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  May 2nd, 2021 | Written by

The Four Levels of Supply Chain Risk

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Supply chain risk comes in many forms – from industry-crashing crises to supplier challenges. To manage it effectively, you need to assess it at every level.

Supply risk can take many forms and can manifest anywhere in the supply chain process. So, to be effective, supply risk management must be built around a framework that evaluates and assesses risk at every level – from overall risk exposure across the value chain, right down to the individual supplier level.

A holistic approach to supply risk management is built around four different levels of supply risk. Here is a look at how those levels break down, and how building your own risk management framework around them can help you develop a holistic view of risk across your supply chain.

Level 1: Value Chain Risk

A common pitfall in supply risk management is assessing risk at an individual supplier level first, then working your way up to developing a holistic risk view. But, in practice, assessments should always start at the value chain level.

By starting with a broad, comprehensive evaluation that considers the full stream of activities required to supply or ‘develop’ a commodity or category, you can establish a deep understanding of the factors, drivers, and variables that can influence it.

Assessing the value chain at this level enables you to look beyond simple economic factors, and encompass a huge range of additional quantitative variables, such as political, social, and regulatory factors.

We start at this level because it enables us to better understand the context and potential impacts of each variable and factor. By looking across the value chain, we can more clearly identify the knock-on impacts of each driver, and truly understand the threat they pose to operations.

That’s not just valuable for shaping your overall risk management strategy – it’s hugely valuable information that will help you better identify and prioritize high-impact risk factors as you work your way down to supplier-level assessment.

Level 2: Category risk

The next logical analysis level is category risk – which is to recognize the inherent factors that influence risk for a specific category. Practically, this requires a deep understanding of both the economic model that underpins a particular category and the specific influencers of those economics.

Here, the starting point is to construct a thorough Should-Cost Model for your category. A strong cost model provides deep insight into what makes up the economics of a product or service – at a line-item level – and provides insights into the key drivers of category economics.

But building that model is just the beginning. What you do with the model – what you learn from it – is where the real value is. By conducting a thorough trends and dynamics analysis, you can build up an understanding of the dynamics that can influence the cost levers that make up your model. Then, you can start identifying which changes and trends are worth looking at, and why.

Level 3: Supply base risk

With the value chain and category analyses as the foundation, attention must now turn to assess risk across the supply base. Critically, this isn’t a one-off exercise – it’s a continuous process, where organizations constantly evaluate and re-evaluate their supply base.

This is where supply risk management gets challenging – and technical. Many organizations have hundreds of suppliers to manage and keep track of, each with a unique risk profile. To build a complete, up-to-date view of risk across them, your team will need some help.

Fortunately, AI and the development of new consumerized dashboards are now making continuous assessment a practical reality, even for companies with extremely large supply bases.

These executive-friendly dashboards are tremendously valuable – but only if they include both financial and non-financial business variables. They should largely be automated, but also enable human input and intelligence, providing a holistic ‘health screening’ that flags key variables and changes across the supply base.

Level 4: Individual supplier risk

Another big advantage of using AI and dashboards to automatically assess risk across your supplier base is that it can help surface the individual suppliers that most need deep individual analysis, so that the right strategic decisions can be made about them.

Historically, supplier risk assessment entailed a cursory credit check, some sort of basic financial evaluation, or an outreach to the suppliers themselves for more information. Today, however, there is a far wider toolset available to procurement executives, enabling them to consider both the quantitative and qualitative factors that make up financial sustainability and business viability.

To understand those factors, teams must ask a demanding set of questions; How does this supplier relate to its competition? How much cash is on hand? What are their key ratios? What are their debt risks? How has the company developed year-on-year? Are there any external factors that will impact the company’s financials?

In other words, not only financials, but also business, operational, and competitive assessments must be factored into the discussion. This kind of holistic assessment is essential at the individual supplier level. Of course, this will not be needed for all suppliers, but it will be needed for the most strategic (or the most problematic).

Take a comprehensive look at supply chain risk

Want to learn more about the four levels of supply chain risk, and discover what it takes to build and execute a robust, future-ready risk strategy in today’s increasingly vulnerable and crisis-prone supply environment?

Get your copy of Risk & Your Supply Chain: Preparing for the Next Global Crisis and explore expert insights from The Smart Cube’s Omer Abdullah and Subash Chandar, designed to help you build a more resilient supply chain and prepare for whatever tomorrow may bring.