Supply chain disruption has become commonplace for the vastnumber of manufacturers, retailers, and other businesses that todayare connected to global supply chains. In a recent BCI survey ofmore than 300 companies, more than 70% suffered a supply disruptionin 2010 – and 50% of those surveyed experienced more than onedisruption. These disruptions are increasingly costly – anunintended consequence of using global partnerships, singlesourcing, and other strategies to squeeze every possible cost outof supply chains.

Experts, including Gary Lynch, leader of global supply chainrisk management at Marsh Risk Consulting, now are calling this “thenew disruptive economy” – a globally interconnected businessenvironment that requires companies to cope with volatility as apermanent feature of the economy.

Lynch recently joined forces with Mike Kerner, CEO ofZurich Global Corporate in North America, to delineatethis new landscape of supply risk – and how companies with globalsupply chains can manage the financial and other challenges thatsupply disruptions cause. Kerner and Lynch presented a strategicframework – dubbed “design for resiliency” – at a May 24PropertyCasualty360.com web seminar (sponsored by Zurich) titled“When Catastrophe Becomes Commonplace: How to Build ResilientSupply Chains for the New Disruptive Economy.” (Editor’s Note: thisweb seminar has been archived and is available for viewing atwww.PropertyCasualty360.com/SupplyChain.)

Essentially, Kerner and Lynch said that companies and their riskmanagers must take immediate steps to better understand their riskexposure, optimize supply chain resiliency in lockstep withoptimizing for efficiency, and prepare (through crisis planning andappropriate insurance coverage) to expedite recovery when theinevitable disruption strikes their businesses.

The Geography of Supply Chain Risk

Kerner kicked off the seminar presentation with the crux of thechallenge: the global pursuit of profitable supply chains can setcompanies up for catastrophic (and very unprofitable) supply chainfailure. Citing a UK study by the Manchester Business School,Kerner noted that the direct financial cost of supply chainbreakdown can be exceeded by the combined indirect costs ofeconomic losses, damage to corporate image, human and environmentalcosts, and other factors.

“Ironically, actions that are taken to drive costs out of thesupply chain can drive greater risk into it,” he said.Consequently, the key focus of supply chain risk management shouldbe to fully understand the cost of risk exposure – and then toprotect profitability when the chain breaks.

To start with, companies must have a clear map of their supplychain. Companies should ask themselves, “Do you know your suppliersas well as you thought?” Kerner says. He noted that each supplierrelationship brings associated risk factors, including otherrelationships, intellectual property, geopolitical andenvironmental exposures, skills and experience. These risks andother exposures can be identified through supplier surveys andother assessment tools, then evaluated and prioritized with the useof risk scenarios and risk grading.

The outcome of risk assessment should be supply chain riskstrategies and informed business decisions that protectprofitability, maintain the flow of funds to the balance sheet,retain customer relationships, and protect the reputation of thecompany brand, Kerner said. This comprehensive assessment also isessential in guiding the company’s selection of appropriateinsurance cover.

In response to increased supply chain risk, insurance companiesare becoming much more innovative and comprehensive in the productsthey offer. So-called “non-physical damage insurance,” for example,allows companies to offset not just direct supply chain losses, butalso the indirect (and potentially very costly) losses associatedwith economic losses, damage to relationships and reputation, andother costs of supply chain failure.

Focusing on Single Points of Failure

Preparing for commonplace catastrophe can be an overwhelmingtask; within the near-infinite universe of things that might gowrong, how do you prioritize and focus limited risk managementresources?

“The ocean is too big to boil,” so the only answer, Lynch said,is a strategic framework that builds resiliency into the entiresupply chain while letting companies focus on their “black swans” –risk events that cross the normal threshold of manageability andthreaten the overall business.

Lynch – author of Single Point of Failure: The 10Essential Laws of Supply Chain Risk Management – sayscompanies must use a “value filter” to segment and rationalizetheir product and services offerings. Margin, liquidity, asset andbrand value, regulatory implications, and other strategic factorsmust be accounted for in a systematic way. If one product familyaccounts for 30 percent of sales but 42 percent of margin, forinstance, that greater impact must be properly factored in, heexplained.

Moreover, “Since failure of any type of resource can cause amaterial disruption, all resources needed to support creation ofvalue should be mapped and analyzed,” Lynch explained. Companiesmust thoroughly understand the flow of their resources, from source(crop in the field or ore from the mines) all the way to the endcustomer – and know clearly what the impact of failure is.

Lynch cautioned that “threat-based analysis” can be extremelysubjective. Instead, analysis should focus on impact “to identify,prioritize, and align exposure to investment.” Loss of yourtitanium supplier, for instance, likely is far more important thana missing fastener shipment or a disruption in the operations of afreight forwarder. Once risks are prioritized by potential impact,then companies can determine what risks can be insured or otherwisetransferred, what alternatives are available for financing, andwhat risks will retained (and ideally mitigated).

With this understanding, companies can employ a data-driven“return on risk investment” model to evaluate their strategic andtactical expenditures for supply chain risk management. This“risconomics” approach, Lynch says, puts business value (ratherthan asset value) at the forefront of consideration and representsthe best way to ensure efficient, effective allocation of scarceresources.

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John DeWitt, a contributing editor to PropertyCasualty360and National Underwriter Property & Casualty, isprincipal and senior consultant for JW DeWitt BusinessCommunications in New Salem, Mass.