Drusspots Inc. designs and manufactures solenoid valves and valve assemblies for controlling air, gasses, water, fuels, and other liquids. Our electromechanical, hydraulic and pneumatic products are used in diverse fields (e.g., industrial, utilities, space, scientific, defense, nuclear) and are also incorporated into end-consumer products by other industries (e.g., aerospace, auto, power equipment). For 35 years Drusspots has made its name and grown dramatically based on our research and design (R&D) and engineering expertise, developing unique and cost-effective solutions for our customers. We have learned in the last three months that our livelihood rests on far more than our R&D expertise.
Drusspots recently had two product breakdowns, one at a utility client and another in a consumer field. Neither of the product failures was severe (resulted in loss of life), and for that we are fortunate; these could have occurred in other applications and brought down an aircraft or misdirected a missile. But both failures resulted in substantial warranty reimbursements and the potential loss of one or more customers.
What’s frightening is that neither product failure was due to our design or manufacturing: One of our many coil suppliers, cash-strapped because of the credit crunch and looking for ways to cut costs, changed to a cheaper supplier of inferior raw material. The material in the coil failed, the solenoid valves failed, and, subsequently, a large utility went dark for 10 minutes. The same material in our solenoids caused a lawn-mower manufacturer to report dozens of failed products.
I thought we did adequate due diligence on our suppliers, but we’ve realized that we do not have the business processes and information systems in place to minimize supply-chain risks to the degree that we should. For example, I now would like to know on a regular basis of the financial state of our suppliers (helping them out when possible or removing them if they choose to take a path that may put our products in jeopardy). In addition, Drusspots has been asked by many utilities (it’s surprising how quickly bad news spreads) that we need to not only mitigate supply-chain risks, but we need to prove risk-management to our customers: documenting, codifying, and sharing information with them to alleviate their concerns.
We know what we need to do, but I’m not sure how to begin this enormous process. We have dozens of suppliers around the globe, and ours suppliers have dozens of suppliers, and so on. Until we figure it out, though, we’re nervously waiting for the next failure.
* The Challenge incorporates hypothetical persons, companies, and products and does not portray the actions of any actual persons, companies, or products.
By Beth Enslow
Drusspots Inc.’s supplier concerns are an issue that every company should be aware of and tackling today. The credit crunch and declining demand for products puts a double-whammy on the cash position of companies and their suppliers. To keep afloat, suppliers may be cutting corners or taking other actions that could significantly damage your ability to serve and retain customers. Or worse, they may become insolvent and leave you stranded for key components or ingredients.
Drusspots should immediately institute a policy with its direct material suppliers to require that suppliers alert Drusspots if they make a change to a second-tier supply source. Drusspots should then re-audit the supply quality and delivery reliability of the affected components. Drusspots also should consider increasing the amount of quality assurance (QA) that it does on its inbound supplies, including the frequency of random audits, and alert customers that it is taking these preventative actions.
Know the red flags
Look actively for red flags with your suppliers to avoid problems:
- An increase in short shipments or shipment delays may indicate that the supplier does not have the cash to fully fund raw-material purchases for your orders.
- A decrease in material quality or increase in quality defects can indicate a supplier trying to stay liquid by reducing its purchasing costs.
- A reduction in QA staff at a supplier is a common staffing cut when times get tough.
- A decrease in order responsiveness may indicate that the supplier no longer has the financial ability to pay for overtime or expediting or has made staff cuts.
All companies should be refocusing on supplier financial audits, if they haven’t already done so. It is important to re-audit all your suppliers at a base level (e.g., credit ratings and basic financial information) and more deeply investigate higher-risk suppliers or those that provide critical materials that would be difficult to replace. Suppliers that are a sole source of materials or components should receive extra scrutiny; consider adding additional suppliers to minimize the chance for disruption.
Be nosy with your suppliers
A few of the financial questions to consider asking your suppliers include:
- How has your credit line with banks changed over the past year?
- Have your suppliers’ payment terms changed?
- Who are your suppliers' biggest customers? (For instance, some of Drusspots’ suppliers may be heavily dependent on the automotive industry and may be triggered into insolvency if an auto OEM enters bankruptcy.)
One company recently told us that a supplier it had been using for 10 years and considered to be financially strong was suddenly in dire straits. It is important to implement a process to continuously audit the financial condition of higher-risk and critical material suppliers — this can range from up-to-the-minute alerts on financial condition to monthly or quarterly reviews, depending on severity.
Note also that in emerging markets it can be challenging to obtain reliable public information on a supplier’s financial condition because of intertwining ownership structures and other factors; you may want to supplement that information with on-the-ground local intelligence, especially in nations facing increased socioeconomic pressures.
Drusspots and other companies also should ensure that their internal finance departments are not putting their supply chains at risk by deploying one-size-fits-all payment term changes. As customers demand longer payment terms and Wall Street increasingly fixates on cash-to-cash cycle metrics (also known as cash velocity), many companies, in turn, are asking their suppliers to accept longer payment terms. For smaller or financially shaky suppliers, this could push them toward potentially damaging cost cuts or insolvency. A safer approach is for supply chain operations to work closely with the finance department and create a stratified approach to payment terms, in which payment term extensions are targeted at stable suppliers with which you have the largest spend; suppliers with potential financial issues remain at their current payment terms; and suppliers deemed in the “danger zone” may actually be offered quicker payment.
