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The supply chain is an essential business function in all industries

By Eddie Austin,2015-02-09 22:00
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The supply chain is an essential business function in all industries

    AIB-SE (USA) 2004 Annual Meeting, Knoxville, TN

    ENVIRONMENTAL RISKS AND THE GLOBAL SUPPLY CHAIN

    Jay van Wyk, Meerkat Associates

    Wilbert Baerwaldt, Air Products

Introduction

    The supply chain is an essential business function in all industries. Generally, at the micro-level the supply chain involves a set of firms that pass materials to the end user. At the macro-level, the supply chain becomes more complex. An industry-wide system emerges within which organizations supply one another with raw materials and other resources. These types of networks are spatial and cut across national borders and regions. Supply chain management (SCM) is a process with the primary objective of integrating and managing the sourcing, flow and control of materials using a total systems perspective across multi-functions and multi-tiers of suppliers.

    A firm’s strategy deals with the alignment of the organization to its uncertain environment. It includes all primary business processes that may influence competitive advantage, including the management of finance, production, marketing, customer service and the supply chain. The rationale of strategy is the coordination of these processes to realize shareholder value. SCM has become an important strategic and competitive factor that affects all shareholder value-drivers such as customer service, costs, asset productivity and revenue generation. An

    overarching concern of strategy is the relationship between risk and return: the higher the risk, the greater the desired return. The measurement of that return is relatively straightforward, i.e. stock prices, financial ratios and income stream. Strategic risk is a more elusive concept. From a traditional perspective, the risk-return dichotomy focuses on financial risk. However, in a globalizing economy, a growing array of market and non-market forces may fuel risk and uncertainty necessitating a broader, innovative managerial perspective. Risk refers to uncertainties associated with exposure to loss caused by events that are not readily predictable. Risk may also cause variability in return based upon changes and uncertainties in the environment. The success of risk management depends upon how accurately the results of a change event may be predicted. Risk management is therefore a company’s ability to implement preventative or remedial policies to minimize strategic risk. The analysis of risk to the supply chain has largely been concerned with internal risks emanating from industry or firm specific risks. These risks include demand forecasting errors, outsourcing and suppliers, inbound and outbound logistic flows, competitors, pricing and disruptive technologies. External or environmental risks to the supply chain have received some attention particularly after the 9/11 terrorists attacks. However, a paradigm shift that embraces a more systematic and comprehensive identification of environmental risks is warranted. A reinvigorated paradigm for risk management is proposed that encompasses a three-pronged approach: (1) identify various environmental risk types; (2) demonstrate the adverse affect of environment risks on supply chain performance and (3) suggest managerial policies to anticipate or to mitigate negative risk impact. It is our intent to provide an innovative and integrated framework for effective management of external risks threatening the supply chain.

Identifying Environmental Risks and Impacts

    Risk Types: Five board environmental risk types may be identified, i.e. political, infrastructure, legal liability, social and natural disasters. These risk types are not mutually exclusive and may cause a complex risk situation flowing from overlapping risk types.

    ; Political risk may originate from three sources often in an overlapping fashion: (1) international relations

    such as inter-state wars, cross national terrorism and anti-globalization organizations which endeavor to

    undermine free trade; (2) unstable political systems or countries characterized by violent domestic conflicts

    over legitimacy and the irregular transfer or exercise of political power; and (2) governmental policies such

    as intrusive business regulations and ownership, corruption and lack of transparency, insufficient capacity

    to enforce the rule of law and ineffective macroeconomic policies.

    ; Infrastructure risks may include IT failures, power blackouts and transport congestion or deterioration.

    Common utility corridors containing pipelines, transmission lines, telecommunication cables, railways and

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    even highways may exacerbate infrastructure vulnerability. Common utility corridors are a good practice

    from an engineering point of view, but a bad one from a security perspective.

    ; Legal Liabilities may arise from compliance with product liability standards, noncompliance with security

    legislation and negligent actions or inactions.

    ; Social risks may include crime, money laundering and health pandemics such as SARS or AIDS.

    ; Natural Disasters may arise from geological events such as earthquakes; space weather such as sunspots,

    and extreme weather events such as hurricanes, typhoons and floods. Natural disasters may cause

    infrastructure damage, telecommunication downtime, damage to a firm’s assets and danger to its employees.

    Risk Impacts: Environmental risks have four board negative impacts on the supply chain: (1) hard costs; (2) soft costs; (3) costs of uncertainty; (4) damage to reputation.

    ; Hard Costs include fines for noncompliance; working capital tied-up in larger inventories; customer

    attrition; cost of physical security of assets and facilities; and loss of assets, inventory and human resources.

    ; Soft Costs add unintended complexity to the supply chain and include congestion or deterioration,

    rerouting of materials, information availability and accuracy, and additional intrusive governmental

    regulations.

    ; Costs of Uncertainty, created by unpredictability of the business environment, include the security of long

    supply chains, facilities and suppliers in unstable markets.

    ; Reputational Damage entails pursuing shareholder value without harming stakeholder value, such as

    damage to the physical environment and harm to the public interest and/or to national security.

    The threat of external risk and its impact on the supply chain are illustrated with several examples. The business operations of Drummond Co., a US mining company in Colombia, face a spectrum of environmental risks including political instability, infrastructure destruction and legal liabilities. Due to the Colombian civil war, Drummond’s railroad supply chain has been bombed 40 times since 1995 by leftist guerrillas. The company outsourced security of its facilities and supply chain to the Colombian military. Drummond now faces allegations of legal culpability for the wrongful death of trade unionists by the military and its associated right wing militias. A lawsuit has been filed in the US under the Alien Tort Claims Act of 1789 (ATCA).

