Supplier Risk Management

Aug. 6, 2009
Using spend analysis, companies can analyze their supply base across multiple dimensions in order to identify suppliers that pose risk.

In this macroeconomic climate, whether you are a product or a services company, your key suppliers may find demand for their own products and services falling at an alarming rate. Unknown to you, such suppliers may have become financially unhealthy. Operating in such an environment, your business operations can be disrupted unexpectedly by the failure of one supplier and can cause significant harm to you. As a result, procurement organizations, which have historically focused on securing products and services of the best quality at the lowest possible cost for their operations, are also being tasked with evaluating, monitoring, and managing the risk from the supply base.

To ensure that they are able to consistently evaluate and manage supplier risk, procurement executives need very clear visibility into their spend with each of their suppliers at various levels of detail -- how much are they spending with each supplier, what products and services are they buying from which supplier, what is the split of a product's purchase across multiple suppliers that you buy from, what regions is each supplier shipping/servicing from, what is the trend line of various operational, financial and legal risk metrics for each supplier, who are their suppliers, how are the various suppliers linked at different tiers, etc. Spend Analysis provides procurement executives clear visibility into answers to such questions.

Spend analysis is the process of determining what is being spent, with whom, and for what. Such an insight is typically used to identify opportunities for cost reduction such as rationalizing supply base, increasing contract compliance, and reducing maverick spending. However, spend visibility is also critical in determining the risk from the supply base. It provides critical information to categorize suppliers by spend, product/service, industry and geography, and enables procurement executives to use that information to create a short list of target suppliers. It allows the procurement organization to enrich the supplier information with data from external sources and internal supplier performance metrics, so a clear risk assessment of the short list of suppliers can be done and programs can be put in place. Hence, investment in spend analysis is the starting point to a comprehensive supply risk management initiative.

First Step in Spend Analysis is Making the Data Ready

However, spend analysis is not just about running analytics on top of procurement data with your ERP system. Spend data lies within multiple systems within the company and so it needs to be aggregated to get visibility into overall spend. A supplier's name may be coded differently in different systems -- a common occurrence. Due to different codes used to describe the same product/service across different systems, it is not possible to get an aggregate view into how much has been spent on that or similar items without adding a corresponding industry classification code for each item in every transaction record. Finally, relationships between suppliers are rarely identified within various systems. For example, your system may not tell you that Lab Equipment, Inc. is a subsidiary of Lab Supplies, Inc. If it did, you would realize that you have greater spend with and risk from that supplier

Due to the data issues listed above, it is not possible to do an accurate and comprehensive analysis of spend by simply bringing data from various systems into a spreadsheet or a Business Intelligence system and performing the analysis. The data has to be cleansed to remove errors, normalized to ensure suppliers are represented in a consistent manner, and finally enriched with classification data, subsidiary relationships, supplier performance data, etc. Only then the analysis can be done on the data to yield an accurate picture of the overall spend. Once data has been cleansed, normalized and enriched, it is now ready to be analyzed to identify risk to a company from its supply base.

For example, in one scenario we can classify suppliers by categories such as total spend, product, industry and geography. Ability to classify suppliers along these dimensions allows a procurement executive to identify all those suppliers where they are either buying large volumes or those suppliers where they are sole-sourcing or those suppliers providing critical components/commodities. This analysis allows them to prepare a shortlist of suppliers that need to be evaluated and monitored for risk. The classification also provides immediate visibility into those suppliers who are associated with either an industry or a product group that increases their exposure from issues such as quality; commodity and labor shortages; price fluctuations; environmental and safety issues; and supply/demand imbalances. It also quickly clusters suppliers by their geographical risks such as political issues, infrastructure difficulties, and currency fluctuations. By analyzing data along these dimensions, procurement executives are able to create a shortlist of suppliers that need to be closely monitored.

Companies that do not use the spend analysis tools end up sorting their suppliers only based on approximate aggregate spend with them and focus their attention on the top 20% of suppliers that make up 80% of the spend. But, low spend suppliers can be a source of significant risk as well. A cheap part in an expensive engine can cause the engine to fail. Data theft enabled by poor security practices of a small IT provider can cause irreparable damage to a retailer's brand and lead to lawsuits. Using spend analysis, procurement organizations can do a comprehensive analysis of their supply base across multiple dimensions such as spend, products purchased, number of other suppliers for the same product, location of plants, supplier/part quality, supplier shipment performance, etc to identify suppliers than pose risk.

There's no measurable return from a supplier risk management initiative unless the risk materializes and you can quantify the avoided loss. Until then, it's only possible to estimate the impact using a metric that takes the probability of the risk and the expected magnitude of the loss. In addition, it is important to remember that even the most successful risk management programs only reduce the impact of a risk, they do not eliminate it. However with a good supplier risk program, you are on your way to reducing the business risk for your organization.

With initial supplier risk evaluation, based on data from spend analysis, you can start the process for reducing the risk from weak suppliers within your supply base in this economic environment.

Naresh Hingorani is the Integrated Sourcing and Procurement Practice Area Leader at Bristlecone, a global supply chain consulting firm.

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