Supply Chain Strategy: Managing emerging market risk

Supply chain risk has become more problematic than ever before—and the increasing need to penetrate emerging markets is only making the problem more acute. Here are five broad-reaching steps shippers can take to establish a safety net.

By Joyce Kline, Accenture -- Logistics Management, 5/1/2007

• Refining the strategy
• Integrating mitigation
• Risk-mitigation strategy

Mature home markets. More and more widespread competition. Downward pressure on margins. Small wonder that companies everywhere are thinking--and acting--more globally. Pure and simple, global business is becoming every company's reality.

Thousands of pitfalls line the path to high performance in global operations. But among the most treacherous is the need to understand and manage risk. Then again, business is all about risk. But with the advent of global operations--and companies' growing interest in emerging markets--risk has assumed a whole new dimension.

For example, risk is exacerbated by limitations in physical infrastructure (roads, ports, facilities, etc), which are usually less developed in emerging markets. Take India (one of the four BRIC countries, along with Brazil, Russia, and China), where transport delays and inadequate cold storage cause nearly half of all domestically grown fruits and vegetables to rot before delivery.

Political structures and policies also enhance risk, since they're nearly always more restrictive in emerging markets. Even in the European Union (EU) supply chain risk is elevated because cabotage (intranational transport) is zealously controlled. Haulers based in one EU country usually are not allowed to travel between points within another EU country.

Or take China, which periodically imposes licensing, health, technical, and packaging restrictions that put foreign companies at a disadvantage. China recently released a draft regulation requiring one dealer license, one product in the auto sector, effectively preventing newcomers from using existing distribution channels and giving domestic manufacturers more time to prepare for direct competition. Figuring out how to surmount these risks is core to the challenge of global operations.

But risk has another, even more dire, component: anticipating and responding to unanticipated calamities. In a recent column in Logistics Management, we profiled a 2006 Accenture study on risk management and mitigation. The results were sobering: Seventy-three percent of companies have experienced supply chain disruptions in the past five years. Of those, executives at nearly 32 percent said it took more than one month to recover and 36 percent said it took between one week and one month to recover.

The vast majority (94 percent) said the disruption affected profitability and their company's ability to meet customer expectations. Fifty-six percent said the impact on customer expectations was moderate or significant. The report also identified the source of most upheavals and the frequency with which they were cited by respondents:

• Poor performance of supply chain partners (38 percent).
• Volatility of fuel prices (37 percent).
• Natural disasters (35 percent).
• Inability to deal with logistics capacity or complexity issues (33 percent).
• Inaccurate plans and forecasts (30 percent).

The bottom line is twofold: Supply chain risk has become more ubiquitous and problematic than ever before, and companies' increasing need to penetrate emerging markets will only make the problem more acute.

A company's first-tier response to global risk should be obvious: develop and refine a global operating strategy. That strategy must begin by confirming the primary reason for addressing an emerging market. Is it to find new sources of supply? Increase revenues by attracting new buyers? Introduce new products or product lines?

If the objective is to increase revenues by tapping hot new markets, it's essential that the company understand on a market-by-market basis the readiness and appropriateness of its product portfolio, logistics channels, make/buy approaches, and sales/marketing support functions. If the goal is new sourcing opportunities, the make-or-break factor could be the right sourcing model: Work with trading agents? Form local joint ventures or wholly owned foreign enterprises? Build international procurement offices? On both sides (selling and sourcing), the key is aligning market-entry objectives with the supply chain characteristics that typify each country or region. What works in Brazil may not work in China.

The above generalities may be useful up to a point. But they don't speak to the specific issue of risk. In its most recent (2006) study of global operations, Accenture found that the global operations strategies of most companies were not developed with specific attention to managing supply chain risk. Three-quarters of the survey's 300 respondents noted that their companies have not fully integrated risk-mitigation with their global operations strategy. Ten percent have done nothing whatsoever. In addition, more than half of the survey respondents stated that their global operations strategies have actually increased supply chain risk. Only 13 percent said that risk dropped as a result of implementing/upgrading their global operations strategy.

