The pandemic has brought business interruption (BI) risk into sharp focus for companies with complex supply chains as well as their insurers. However, many firms still struggle to accurately quantify which supply points and exposures pose the biggest threats to their profits.
The wave of insolvencies and production shutdowns caused by recent global supply chain disruption has highlighted the importance of knowing where your exposures lie and having agile business continuity plans in place – particularly in complex manufacturing segments whose supply chains contain multiple suppliers and interdependencies. Unfortunately, these plans are often misguided as they are based on the wrong type of information.
Focus on Profit at Risk, Not Gross Spend
When prioritising where to focus risk management efforts within their supply chains, companies often look first at the gross sum they spend with each supplier. However, this ‘risk by spend’ approach paints a distorted picture of the company’s risk profile as the gross cost of a component tells you little about its impact on business continuity.
The figures that really matter are the revenue or gross profit at risk if any given supply point fails. These are the numbers that tell how much money your company stands to lose every day, week or month you are unable to supply your customers because of being without any given component.
These are the numbers that define success and failure as a business – and guide you on where most investment should be spent mitigating risk and putting business continuity plans in place.
At present, SCAIR is the only Enterprise Grade supply chain risk assessment tool that calculates value at risk.
Holistic Risk Assessment
To accurately quantify supply chain exposure, several other factors must also be taken into consideration, such as the risk mitigation actions the company has in place. If a contract is already in place with an alternative supplier, for example, this will have a material impact on mitigating the real-world profit exposure and should be factored into calculations.
So should the projected recovery time of specific facility types, the cost and time of onboarding alternative suppliers or building new facilities if supply points fail. It is vital to extend the assessment to tier two suppliers or beyond to root out interdependencies lurking further up the supply chain.
Testing exposures against multiple scenarios is also key. How would an earthquake in Japan affect production? Are there multiple suppliers located in the same Florida floodplain or Californian wildfire zone? How would a regulatory shutdown, cyber-attack or insolvency of one or more suppliers disrupt your organisation – and at what cost?
Failing to assess risk in this level of detail makes it impossible to accurately quantify business interruption exposures across a highly complex supply chain. As well as exposing companies to potentially devastating – and unexpected – financial shocks, this can also result in misplaced allocation of effort and resources, as well as over- or underinsurance.
For insurers, many of whom have been hit with heavy BI losses from the pandemic, it is prudent to ensure clients accurately quantify their BI exposures from both an underwriting and loss mitigation perspective. Scenario testing across portfolios of insured risks can also play a key role in helping insurers manage their own underwriting exposures, rooting out hidden interdependencies and unwanted risk accumulation within their portfolios.
Armed with this information, insurers can more accurately price risk, meaning clients are charged premiums that fairly represent their risk. Overlaying company non-compliance data across the portfolio can also help insurers in the client due diligence process.
Say Goodbye to Spreadsheets
As well as getting the methodology right, companies also need to be using the right infrastructure for their risk assessments. Most firms – including even large brokers with market-leading business interruption assessment capabilities – still quantify their exposures on spreadsheets. This comes with a variety of risks and limitations. While spreadsheets can be easily adapted to suit the characteristics of any given company or supply chain, they become increasingly unfit for purpose as organisational and supply chain complexity increases.
Spreadsheets are easily broken, vulnerable to human error and lack transparency and flexibility. One of the biggest risks is that risk accumulations can go unnoticed. For example, a supplier may have acquired another and although they may operate under two names, they are in fact the same organisation, with many shared risks. If address and supplier name identification is not automated and verified this is easy to miss.
Spreadsheets also do not integrate easily with third-party datasets, models and overlays and require manual management, making it difficult for the company to view their exposures in real-time or slice and dice data for analysis or visualisation purpose, limiting its agility.
Leading organisations are moving away from spreadsheets for these reasons in favour of tools that enable them to centrally manage, analyse and visualise their evolving supply chains while, crucially, more accurately calculating their exposures.
With supply chains under exceptional pressure, these firms are at a distinct competitive advantage and while the threat to those left behind continues to grow.
SCAIR's supply chain risk assessment and management tools can help organisations identify, track and manage supply chain exposures.