When it comes to responding to risk, companies often experience a disconnect between the executive suite and frontline employees. Steven Carnovale, assistant professor of supply chain management at the Rochester Institute of Technology, offers some tips on how to avoid falling into that trap.
Q: What do you mean when you say that people compensate for risk in the supply chain in different ways?
Carnovale: Everybody deals with risk. We’ve all got this profile for how much risk we crave. I think about it like a thermometer inside your house. Some people like it at 75, some at 68. In a supply-chain context, we want to know whether people crave risk in terms of their sourcing strategy. Things like how many weeks or months of inventory to carry, whether or not they should have a larger or smaller portion of their suppliers geographically close, or far away.
We asked purchasing managers how they would respond given some type of external stimulus, in communicating risk levels within the supply chain. The results were pretty interesting. It turns out that people do in fact compensate, but in different ways. We found that if people felt comfortable, they ratcheted up the level of risk in their sourcing strategy by decreasing the amount of safety stock.
With regard to how people compensate for risk in supply chains, I like to think of it in terms of seatbelts. When seatbelt laws were put in place, people started to take more risks when they drove, so incident levels rose. The theory is, when you have a seatbelt on, you're more inclined to take risks. It turns out that this tendency was really interesting because it happened with purchasing professionals in a supply-chain context.
Q: Are people even thinking in terms of risk? Only recently has the concept of risk management really come to the fore in supply-chain management. Are they simply moving forward without even realizing they're taking a risk?
Carnovale: Everybody has a point where they're comfortable with risk, whether it’s setting a sourcing strategy or driving a car. It the risk levels around them aren’t high, they're willing to ratchet it up. It's a human condition, not just a supply-chain condition.
Q: When it comes to approaching risk on a day-to-day basis, is there a miscommunication between the C-suite and people in the trenches?
Carnovale: That's exactly right. The thing that motivated our investigation was that there’s a disconnect between those making high-level decisions and purchasing line employees. It’s the purchasing agents and supply-chain analysts who are implementing the strategy. On one hand, from a legal standpoint, if you're a publicly traded company, you've got to report certain risks financially. You need to think about the way that the purchasing employees who are tasked with actually making the decisions are going to react, and ensure that there's oversight. That was the key takeaway — the unintended consequences of people saying “Our supply chains are being exceptionally well-managed.” Potentially, they could be exposing themselves in ways they don't expect.
Q: What happens when you get into buyer-supplier relationships? What should managers be looking for there?
Carnovale: In the questions we were asking, there was a large emphasis on price pressure. It was born out of the recession, but has manifested itself since. What happens in a buyer-supplier relationship is that the big OEM is looking for constant price reductions by the supplier. When you think about the margins in certain businesses, a 10-percent cut can be huge. Even if the supplier acquiesces, it’s less likely to invest in service when dealing with the customer. It’s also less likely to invest in research and development for the future, or continue to enhance quality specific to the OEM. It's another unintended consequence.
Q: Is it valuable to think of hedging risk in the supply chain? And if so, how does one go about doing that?
Carnovale: Unquestionably, it’s extremely important. We found that the best way to hedge risk was to establish solid buyer-supplier relationships. If the OEM provides resources to help the supplier reduce its costs, that goes a long way toward ensuring that the relationship continues to work. One example is an automotive manufacturer that sent a team of engineers to the supplier to work with it on cost reduction and design thinking. Then it was like expanding the pie. Let's share the amount of wealth that we’ve got, so to speak, and the supplier will be willing to pass that forward.
Quality communication between the OEM and supplier was shown to ameliorate negative outcomes in a lot of ways. Price negotiations can be win/lose situations, in the sense that I may have reduced my cost, but I’m potentially losing because of these unintended consequences.
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