    With heightened global security risks, government action may disrupt supply chains without sufficient warning. The start of hostilities in Afghanistan in October 2001 led the US government to impose a railroad moratorium on the shipment of certain poison-by-inhalation chemicals (PIH). Many companies did not receive advanced notice and had to scramble to make contingency plans. According to Gerald Donnelly, Director of Global Logistics for DuPont Chemicals, the moratorium would have had serious revenue implications for the company if it had lasted more than three days. The government ruling caused uncertainty and confusion because of differing interpretations of “moratorium” by rail crews --- that is, whether cargo in transit should be delivered or stored. Companies that do not maintain adequate security standards may cause international security concerns and harm to their reputation as safe suppliers of hazardous materials. In 2002, a truck carrying 96 drums of sodium cyanide from Degussa, a German chemical company, was hi-jacked in Mexico. Degussa outsourced the HAZMAT cargo to a trucking company that hired a driver without security clearance. The driver deviated from Degussa’s pre-approved route apparently to

    pocket the toll road fee. On route, the truck was hi-jacked. The incident created a diplomatic furor based on fears that terrorists had stolen the chemicals for use against US targets. The truck and the drums were recovered one week later, but six of the drums were never located.

Managerial Decision Making and Suggested Options

    The third element of the proposed risk management paradigm is the formulation and implementation of “must-

    do” policies to anticipate or to mitigate the adverse impact of environmental risks on the supply chain. Formulation

    of policies necessitates a fresh orientation to managerial thinking in supply chain management including

    ; Parsimony in approach rather than a complex one will expedite policy execution. That is, drivers of policy

    should be common sense, nimbleness and “prevention-is-better-than-cure”.

    ; Follow the “RPM” process of recognition, prioritization and mobilization.

    ; Fluid circumstances dictate flexible, innovative policies in terms of time, spatial dimension and IT

    application.

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    ; Benchmarking is a good discipline to expose a company’s vulnerabilities and to improve the shortcomings

    of risk management.

    Five broad, “must-do” policies are available for the continued improvement of supply chain risk management. These are not merely choices; rather higher efficiency must be achieved with the integration and implementation of all five of these policies into the company’s strategic management. These policies are (1) protect and secure resources, (2) network adjustments, (3) collaboration and lobbying, (4) training and procedures and (5) financial instruments.

    Protect and Secure Resources: A primary and immediate term task is the protection of company resources (people, plants, processes, products and the supply chain) against threats. In a post 9/11 world, the realities are that companies with global supply chains must shoulder the burden of increased responsibility for security:

    ; The first task is to improve shipping visibility.

    ; The second task is for companies to implement innovative but common sense policies to secure cargo in the

    supply chain. Practical policies range from information sharing among various stakeholders regarding risks

    to IT solutions for tracking patterns of vulnerabilities.

    ; The third task is to obtain valid intelligence from commercial and governmental sources about uncertain

    environments and threats to the supply chain.

    Network Adjustments: In the short and medium term, companies must remain flexible and agile in order to cope with the uncertainties generated by external risks. Suggested approaches include using only ports in CSI compliance, inventory adjustment, outsourcing, alternates to IT reliance, know your customer, benchmarking and joint ventures. Collaboration and Lobbying: Emphasis may be placed upon political strategies (lobbying) that influence the decision-making of governments and bureaucratic agencies. Governments are prominent players in mitigating risks such as terrorism, infrastructure breakdowns, natural disasters, crime and health concerns. Collective Horizontal and

    Collective Vertical lobbying techniques may be used to maximize lobbying efforts. Lobbying focuses on three games: value-net, public interest and public-private interest.

    Training and Procedures: It is imperative to train and to motivate managers and personnel to cope with crises and uncertainties resulting from external risk exposure. Innovative guidelines address (1) Create company wide metrics for risk management performance, (2) Integrate risk consciousness into company culture, (3) Strengthen company loyalty to counter political ideologies.

    Financial Instruments: Just like any other project that needs validation, investing in risk mitigating initiatives requires value assessment. A variety of approaches may be used: discounted cash flows techniques, real option pricing methods and insurance.

Conclusion

    Our three-step approach has attempted to offer an integrative, strategic perspective to supply chain managers faced with a growing array of external risks. We have attempted to

    (1) Identify various external risks generated by market as well as non-market forces,

    (2) Demonstrate the potential adverse impact such risks may have upon the supply chain, and

    (3) Recommend strategies and policies for managerial decision-makers to counter negative impacts. Much work remains to be done for refinement of this preliminary framework:

    ; Application to individual case studies in the Chemicals Industry to illustrate the impact of environmental

    risks on a supply chain stretching across multiple national boundaries

    ; Development of metrics to determine the relationship between costs, opportunities and the appropriateness

    of policies to enhance continued improvement of SCM security

    ; Integration of external and internal risks in SCM: a strategic approach dictates a better understanding of the

    intervening impact of external risks on the calculations of demand and supply risks.

Authors:

    Dr. Jay van Wyk is a member of the International Business faculty at the Anderson Schools of Management, University of New Mexico. His research interests include risk management in the international business environment. He may be contacted at vanwyk@mgt.unm.edu or meerkat@nm.net.

    Wilbert Baerwaldt, a supply chain manager in the Chemicals Industry, possesses a MSc from Purdue University and a MBA from TIAS, Tilburg University, The Netherlands. He may be contacted at w.baerwaldt.planet.nl.

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