US seaports
(Adam and Woolever, 2003). Multiply this number by the hundreds of pairs of human
hands through which that cargo passes and you can begin to see the magnitude of the
port security problem.
Also, this is especially important for products like computer chips, Anthrax
vaccines, biodegradable packaging, biological agents, items for national security, etc.
The ramifications of unforeseen events on customers in such situations are great.
Customers need to know for certain whether or not the product has been tampered with
when it hits the market because this can radically damage the product, constitute
health hazards (Staff, 2003). With increasing public demand for environmentally safe
products and potential overall reductions in cost, adoption of environmentally sound
purchasing policies and practices may provide firms with a competitive advantage in
the marketplace (Zsidisin and Hendrick, 1998). Additionally, there is also the issue of
brand integrity. Customers are going to look at company name on the label and hold
that company responsible both ethically and legally (Staff, 2003). Thus, risks of failures
in the case of products that require high security can be detrimental to the long-run
credibility of companies.
Meeting the need for security challenge requires an end-to-end technology solution
is necessary to thwart any attempts to damage the product. Investments in security
using disparate and disconnected technology solutions are not sufficient. What is
needed is a system of systems where all pieces of the security puzzle can be connected
and monitored simultaneously (Adam and Woolever, 2003). Extensive risk
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management systems investment are needed in the supply chain in order to develop a
holistic approach would enable all interested parties to track the whereabouts of a
single toy, for example, and determine whether the container it is shipped in has been
tampered with, and where along the supply chain the tampering has occurred (Adam
and Woolever, 2003).
Purchasers in this case should invest more to move to adopting closer relationships
with key suppliers that will enable them to scrutinize their suppliers’ production and
deliveries processes and, thereby, avoid the long-lasting negative impact of supplier
failure. That is:
P2. Those suppliers who provide items that have high security requirements
require more extensive risk management than those providing items with
relatively less security needs.
Relative importance of suppliers
Antonette et al. (2002) posited that suppliers that are vital to the success of the firm, in
terms of their reliability in both items availability and on the competitive edge of the
final product, impact the level of risk. They deliver the key elements that exist in a
business to deliver to its own core customers. The impact of the purchase on the
profitability is another supplier factor that was found to influence the supply risk
(Zsidisin, 2003). Should the risks to the bottom line be significant, then, with the
approval of management, critical resources of knowledge, information, and technology
should be obtained, and organizational processes put in place to facilitate optimum use
of these resources to meet this purchasing challenge.
The relative importance of suppliers is an important determinant of how much time
and effort should be dedicated to risk management. As dependence of the buyer on a
certain supplier increases, relative importance of that supplier compared to other
suppliers that the buyer deals with increases. Dependence on a supplier may arise as a
result of the large quantity of items provided by that supplier and/or from criticality of
these items. For example, if the buyer is building a computer and a critical component
is available on time in stock, the buyer would not be able to complete the assembly of
the finished product (Staff, 2003). Obviously, that is a huge productivity risk, especially
with many firms going to just-in-time (JIT) inventory systems. Such risks are present
when procurement may involve investments made by the firm specifically for the
supply relation, or when items crucial to the firm’s operations and processes are being
contracted (Iyer, 1996).
Another reason for the increased relative importance of a supplier is prior
commitments to a technology (Heide and Weiss, 1995). For products like computer
products and customized machinery, buyers usually invest in technologies
incompatible with other products and suppliers. Thus, the risk of any production
problems that might occur on the part of suppliers involves high switching costs
because of the high investments that need to be changed if a new relationship with a
new supplier is to be established. Hence, in dealing with major suppliers that provide
critical items supply management is expected to take the necessary precautions since
risks of their performance failure can be prohibitive. Strategies such as supplier
certification, quality management programs and quality audits can help mangers in
selecting the most reliable suppliers. Companies that have strong supplier certification
programs are able to reduce their supplier base, which is a risky endeavor, to assure
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they met standards (Smeltzer and Siferd, 1998). These activities essentially reduced the
risks of poor judgments in supplier selection. Hence:
P3. Major suppliers of high volume, value and/or critical items require more
extensive risk management than those who supply fewer or less critical items.
