An Introduction to Supply Chain Risk Management: Definitions and Theories Perspective

Abstract

Risk management has a long history among the academics and practitioners and it is a currently debated topic in the area of supply chain management. The topic derives its importance due to several industry trends currently in place: market globalizations, increase use of outsourcing, short product lifecycle, unpredictable demand, uncertain supply and pressure for lean production. This article describe several models for managing supply chain risks and the choices for type of responses such as such as separation, transfer, weakening, avoidance and insurance.

Headnote

Abstract

Risk management has a long history among the academics and practitioners and it is a currently debated topic in the area of supply chain management. The topic derives its importance due to several industry trends currently in place: market globalizations, increase use of outsourcing, short product lifecycle, unpredictable demand, uncertain supply and pressure for lean production.

This article describe several models for managing supply chain risks and the choices for type of responses such as such as separation, transfer, weakening, avoidance and insurance.

Keywords: supply chain, risk management, supply chain management, supply chain risk management, risk analysis, risk response

JEL Classification: M11

Introduction

Supply chains are essentially organizational frameworks based on exchange and dependence between firms, each with its own objectives and motivations and drawing a payoff, whose risks it must also sustain and manage, in as many ways as it may be able to measure and conjure [Tapiero & Kogan, 2007].

Risks to the supply chain consist of anything that might interrupt the smooth flow of materials. The flows in a supply chain mainly include the forms of material, finance and information. Thus, supply chain risks can be classified into four types: material flow risks, financial flow risks, information flow risks and then a fourth type of risk based on the ways that these flows are organized [Waters 2007]:

- Physical risks are associated with the movement and storage of materials - and include risk to transport, storage, delivery, material movement, inventory systems, etc.

- Financial risks are associated with the flows of money - and include risks to payments, cash flows, debt, investments, accounting systems, etc.

- Information risks are associated with the systems and flows of information - and include data capture and transfer, integrity, information processing, market intelligence, system failure, etc.

- Organizational risks arise from the links between members of the supply chain - and include relationships between suppliers and customers, alliances, shared benefits, etc.

The primary function of a supply chain is to keep goods, information, and payments flowing through the network and arriving everywhere in the right numbers at the right time and in good shape. Therefore the chief risks to supply chains are all those events that might disrupt the flows.

1. Supply Chain Risk Management Framework

Risk is present in numerous firm activities and having been studied from many perspectives including strategy, finance, production, accounting, marketing and Supply Chain Management (SCM). Supply chain management, in general, is still a relatively new concept in most developing countries; and many companies have not even begun to consider the formal management of their supply chain [Blos et al., 2009]. "Supply chain management is the integration of trading partners' key business processes from initial raw material extraction to the final or end customer, including all intermediate processing, transportation and storage activities and final sale to the end product customer"[ Wisner et al., 2012].

In supply chain literature, there are various definitions of risk. For example, "Supply chain risk management is the management of supply chain risks through coordination or collaboration among the supply chain partners so as to ensure profitability and continuity." [Brindley, 2004]. SCRM can be viewed as a strategic management activity in firms given that it can affect operational, market and financial performance of firms [Tang, 2006]. Figure 1 illustrates the origin of SCRM at the border between Risk Management and Supply Chain Management [Blos et al., 2009].

In today's business environment the management of risk has been dramatically growing as perhaps the number one reason companies have become more focused on their ability to more flexible and adaptive. As illustrated in Table 1, risk in today's supply chain can be located in four areas [Ross, 2003].

In recent years, the adopting of some supply chain practice such as outsourcing and lean production helps in smoothing the operations, but it also results in little buffer inventory in a supply chain which may lead to increased vulnerability of the chains. At the same time, the business environment has evolved to be an increasingly complex scenario characterized by high uncertainty and rapid and frequent changes [Li et al., 2011].

To widen the focus on supply chain vulnerability it is suggested that a supply risk profile be established for the business. The purpose of the risk profile is to establish where the greatest vulnerabilities lie and what the probability of disruption is. In a sense this approach takes the view that [Christopher, 1992]:

Supply chain risk = Probability of disruption x Impact

The risk of disruptions caused by both factors within supply chains and outside environmental forces is one of the main concerns of both practitioners and researchers [Trkman & McCormack, 2009].

1. Uncertainty and Risk in the Supply Chain

Risk and uncertainty are not the same but it is not clear to distinguish them in supply chain operations. Slack and Lewis [2001] describe uncertainty as a key driver of risk but argue that managers are able to measure and change their exposure to risk through the development of prevention, mitigation and recovery strategies. Tang and Nurmaya Musa [2011] suggests that risk sometimes is interpreted as unreliable and uncertain resources creating supply chain interruption, where as uncertainty can be explained as matching risk between supply and demand in supply chain processes

Other authors (Figure 2.) subdivide this set of sources of uncertainty in two subsets: internal sources of uncertainty at the end external sources of uncertainty [Cucchiella & Gastaldi, 2006].

The principal's risks resulting from the selected uncertainty internal and external sources are the following [Cucchiella & Gastaldi, 2006]:

- Available capacity: financial capacity (the project is not realizable of the excessive financial exposure); production capacity (the project is too much great or complex); structural capacity (the network does not have the necessary infrastructures).

