When working with suppliers, every company faces some inherent risks. It’s the caveat of working with a third party. The bigger your company, the more suppliers it requires, and, ultimately, the greater the risk.
Supplier risk management is not an easy task, and it requires significant attention. You must manage supplier risk to prevent or at least minimize potential disruptions and ensure business continuity. The guide below covers the essentials of supplier risk assessment.
What Is Supplier Risk Management?
Supplier risk management is a multi-tier process in which you identify, assess, and mitigate the threats and vulnerabilities associated with your suppliers. It focuses on addressing areas where supplier issues may arise, such as collaborations, supplier onboarding, natural disasters, geopolitical factors, or cyber threats, among other things.
Ultimately, supplier risk management aims to protect your organization’s assets and reputation by approaching your risk management proactively rather than reactively. Multiple departments in the company, from finance to legal, must work in sync to accomplish this feat.
Why Is Supplier Risk Management Important?
We live in a time when even a minor disruption in the supply chain can create a gap for a competitor to claim the market share. The competition is just too high.
Similarly, a supplier-related problem that delays production or delivery can result in financial loss and customer dissatisfaction. An Economist report found that the total cost of supply chain disruptions makes up 6% to 10% of annual revenues to businesses. Customer complaints and reputational loss further aggravate these losses.
An adequate supplier risk management plan can mitigate these risks to keep your supply chain functioning smoothly. More importantly, with a proactive plan in place, you can reduce uncertainty in supply chain operations and improve the overall efficiency of your business. It’s a win-win in every regard.
Types of Supplier Risks
Supplier risks may be financial, ethical, environmental, operational, compliance-related, political, or economic. Here are the general types of supplier risk.
Financial Risks
A financial risk arises when a supplier fails to meet financial obligations. These issues can include bankruptcy, non-payment of debts, or failure to deliver goods due to cash flow problems. If your supplier deviates from the contract terms, that’s a problem, too.
Operational Risks
Operational issues on the supplier’s end, such as safety violations, production delays, or workforce strikes, can have a domino effect, starting with supplier issues and ending with disruptions to your business. Operational risks also include product quality and performance issues. These ultimately become the precursors to reputational damage and costly recalls.
Compliance Risks
Regardless of the industry, suppliers must adhere to set standards and regulations. Compliance risks occur when suppliers fail to follow these regulations, resulting in penalties and lawsuits.
Some examples of non-compliance include unsafe working conditions, child labor, violation of environmental laws, and data privacy breaches. If the word about them gets out, it’s not just about monetary loss; your reputation is also at stake.
Actionable Steps for Supplier Risk Assessments
Supplier risk assessment should be a mandatory addition to your supply chain design. Here’s how to incorporate it into your processes.
Identifying Critical Suppliers
First, determine who your critical suppliers are. These suppliers could greatly impact your business if things go south. For example, suppliers who provide essential raw materials or those who are the sole providers of your products are critical suppliers.
Similarly, suppliers from regions with a history of natural disasters or political unrest should also be considered critical.
Gathering Supplier Information
Once you have pinpointed your critical suppliers, the next step in your supplier risk management strategy is to gather their information. Here are a few areas to cover:
- Financial stability and creditworthiness
- Quality control measures
- Compliance with regulations
- Business continuity plans, including disaster recovery and crisis management strategies
- Environmental sustainability practices
Keep updating this information as the supplier does. You don’t want to rely on outdated data when making important decisions.
Analyzing and Evaluating Risks
The final step is by far the most important. The reasons you designated a supplier as ”critical” will tell you all you need to know about the risks associated with them.
For example, if a supplier is considered “critical” because they are your only raw materials provider, you know that any issues they have could lead to delays in raw material delivery. This could lead to supply chain disruption and delayed manufacturing.
You should evaluate each of your company’s suppliers in this fashion. Why are they high-risk? Which risks do they pose? Then, you can categorize and prioritize the risks based on their potential impact.
A probability and impact matrix is helpful in this regard. It’s a tool that you can use to assess risks in a business or an operation based on their likelihood and severity. You can then devise risk prevention and mitigation strategies accordingly.
Best Practices for Managing Supplier Risk
Supply chain risk management isn’t a unidirectional process but a cycle requiring constant monitoring and evaluation. The following supplier risk management best practices will be of help when designing your plan.