Purchasers’ prior experience
Previous research addressed “purchasers’ experience” as an important determinant
factor of the investment in information gathering and alternative assessment (e.g.
Robinson et al., 1967; Johnston and Lewin, 1994; Iyer, 1996). The buy class framework
that was presented by Robinson et al. (1967) predicted that these three criteria
increased in value as the buying situation changed from straight rebuy to modified
rebuy to new task buying. Johnston and Lewin (1994) concluded that the “levels of risk
associated with a given purchase situation” account for much of the variation in
organizational buying behavior. Further, this risk “is a function of the importance of a
particular purchase and/or uncertainty of the purchase outcome” (Iyer, 1996). Purchase
importance and outcome uncertainty reflect strategic concerns for the buying firm and
provide the crucial links between the procurement decision and organizational
strategy.
The investment in the risk management systems involves reducing the likelihood of
being exposed to supplier opportunism. Some forms of investments here can be in
backward integration. Moreover, wherever supply relations involve providing critical
information to suppliers, there is always a risk that the supplier may “piggy-back” on
the firm’s knowledge of products and processes for their own forward integration
attempts. Thus, the risks of supplier opportunism and priorities in the protection of
firm-specific knowledge may call for a more strategic – as opposed to cost-based –
reasoning of the “make-versus-buy” decision.
When supply professionals have greater experience in a certain buying situation they
are better able to employ more effective strategies for customization and adaptation to
risks associated with that situation and, therefore, need to employ risk management
activities to a lesser extent than if confronted with a novel situation. That is:
P4. Suppliers with whom purchasers have less experience require more extensive
risk management than those with whom there is a history of purchasing.
Situational risk management continuum
The conceptual research has presented the movement from risk buffering to risk
management. When a firm utilizes risk management techniques it must allocate
different investment levels for each situation. Based on past research we have
identified four situational factors that affect the extent of risk management.
Figure 2 highlights the four dimensions that will affect the extent of risk
management activities in the supply chain. Using these as a guide can help direct
supply manager to the appropriate risk management strategies.
These four dimensions that determine the extent of risk management needs are the:
(1) degree of product technology involved in the item purchased (high-tech vs
low-tech products);
(2) need for security in handling, packaging and transporting the product (high vs
low);
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(3) importance of the supplier (regular vs critical suppliers); and
(4) purchasers’ prior experience with the situation whether it is a new item, new
supplier, or both (limited vs significant experience).
Thus, the higher the technical sophistication of the product; the greater the need for
security in the process of producing and transporting the product; the more critical the
supplier’s item; and the less the previous experience with the situation, the greater the
need for performing risk management. When all of these factors are combined, they
produce a situation in which the likelihood and/or the detrimental effect of an
unforeseen event can be quite costly for all firms in the supply chain.
By the same token the lower the technology of the product, the less the need for
security in the process of producing and transporting the product; low importance of
the suppliers’ items to the buyer; and extensive previous experience with the situation
(supplier or product), the less the need for risk assessment. In such cases, supply
managers can limit risk management activities because the likelihood and the
detrimental effect of unforeseen events are more manageable.
These two situations are the extreme opposites of the risk management continuum.
It is most likely that supply chain members will encounter situations characterized by
a combination of different levels of these four dimensions, which require moderate risk
management efforts. In such situations supply managers should use their judgment in
identifying the extent to which risk management is necessary. Although it is beyond
the scope of this paper to address all possible combinations of risk dimensions in
buying situations, the following discussion addresses some situations that represent
Figure 2.
Determinants of the
degree of risk
management
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how supply managers should handle differently possible buying situations that
involve various degrees and sources of risks.
