Risk Management Rarely Gets to the Root Cause

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Large corporations typically have internal risk management functions. Many are staffed by individuals with advanced degrees—even Ph.D.s—in areas such as mathematics, statistics, actuarial science, etc. The role of these folks is to identify areas of financial risk and forestall or reduce the threat they pose to their employer’s profitability. Supply chain risk is evaluated and managed in this way.

Over my career, I’ve worked with risk management groups and in my experience, they are staffed by very smart people. On the other hand—as I’ve seen with most corporate functions—they don’t seem willing to question corporate strategies or practices that have already been decided at the executive level. In other words, they know which way the wind is blowing and are reluctant to recommend any alternate strategy that would make them appear to be a rogue sect.

Instead, they recommend actions that they hope will dampen the financial risks of specific corporate business strategies. At least in supply chain, my observation has been that their risk-reduction efforts haven’t necessarily addressed root cause. A perfect example of this is the supply management sourcing selection strategy of picking suppliers almost exclusively on lowest piece-price.

Price vs. Agile Suppliers

When I was a materials manager in the late 1990s, sourcing with low piece-price overseas suppliers was the norm. Associated with this strategy were the customer risks of an extended supply chain. The selling season for our division’s primary products was three months. When you think about it, this is the length of time it would take to change schedule and receive parts from sources located, say, in China. This meant that with our Chinese suppliers we wouldn’t get parts in time to adjust our schedule volumes or SKU mix within our selling season to compensate for forecast errors. The financial damage, then, would be lost sales, lower revenues and having leftover product that didn’t sell.

When I brought this up at the VP level, my position was largely ignored: that suppliers should be selected on the basis of whether they can support the demand dynamics of the market they supply to. When I complained to a trusted colleague about being regarded as a rogue heretic, he gave me what I’ve come to believe is sage advice:

“When taking on the world, bet on the world”

I will say that my career would have been a lot less stressful if I had taken that advice. In the end, though, I suspect that it would not have been as satisfying.

This is not to say corporations didn’t take any action in an effort to reduce the risk associated from sourcing through lengthy supply chains.  For instance:

• They bulked up their logistics departments.  And I mean “bulked up”, going from a few individuals in the pre-1990s to large, costly logistics empires today. This greatly increases a purchasing function’s fixed costs.
• They purchased millions and millions of dollars in software designed to help them track, step by step, the exact status and location of their purchased part shipments. When you think about, though, this isn’t worth much when they are stuck in ships sitting outside the port of Los Angeles.
• Many also greatly expanded their warehousing capability to be able to store the additional “safety” stocks of inventory they will likely need to minimize the impact of supply shortages.  Of course, this added more fixed costs since those inventory levels were based on forecasts which, as we all know, have error.

 As previously mentioned, none of these actions addressed root cause and so should only be considered Band-Aids.

Overlooking the Root Cause

It doesn’t take a Ph.D. to understand that these Band-Aids have been ineffective in avoiding or mediating financial risk. Again, to address root cause, supplier response capabilities must align with market dynamics and historic levels of forecast error. And sometimes the overall most cost- and revenue-effective approach is to accept a higher piece-price. This should have been the recommendation of my employer’s risk management function.

Read more of Paul Ericksen's supply chain management articles.

It should be pretty clear that corporate actions to address the inherent risk in sourcing overseas didn’t address root cause. Specifically, the longer a supply chain, the more risk that something will negatively impact the transportation process or prevent the supplier from being able to respond in time to support market changes.

I’m pretty sure “market dynamics” and “forecast error” haven’t been on the radar screens of most corporate strategic sourcing functions. Going forward, progressive corporate supply management functions will understand that there is no “one size fits all” sourcing strategy.

In Closing, a Cartoon Caper …

The newspaper I subscribe to has daily cartoon strips and a couple of months ago one of them got my attention. It consisted of four panels, as described below:

Panel One:

Woman asks man:  What is going on lately?

Man:  I read there are multiple problems in the supply lines 

Panel Two:

Man:  But in all fairness, when it was decided to manufacture most of our goods in Asia….

Panel Three:

Man: And ship them across 6,500 miles of ocean. 

Panel Four:

Man: Who could have imagined that something might go wrong?

I suspect the author of this comic strip didn’t have a Ph.D. in any of the areas cited above.  Honestly, it’s a sad sign that corporate supply management strategies are now being mocked in comic strips.