Simplifying supply chain complexity
Given the large supply base at Drusspots, like that of many companies, where to start? In addition to categorizing suppliers by financial viability level and doing different levels of due diligence accordingly, companies should take what we call a “value-based segmentation” approach.
Focus your deep supply chain risk analysis and mitigation planning first on those product lines of highest or most competitively differentiating value for your company, such as the key lines that produce the most cash flow for your company or that you are betting will be your future growth engine. Be sure to analyze your vulnerabilities across the end-to-end supply chain — for instance, we often find the critical failure point is at a tier two or tier three supplier. Move on to other product lines when the first set has been evaluated and secured. New insurance-based risk transfer products that came on the market in 2008 also can help protect these high-value supply chains from the risk of supply disruption and supplier insolvency.
Get money’s worth from risk management
The good news is that instituting effective supply chain risk management processes can be “monetized” by a company to gain market share or improve its credit rating. You mention that it is increasingly common for Drusspots’ customers to inquire about your internal risk-management processes, including asking to see your business continuity plans. Establishing and then proactively promoting your risk processes can make the difference in gaining or expanding business with a customer, especially as companies seek to protect themselves from the current market volatility. In addition, Standard & Poor’s has announced that a company’s risk processes will now be one of the inputs into its credit rating. This means that how well you manage your supply chain risk can now positively impact your company’s cost of capital and access to credit.
Beth Enslow is a senior vice president in the Supply Chain Risk Practice at Marsh Inc. (www.marsh.com), the world’s leading insurance broker and risk advisory company. She helps companies assess and protect their businesses against operational and financial supply chain risks, including implementing processes for effective supply chain risk governance. Enslow has previously run the supply chain research and advisory practices at Aberdeen Group and Gartner Group. She also is an executive education lecturer on aligning supply chain management with finance at the Schulich School of Business, Canada’s top-rated business school. She can be reached at beth.enslow@marsh.com
By Randy Littleson
Identifying and managing supply chain risk is near the top of the list of priorities for many supply chain management professionals. Outsourced and global supply chains increasingly are a network of interconnected partners dependent on each other to ensure end-customer demands are met. This is not your father’s supply chain. This environment that Drusspots encounters is substantially more complex and prone to risks that threaten product quality and operations performance objectives, one that could irreparably damage your brand.
To get ahead of the curve, I would recommend a three-step approach for Drusspots to manage supply chain risk:
- Risk assessment — Understanding where you have risk exposure is the first priority to any supply chain risk-management strategy. Some keys to assessing risk:
- Supply chain visibility: Visibility into your entire supply chain is a must if you are to quickly sense and respond to risks. Many companies that have outsourced their manufacturing take a hands-off approach to managing the end outcome, thinking “this is why we outsourced.” That’s a mistake. Managing an outsourced supply chain still requires very active participation — after all, you still are accountable for quality, your brand, etc. You need to ensure you have visibility into at least the first tier of your supply network, and ideally into other key suppliers as well. One area to focus your supply chain visibility initiative is around inventory. Inventory can be both a blessing (added flexibility to deal with volatility) and a curse (potential excess and obsolete inventory resulting from substantial volatility and short product lifecycles).
- Early warning: The sooner you know about a potential supply chain risk, the sooner you can take action. Leverage your increased supply chain visibility to set up alerts that automatically look for and notify you of exceptions that require your attention. That last statement is key. There are bound to be lots of exceptions in today’s fast-changing supply chains. The key is finding those that actually pose harm to the future state of your business. These are the ones on which you need to focus your time and resources.
- Risk mitigation — A goal of any supply chain risk-management effort certainly is to mitigate the negative impact of any potential risks. Once you know about potential risks, the key then is to understand what they mean (or could mean) to Drusspots. Here is where what-if analysis becomes an essential tool. You want to be able to simulate the impact of potential risks that you have not yet experienced so you can develop plans to avoid and/or manage them if they occur. You need to be able to quickly simulate a variety of situations and variations of potential outcomes, and truly understand how they would impact your business across your key performance indicators (KPI). For example, you might analyze the ramifications of a potential worker strike, and in doing so develop a plan to manage such an event. In today’s economy, you also should be able to evaluate the impact of a key supplier going out of business or what a sudden shift in forecast (off by 10%, 20%, or 30%) might mean to your company.
- Risks response — Despite all of your best attempts to assess and mitigate risks, inevitably you will have to deal with some risks that could harm your business if not properly managed. Having an efficient and effective risk-response strategy, supported by the right tools, is the key to being able to deal with them in a way that reduces the negative impact on the business and, ideally, turns risk into opportunity. An effective risk-response tool will include what-if analysis to detail and review viable risk-response options, enabling you to confidently deal with real risks and engage people to collaboratively assess the appropriate compromises and apply course corrections.
The reality of today’s supply chains means that supply chain risk-management strategies need to be core competencies for any manufacturer. Applying the right process to identify, mitigate, and respond when need be is the key to proactively managing risk. Those companies that excel at supply chain risk management will differentiate themselves in the marketplace. By being more responsive and adaptable to changing conditions, Drusspots can get a leg up on the competition, provide better service to your customers, and operate more profitably.
Randy Littleson is vice president of marketing with Kinaxis (www.kinaxis.com), the provider of an on-demand service that empowers multi-enterprise manufacturers with the integrated demand-supply planning, monitoring, and collaborative response capabilities required in today’s complex and dynamic world. Randy can be reached at rlittleson@kinaxis.com
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