In situations where buyers have no or limited experience, supply professionals can
learn through others’ experiences, researching best practices, and taking necessary
precautions. Additionally, organizational learning through prior exposure to similar
situations and their potential losses should lead to proactive actions to prevent these
future losses.
Managerial implications
One of the first reactions supply managers may have in dealing with risk is to grab for
greater control. Control-oriented mangers in times of increased risk will move their
organization to adopt conditions that produce short-term results, but overturn recent
advances in supply chain management. Therefore, it is up to the progressive supply
managers to resist these attempts to grab for greater control and, instead, focus on
managing risk. Failure to do so will result in a step back for these firms and the gap
between best and worst performers will grow even larger.
Even though using process improvements and various risk management activities
can reduce supply risks, risk cannot be completely eliminated. Risk management
policies need a clear mandate from top management. Because risk management is time
consuming supply professionals can spend a large portion of their time in planning and
assessing supply risk, they need to rationalize the investment that they make in each
buying situation by identifying its distinguishing characteristics.
If the buying situation is novel, involves critical high-tech items, and requires high
levels of security in its production and delivery to customers the risks of failure can be
prohibitive. In this scenario, supply professional should rely on early supplier
involvement, share and assess supplier risk management plans, implement automatic
integration with supplier operations, and increase and strengthen the flow of
communication with the supplier. In this case the risk management investments can be
easily justified.
There conversely will also be commodities, products, and services that require very
little risk management such as certain standard materials, machine parts, office
supplies, and some general MRO items. In these areas little investment in risk
management is necessary since the switching costs are low and market availability is
high.
Supply professionals must have top management support. If a risk never
materializes, it becomes very difficult to justify the time spent on risk assessments,
contingency plans, and risk management (Zsidisin et al., 2000). Also, the total cost of an
undesirable event occurring needs to be evaluated in comparison to the benefits
realized from having strategies in place that significantly reduce the chance and/or
effects of detrimental events with supply.
Organizations that employed more qualified purchasing employees reduced risk
because purchasing had the required competencies to manage the risk (Smeltzer and
Siferd, 1998). Companies can rely on outsourcing and still avoid its associated risks
when they develop quality certification programs and audit the suppliers to assure
they meet required standards. These activities essentially reduce the risks of poor
judgments in supplier selection. Long-term alliances make organizations dependent on
fewer suppliers and, hence, increase risks (Smeltzer and Siferd, 1998). However, with
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highly qualified purchasing managers working with the supplier to maintain and
improve the desired technology and remain cost competitive, the risk is managed.
To mitigate supply risks and develop competitive advantage today, supply
professionals need to coordinate the relationships in the supply chain and increase the
flow of information and communication efforts. This is evident in the research findings
that emphasize that interpersonal communication, ability to work in teams, and
negotiation skills, which are all skills needed to support the integration of the supply
chain, are critical to succeed and, even, to survive in today’s competitive arena
(Giunipero and Pearcy, 2000). Thus, hiring and developing employees is the key to
managing risks in supply chain. It is equally important as well that top management
allow purchasing the freedom to pursue potentially risky endeavors as long as an
appropriate plan to manage risks is developed.
Conclusion
Increasing tension, risks and dangers are present in the world environment today. This
coupled with supply management’s movement to adopt more progressive and strategic
practices will require the development of risk management to insure efficient and
effective supply chain practices. We have traced the evolution from risk buffering to
risk management and some of the problems inherent in taking a one-size-fits-all
presumption. Taking a more situational approach we have proposed four buying
factors; degree of product technology, security needs, relative importance of the
supplier, and the purchasers’ prior experience as being critical to the process.
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Iyer, G.R. (1996), “Strategic decision making in industrial procurement: implications for buying
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Koutsoukis, N.S., Ballesteros, B.D., Lucas, C.A. and Mitra, G. (2000), “A prototype decision
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