Continuous Monitoring and Review
On your part, you have to assess your suppliers’ performance regularly. Track key risk indicators, such as on-time delivery, quality of materials, compliance, and pricing.
Also, keep an eye out for any changes in the industry that could affect your suppliers, such as economic downturns. Be prepared for unprecedented events, too. The COVID-19 pandemic and the 2008 financial crisis weren’t predictable, but they had a massive impact on supply chains.
You can monitor suppliers using automated tools or through regular reviews and audits. Use supplier scorecards to detect warning signs about logistical or financial challenges.
Establishing Clear Communication
A big part of supplier risk management is proactively and successfully communicating with your supplier. You should have a clear line of communication when managing supply chain complexity. It’s also good to have regular meetings with suppliers through their preferred channels.
Pre-plan a communication strategy for risk situations. For example, you can designate one point of contact to prevent communication from falling apart during times of stress. Both parties should know who to talk to, which course of action to take, what tool to use, how often to provide updates, and other key communication details.
Building Strong Supplier Partnerships
Your supplier is like an extension of your business, as they tend to be one of the first steps in your business processes. So, building a strong and collaborative partnership with them is imperative to ensure long-term resilience in your organization.
What do we mean by partnerships, though? The key is to see your suppliers as your allies in business and not just vendors you outsource tasks to.
A partnership involves an open exchange of information, mutual support, shared goals, and a transparent relationship built on trust. Such a relationship allows for joint risk management through shared contingency planning and regular communication.
Strategies for Identifying Supplier Vulnerabilities
When fostering strategic supplier relationships, you also have to identify the vulnerabilities of the other party. Here’s how.
Risk Mapping Techniques
Risk mapping means determining the risks that your suppliers face and, in turn, how those risks might impact your business. You can use the following techniques to map your supplier risk.
- SWOT Analysis: In a SWOT analysis, you map the following: Strengths, Weaknesses, Opportunities, and Threats. It gives you an idea of which threats you may face, how your weaknesses may aggravate them, how your strengths can help mitigate them, and finally, how external opportunities can help you tackle them.
- PEST Analysis: A PEST analysis involves mapping the following factors to determine how the broader environment can impact supplier operations: Political, Economic, Social, and Technological.
- Audits: You can hire an external agency to conduct a supplier audit. These can help you find vulnerabilities before they become risks.
- Site Visits: Visits to the suppliers’ facilities also provide valuable insights into potential vulnerabilities, such as inadequate infrastructure.
Scenario Analysis
In scenario analysis, you explore hypothetical situations. For example, what if a regulation changes? How will it impact your supplier and then you? You’ll also analyze how you and your suppliers will respond in such a situation and what steps you’re prepared to take.
Scenario analysis is an effective way to identify weak points in your supplier risk management plan. Wherever you get stuck on ”what to do next?” is where you need to focus your attention.
Stress Testing Suppliers
Why wait for a situation to arise to see how suppliers react? Instead, you can stress test them yourself by creating conditions in which you subject them to simulated stressors like financial pressures or high product demand.
Take note of how the suppliers perform in such situations. Their response lets you identify where they may need support or improvement.
Leverage the Best Technology To Mitigate Supply Chain Risks
We’ve already mentioned earlier that specific tools can assist you in supplier risk management. GAINS stands out as a stellar option with its rapid onboarding and tangible results. Our Proven-Path-to-Performance (P3) methodology employs machine learning algorithms to help companies automate up to 95% of their purchasing decisions.
You don’t need to be a tech expert to get our system to yield results. It’s intuitive and easy to use so that you can focus on what matters most: managing supplier risk. When you need a hand, our implementation team guides you through the process, helping you make the most of your investment.
FAQs
What is the supplier risk management approach?
The supplier risk management approach is the action plan to identify and address risks associated with working with third-party suppliers. It encompasses strategies, processes, and tools that help companies mitigate potential disruptions or failures in their supply chain caused by supplier-related risks.
Why is supplier risk management important?
Supplier risk management keeps you prepared for any supplier-caused risk, be it compliance, environmental, financial, or operational. Companies can protect their interest and ensure business continuity with proper supplier risk management.
What are the risk issues of suppliers?
Supplier risk issues may be ethical, reputational, compliance-related, financial, environmental, legal, or operational. The severity of each risk varies. However, each of these risks can put a company’s reputation, supply chain continuity, financial interests, and compliance status at risk.