- Customs regulations: development from the consumers of a own product; not usability of product without right regulation.

- Information delays: lack of information necessary for the right definition of product characteristics; lack of information necessary for the definition of the right moment of product emission on the market.

- Internal Organization: not cooperation among the actors; low ability to adopt the new technologies.

- Competitor action: Competitor actions can delete the achieved advantage; Detention from competitors of a competitive advantage.

- Manufacturing yield: low consumer demand of products; consumer demand of products superior than forecast.

- Political environment: an excessive demand of the consumer could make the mature product; not forecast of the possible actions of the vigilance authority; changes in the reference context can modify the type of demand products.

- Price fluctuations: Not coverage of the costs sustained by the network due to product price fluctuations.

- Stochastic cost: a new technology on the market could make obsolete the product.

- Supplier quality: Not availability of specific skills required to the suppliers.

This classification of risks is only one option and a more detailed view of supply chain risk illustrated in Table 2 can describe risks as internal risks, risks within the supply chain and risks in the external environment [Mason-Jones and Towill, 1998].

Internal risks arise from operations within an organization. They might be inherent risks in operations and risks that arise directly from managers' decisions. Supply chain risks are external to the organizations, but within the supply chain. These occur from the interactions between members of the supply chain, and are principally risks from suppliers and risks from customers. External risks are external to the supply chain and arise from interactions with its environment.

Risk identification reviews the uncertainties in a supply chain and lists the consequent risks. We already know that it is virtually impossible to list every conceivable risk, so it is fairer to say that identification gives a list of the most significant risks. This is a key activity, which forms the foundation for all other aspects of SCRM, so it must be done properly [Waters, 2007].

3. Approaches to Managing Risk in Supply Chain

There is no doubt that managing supply chain risk should be an important activity for most organisations [Khan & Burnes, 2007]. "Global supply chain risk management is the identification and evaluation of risks and consequent losses in the global supply chain, and implementation of appropriate strategies through a coordinated approach among supply chain members with the objective of reducing one or more of the following - losses, probability, speed of event, speed of losses, the time for detection of the events, frequency, or exposure - for supply chain outcomes that in turn lead to close matching of actual cost savings and profitability with those desired" [Manuj & Mentzer, 2008].

Other authors suggest a basic decision-making model for supply chain risk management that breaks down into three generic steps (Figure 3.). These steps are risk features, analysis and risk measurements [Xia & Chen, 2011].

Risk features may vary along supply chain operation processes, but there are several ultimate forms of SC risks: quantity, cost, quality and time [Xia & Chen, 2011].

Each organization must respond to risks, but there are many alternative ways in which the process used can be applied To deal with various risks with different attributes, practitioners may have many choices, such as separation, transfer, weakening, avoidance and insurance [Xia & Chen, 2011]. Other authors refer to the following different types of risk responses [Waters 2007]: Ignore or accept the risk, Reduce the probability of the risk, Reduce or limit the consequences, Transfer, share or deflect the risk, Make contingency plans, Adapt to it, Oppose a change, Move to another environment.

Tang [2006] suggests four basic approaches to mitigate the impact of supply chain risks (Figure 4.). Each of these four basic approaches is intended to improve supply chain operations via coordination or collaboration as follows. First, a firm can coordinate or collaborate with upstream partners to ensure efficient supply of materials along the supply chain. Second, a firm can coordinate or collaborate with downstream partners to influence demand in a beneficial manner. Third, a firm can modify the product or process design that will make it is easier to make supply meet demand. Fourth, the supply chain partners can improve their coordinated or collaborative effort if they can access various types of private information that is available to individual supply chain partners.

Managers can choose from different types that range from the very easy to the enormously difficult. At one extreme, we have seen that the easiest response is to simply ignore a risk. At the other extreme are very severe responses that managers only use when a risk is so serious that it threatens the organization's survival [Waters, 2007]. Each of these is best suited to different circumstances. In principle, prevention is better than cure, so the preferred options, in descending order of preference, are preventing a harmful event from happening, then reducing the consequences if it does happen, and finally seeking redress for damage after it has happened [Pauchant & Mitroff, 1992].

Conclusions

There are several types of risk in the supply chain, witch we describe as internal, supply chain and external. In reality, these risks are not isolated, but are interrelated. As each member of a supply chain occupies a unique position, risks to a single member can be transmitted and expand t give risk to the whole chain. The best way of dealing with these mutual risks is not t o work in isolation but to have all members cooperating and working together to reduce the level of risk to the whole chain.

The context for risk management is laid by the organization's broad strategies, particularly its risk strategy, which is passed on to the separate functions and forms the basis of their own risk management. The supply chain is particularly vulnerable to risk, and supply chain risk management is clearly growing in importance. In principle, SCRM is similar to organizational risk management. But now the process is much more complicated, as it needs cooperation between organizations with widely different operations, aims and views.

The overall aim of SCRM is to ensure uninterrupted flows of materials and its core activities are risk identification, analysis and response. Around these three core steps is a series of other activities, starring with preparation for SCRM and ending with monitoring and control of risks. These steps do not give a recipe for SCRM, but they outline a continuing process that evolves over time. This brings numerous benefits, centred on better decisions about logistics and reduced supply chain vulnerability.

References

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