Understanding Supplier Risk Management
Supplier risk management (SRM) is an integral part of an organization’s risk management strategy. Direct procurement involves coordinating with different suppliers to get the products and materials you need to keep operating.
As organization’s grow, more suppliers are needed to While having multiple suppliers can help mitigate risk if one supplier has an issue, it also introduces new risks that need to be managed. Managing these risks is essential to your company’s success and survival. Consequently, this is where supplier risk management comes in.
In this article, we will discuss the importance of supplier risk management, some best practices for managing third-party risk, and more.
Identifying Supplier Risk
Supplier risk is the potential for financial losses or disruptions to company operations that can occur when working with third-party organizations, particularly suppliers. This may involve various issues, such as supplier bankruptcy, quality problems, delivery delays, or ethical breaches.
Supply disruptions can result in high costs and damages to any brand, which is why supply chain risk management has become an important part of doing business.
While it’s impossible to eliminate all risks and potential disruptions, a good supply chain risk management program can help minimize these risks’ impact on the company.
Types of Supplier Risk
There are many types of risks associated with suppliers. Here are some of the most common:
Cost savings is the primary reason companies outsource, but if a supplier experiences financial difficulties, it can jeopardize your company’s operations. This type of risk is often difficult to predict or mitigate, which is why you need to plan strategies to reduce risk. Additionally, if suppliers don’t stick to the terms of the contract you agreed on, this can be a sign of potential issues down the road.
A supplier’s involvement in illegal or unethical practices, such as child labor, can negatively affect your company and damage your brand. Ethical risks can be minimized through careful screening of suppliers and ongoing monitoring.
There is a risk that the suppliers’ operations will cause environmental pollution. For example, using hazardous materials in manufacturing or mining activities can contaminate soil and water in their area of operations.
Having a supplier involved with this type of risk can lead to bad publicity and damage to the company’s reputation. Plus, your company also indirectly contributes to environmental pollution. Environmental risks can be minimized through careful screening of suppliers and ongoing monitoring.
A supplier based in a country with unstable political conditions can affect the quality and reliability of its products or services. Political risks can be mitigated through careful selection of suppliers and diversification of the supplier base.
The economy can affect a supplier’s ability to meet your company’s needs. It can also affect the price of its products or services. For example, the supplier’s country may have an unstable currency, making it difficult to predict the cost of goods over time.
What is Supplier Risk Management?
Supplier risk management is the process of identifying, assessing, and managing risks that could arise from working with third-party suppliers. SRM is a key part of an organization’s overall risk management strategy and can help protect against disruptions in supply chain operations, quality issues, and financial losses.
The goal of SRM is to protect an organization’s interests by minimizing the impact of supplier-related problems. To achieve this, your SRM strategy must identify which supplier-related problems could harm the organization, assess the likelihood and severity of these problems, and put controls in place to mitigate the risks.
Why is Supplier Risk Management Important?
In supplier collaboration, it’s inevitable for supply chain disruptions to occur with the following:
- Lack of knowledge about supplier risk
- Inadequate assessment of third-party risk
- Poorly designed contracts
- Unclear understanding of the consequences of disruptions
- Inadequate contingency plans to mitigate risks and promote supply chain resilience
- Fragmented responsibility for managing supplier risk across organizations
With this in mind, proper supplier risk management is essential to protect an organization from the consequences of disruptions.
Here are some of the main reasons supply management is important:
1. To protect the organization from financial losses
Being one step ahead of the game is always good, which applies to supply chain risk management. An organization can avoid or minimize financial losses by having a plan in place to deal with disruptions.
2. To maintain compliance with regulations
Organizations must often comply with regulations set by industry bodies or government agencies. If a supplier cannot meet its regulatory obligations, the organization may be at risk of non-compliance. A plan can help ensure that suppliers comply with all the necessary regulations.
3. To safeguard the organization’s reputation
An organization’s reputation can be severely damaged if it is associated with a supplier that has ethical or other issues. For example, if a company uses child labor in its supply chains, the news will quickly spread, and customers may start to boycott its products and the products of its associated brands.
However, having supply chain risk management in place can help you be one step ahead and take necessary precautions to avoid such disasters.
4. To avoid disruptions in the supply chain
Disruptions in the supply chain can have a ripple effect, causing delays and shortages of materials further down the line. But, a supply management plan can help mitigate the risk of these disruptions by identifying them and then putting protocols in place to avoid or mitigate them.
5. To ensure the continuity of operations
In some cases, disruptions to the supply chain can cause a complete shutdown of operations. This is especially true for companies that rely on just-in-time delivery of materials. A plan that expects disruptions can help ensure operations can continue, even if it’s at a reduced capacity.
How Do You Manage Supplier Risk?
Organizations need to manage supplier risks just like any other type of business risk. This means understanding what might happen if a supplier fails to meet its obligations and taking steps to minimize the potential impact.
There are many ways to approach supplier risk management, but one common framework is to think about it in terms of three key elements: identification, assessment, and mitigation.
Before managing supplier risks, you must identify which suppliers pose the biggest threats. This requires looking at the organization’s overall exposure and the specific risks associated with each supplier.
To get started, ask yourself these questions:
- What products or services does the supplier provide?
- What is the total value of our purchases from the supplier?
- What is our dependence on the supplier?
- What is the supplier’s financial health?
- What is the supplier’s track record? Have they had any quality issues in the past?
- What is the political and social stability of the country where the supplier is located?
Once you’ve identified which suppliers pose the biggest risks, it’s time to assess the potential impact of those risks. This step involves understanding what could happen if a supplier fails to meet its obligations.
To do this, ask yourself these questions:
- What are the consequences of a disruption in the supply chain? For example, would it cause a production stoppage? Would it lead to lost sales?
- How likely is it that the supplier will experience a disruption? What are the warning signs we should be looking for?
- How severe would the impact be? Would it be a minor inconvenience or a major crisis?
After identifying and assessing the risks, you can develop mitigation strategies. The goal here is to reduce the likelihood of disruption and minimize the impact if one does occur.
There are many ways to do this, but some common approaches include:
One way to reduce risk is to spread it out by working with multiple suppliers for the same product or service. This way, if one supplier has a problem, you’re not entirely reliant on them.
Another approach is to have redundant systems in place so that if one supplier has a problem, you can quickly switch to another. For example, if you’re relying on a single supplier for parts, you might keep a stock of components from other suppliers on hand to continue production if there’s a disruption.
Another way to reduce risk is to include clauses in your contracts that protect you in case of a problem. For example, you might require the supplier to provide replacement parts at no cost if they experience a production stoppage.
No matter which approach you take, it’s important to have a plan in place to know what to do if a supplier has a problem. This plan should include contact information for key people, a list of alternative suppliers, and instructions on how to implement the mitigation strategy.
Practice Smart Supplier Risk Management
Supplier risk management is critical for any business that relies on external suppliers for materials or services. By identifying and assessing risks associated with supplier relationships, companies can take steps to mitigate those risks, protect their interests, and improve their supply chain resilience.
There are several different approaches that businesses can take to supplier risk management. Still, the key is to clearly understand the risks involved and develop a comprehensive plan for addressing them.
By taking these steps, businesses can protect themselves from potential disruptions in their supply chain and ensure that they can continue to operate smoothly and efficiently.