One of the driving forces behind the expansion of business relationships is a mindful effort to reduce risk. This is particularly true in supply chains.
To be sure, the pursuit for lower-cost materials and more efficient logistics are very important to industries of all kinds today. But reliability of supply and precautionary redundancy have prompted firms in industries ranging from basic materials like steel and chemicals to high technology, to establish supply networks across the globe.
Ironically, it’s likely that in going global, companies have not actually decreased their risk profile but actually increased it. Broadening exposures can actually drive total risk higher, either by actual exposure to new perils or simply by making existing risks more difficult to quantify or manage.
That is especially true of global supply chains, through which goods or services often come from countries with low per-capita income, weak regulatory control or where the quality of risk management practices—as well as building codes and standards—are weak or nonexistent. In several memorable cases, retail chains and clothing brands have had to respond to fires and collapses of the factories making their garments on the other side of the planet.
Even the industrialized world is not immune to global risks, as was proven by the earthquake and tsunami in Japan in 2011. Automobiles, car parts, electronics, and many other sectors saw their supply chains disrupted for weeks or even months, prompting them afterward to geographically diversify their sourcing, production and inventory.
One response by some firms to the losses suffered by global supply chains has been to bring operations and manufacturing back to the U.S. or source locally. Such decisions are often made with the thinking that stateside the risks are more controllable, or at least more knowable. What the on-shore trend implies is that security, control or at least some degree of transparency are worth some cost.
At first blush, that might seem to militate against a wide global supply chain, but for some organizations such an option is not practical. There are many countries with lower labor and materials costs, as well as low regulatory or tax burdens. Yet, in both scenarios, whether the supply chain goes as far as Lima, Peru, or only to Lima, Ohio, companies need to know what they are gaining, what they are saving, what they are risking.
What many companies increasingly want to know, because it is critical to their business model, is whether they are making informed decisions that can make their organizations more resilient. To know for sure they need quantitative frameworks to better understand and manage unknowns that may affect their supply chains on a broad level with an understanding that expanding a supply chain and making it more complex does not by itself make a supply chain more resilient. Complexity is not resilience.
While traditionally, many organizations have looked at their vulnerability to supply chain risk on a supplier-by-supplier basis, often times such an analysis may overlook critical aspects. The devil can often be found in the details. That’s why it’s important to examine those suppliers, large or small, whose loss would materially impact revenue and profitability rather than making decisions based on their biggest supply chain spend. Likewise, it can be revealing when examining systemic risk inherent to countries themselves, which can affect a wide range of suppliers in a particular region.
One way to assess a country’s resilience to supply chain disruption, for example, is by examining it in three broad ways:
- High-level economic risks specific to a country;
- Risk quality within a nation, which include common measures such as property risk exposures and quality of risk management practices inherent to a nation;
- Inherent supply-chain risks within that region, which are the tactical, logistical hazards of the specific modes and means of transportation, storage, and distribution of goods.
Together these represent key factors that can help pinpoint where in the world a company is potentially vulnerable.
In a recent assessment of more than 100,000 commercial property locations across the globe that my company insures, we uncovered findings that may be considered counter-intuitive to mainstream thinking. For example, the U.S. is often considered among one of the safest places for global business and trade. However, when looked at through the lens of supply chain resilience, the country doesn’t come out at the top of the list among countries in the world, due in part to political risk, corruption and local supplier quality.
The U.S. is further weakened in this respect due to geographic risk. We divided the U.S. into three zones—East and Gulf Coast, Central, and West Coast—and found that the Eastern third of the U.S. and Gulf Coast end up ranking 18th in the world for its resilience to supply chain disruption because of exposure to windstorms. Similarly the Western third of the U.S. ranks 21st due, in part, to exposure to earthquakes. The Central region ranks highest at 10th because of limited exposure to natural hazards.
In contrast, Norway, Switzerland and Canada rank as the top three most resilient countries in the world due to strong economies, high-quality infrastructure and a high level of risk quality. Of course, one also needs to consider, when deciding how to proceed, some less desirable aspects of doing business in countries such as high wages and foreign exchange exposures.
A country-by-country analysis in this way, as well as a quantification of resilience, can be thought-provoking and get an informed conversation started. This can be particularly beneficial when selecting suppliers based on where they are located, deciding where to locate facilities and assessing where customers’ facilities are based. Put another way, while some may have never considered Norway as a top choice for seeking supply chain partners, its resilience data shows that perhaps its worthy of consideration.
Similarly, if a global supplier produces inexpensive goods but is located in a country with lower resilience, such as numerous countries in Latin America and the Caribbean, there may be another low cost supplier nearby in a nation with higher resilience. At a minimum, understanding the potential inherent country exposures that supplier faces, can begin to help one make more informed risk management decisions based on their risk awareness and tolerance. Then decision makers can better manage such risk physically or logistically.
Of course, not every problem can be fixed, especially those on the other side of the world. Sometimes it may be wiser to consider accepting that risk, and attempting to mitigate the effects with redundant make up capability, inventory on hand or financial protections, such as business interruption insurance that cover your own facilities and disruptions to suppliers, and suppliers of suppliers.
The drivers of a country’s resilience to supply chain disruption can be a notable blind spot and it behooves companies buying or selling globally to understand local risk intrinsic to the markets they rely upon.
While supply chains are becoming increasingly complex, organizations that are able to identify the level of resilience in their supply networks and guide their operating strategy accordingly will ultimately benefit over those companies that do not.
Eric P. Jones, CPA, CVA, CBCP, CBCA, is Vice President and Global Manager of FM Global’s Business Risk Consulting (BRC) practice. Jones leads the BRC team’s effort, working in partnership with clients to fully identify and quantify their financial exposures related to potential business interruption losses. Contact him at email@example.com.