Finance’s crisis role in managing supply chain risk

Supply chain disruption has been an inevitable consequence of the outbreak and spread of the coronavirus. According to survey results released in mid-March by the Institute for Supply Management, which has members in 90 countries, 75% of US companies have experienced supply chain disruption due to the current health emergency.

Furthermore, those companies expecting supply chain impacts anticipate that their severity will increase after the first quarter of 2020.

Julia Graham, deputy CEO and technical director of Airmic, the UK-based association for those leading organisations’ risk management or insurance, said the current coronavirus outbreak was a “classic emerging risk … a known unknown” of the type the World Economic Forum (WEF) identified in its Global Risks Report over several years.

In the WEF’s 2020 report, infectious diseases is rated the 10th-highest risk by impact, but it was not in the top list by probability. This meant many businesses have been taken by surprise: Risk severity for most organisations — and governments — is viewed as a combination of probability and impact, Graham explained.

“It does just bring home the fact that emerging risks need to be on your radar. … Sometimes they are not things that happen overnight and not even new things, but are creeping risks,” she said. Companies’ risk horizon-scanning and planning scenarios need to consider these types of risk, Graham added.

First actions

With an event such as the spread of COVID-19, a first action for a business, Graham suggested, is to analyse its supply chain and its likely points of failure.

She said: “If you are an organisation dependent on your supply chain, then you ought to be talking to your regular advisers.”

Over the next few months, after taking steps to assess, protect, and where appropriate reconfigure supply chains, businesses may consider redesigning the chains’ components to make them more resilient, she suggested.

Supply chain and logistics expert John Manners-Bell is chief executive of UK-based market research company Transport Intelligence and honorary professor at London’s Metropolitan University. He said companies worried about whether their supplies either from China, Italy, or other parts of the world are going to be affected “need to urgently undertake audits of their suppliers … and their suppliers’ suppliers”. For high-tech business or automotive manufacturers there will be at least five tiers of suppliers, Manners-Bell said.

“A lot of companies prefer to work with a single supplier because, from a cost perspective, they are able to leverage their buying power and drive down costs, but also build a relationship with a single supplier,” he said.

However, Manners-Bell said that while sometimes difficult to do, over the next few months the number one priority is for companies to diversify their supplier bases by building relationships in different parts of the world with suppliers who can provide a similar standard of components.

The trend over the past 20 years and more has been towards lean supply chains driving down inventories, he said. Now, Manners-Bell advised, companies should be building up their safety stock to appropriate levels within their supply chain.

By getting rid of inventory, companies can drive down internal costs, but at the same time they increase the external risk from a pandemic or natural disaster or industrial action at a port having a large negative impact on their supply chain.

“It looks good to drive down inventory levels and spend money elsewhere, but when you have this sort of disruption, then the whole of the supply chain is at risk, and the whole of the company is at risk if you don’t have appropriate levels of stock,” he said.

Finance’s role

Decisions on supply chains cannot solely be based on finance, but rather a balance between risk and opportunity, Graham suggested. CFOs together with the chief risk officer should look at their risk appetite in this context, she said.

She explained that going too far in reducing the number of suppliers and locations could increase a company’s risk profile, in the event of a similar crisis.

“It may be opportune for you to reduce the number of suppliers, and it may be opportune to reduce the number of your manufacturing plants, but you should never forget this is all about balance,” she said.

“Be careful that your actions don’t create other risks. … That’s why you need an ERM [enterprise risk management] approach of the relevant stakeholders around the table to say, ‘If we did X, what’s the implication of this in terms of Y?’,” she advised.

Manners-Bell said finance has a role in changing companies’ thinking around inventory. He said “a risk-agnostic supply chain that has higher levels of inventory” was needed. A different approach — to insure supply chain risk — could be more problematic, he suggested.

He explained: “It’s quite difficult to insure risk because it is actually quite difficult to measure the impact of any particular event on production, for example.”

A recovery plan

The ISM report revealed that more than 44% of US companies do not have a plan in place to address supply disruption from China. Of those, a majority report current disruptions.

It’s clearly desirable to have a continuity plan to fall back on, but it’s never too late to create one, Graham said.

“When you are leading a recovery, people need to understand what their roles and responsibilities are and, even if it is at a high level, it is something you need to do,” she advised.

Manners-Bell said companies without a business continuity plan already in place need to build one to look for alternative sources of goods.

“They need to increase their levels of visibility to find out where these particular components are as well as looking at alternative shipping arrangements. … In some cases, they will need to spend more money to expedite emergency freight shipments to prevent bottlenecks in production, for example.”

Further advice

Graham’s other advice for management accountants includes:

• Learn from the outbreak. Learning from dealing with disasters of any type is critical for businesses, Graham said. “There will be other diseases. … Learn from what you’ve understood this time, and don’t fall down into any paths that didn’t work for you again,” she said.
  
• Look at spin-off risks as well as opportunities. “Keep your ears and eyes open — you may be able to help. … You may be able to step in and do good things to help other people,” Graham said. “Opportunity is not a dirty word. It’s good management and, if you can see that you can do things better in the future, you should do them.”
  
• Communicate with the board. While it is not the board’s role to run the plan or even necessarily to have a role in the plan, it needs to know it’s working, who leads it, and the communication process from the C-suite to board members in order to discharge their responsibilities.
  
• Build resilience. The major components of resilient organisations — agile people, thinkers, and systems — can enable companies to put supply chain alternatives into place, for example. People who feel empowered can react and look at other options.
  

For more news and reporting on the coronavirus and how management accountants can handle challenges related to the outbreak, visit FM’s coronavirus resources page.

— Oliver Rowe (Oliver.Rowe@aicpa-cima.com) is an FM magazine senior editor.