So what are the right ways to minimize the risks associated with emerging markets? And what is the right way to make those approaches part of an evolving, continuously improving global operations strategy? Naturally, there are hundreds of individual steps that can be taken to reduce supply chain risk.

However, research by Accenture has identified five of the most far-reaching and significant. As shown in Figure 1, each resides on a continuum of supply chain maturity.

1. Increasing inventories and safety stocks is a viable and widely practiced option. However, it's also a buffer strategy that's typically employed by companies seeking a foothold in an emerging market. And it can be costly, and therefore less likely to align with the company's broader inventory management objectives or the wishes of its C-suite.



2. Forward buying/hedging strategies also can mitigate risk by ensuring the cost-effective acquisition of needed products and materiel from emerging markets. However, a forward buying and hedging strategy must be evaluated in light of each specific purchase. Acquiring supply-constrained materials such as titanium will likely be viewed as strategic. But hedging on a more readily available commodity would likely be an inappropriate risk-abatement solution.
   
   
3. Building contingency relationships with additional suppliers or logistics services providers is often a good way to prepare for potential disruptions in supply, unless it somehow detracts from companies' valued relationships with current supply chain partners. However, this is not a simple short-term initiative, nor is it easy to undo.

New relationships increase agility and potentially reduce risk, but they take time. The key is ensuring that prospective partners are highly qualified, and that their supply chain processes are compatible with those in place at the companies that engage them. Take the case of a leading high-tech company seeking to maintain operations in the wake of the Indonesian tsunamis. Strong contingency relationships enabled it to move supply and production from its Asian operations to alternate venues in North America and Europe. At no time did this shift impact the company's customers.

Further along the continuum is the development of a formal risk management program that clearly defines and prescribes a company's range of responses to a potential disruption. In simplest terms, this involves the development of a structured, integrated resilience life cycle across which companies:

• Identify and categorize risks.
• Monitor threats.
• Circulate information and alerts.
• Develop mechanisms for minimizing the effect of disruptions.
• Prefabricate and enact potential responses.
• Develop mechanisms for recovering in the most rapid and efficient way.
• Measure performance and develop metrics for continuous improvement.

The most mature example of supply chain risk mitigation is an intentionally geographically distributed supply base--the operative word here is intentionally. Many companies seek to develop an extended supply chain in order to reduce cost and maintain competitiveness. As a result, suppliers in emerging markets are often targeted. However, the qualification process can be long, and ensuring certainty of supply is always challenging.

In the high-tech and aerospace industries, for example, supplier qualification can take 12 months or more. Another challenge associated with distributed supply bases is the more complex (and potentially more expensive) circulation of material for assembly or point of use. Simply put, emerging markets and intentionally distributed supply bases are poster children for the design of insightful, innovative global operations strategies.

It is interesting to note that Accenture-researched companies haven't necessarily enacted the five practices in the same sequence we have just described. As shown in Figure 2, forward buying/hedging is used more widely than the less mature practice of increasing inventories and safety stock.

Yet both have the narrowest effectiveness gap--the difference between those companies deeming the practice effective versus ineffective. Generally speaking, however, the more mature practices have been enacted by fewer companies and have a significantly higher level of perceived effectiveness.

In net, every emerging market and every supply chain strategy has its own cadre of risks. Though there are hundreds of responses, most are mirrors or subsets of the five strategies we've just discussed. We should also highlight that companies bent on high performance develop their global operations strategies knowing that built-in risk management programs are critical. These companies balance their emerging market objectives against the related (and documented) risk. In fact, it's often high expertise, high expectations and, most of all, high levels of preparedness that make them high performers.

Additional Resource: "Risky Business" by By Russ Beverly and Jade Rodysill from Outlook Journal, May 2007 offers detail on the Accenture research and discusses how to build a resilient supply chain.