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ARC: HOW TO CONTEND WITH EMERGING RISKS AS THE ECONOMY CONTINUES TO RECOVER

Improving economy puts pressure on supply chains

Supply Chain Management

An improving economy can strain an organization's supply chain as it tries to meet increasing demands.

Risk managers and other executives who oversee supply chains must focus on a host of risks when trying to maintain adequate capacity from companies supplying products and materials.

One aspect of an improving economy that can create risk management issues related to supply chains is increasing mergers and acquisitions. M&As often create risk management concerns, said Jill Dalton, partner in charge of Dempsey Partners L.L.C.'s New York office.

“That can definitely affect supply chains, especially if the M&A activity affects one industry or one type of product,” she said, noting that such deals can affect negotiations with suppliers, product quality, transportation costs and contracts.

While M&As can shrink an organization's supplier pool, such deals also can increase the acquiring company's exposures, said Eric Jones, Dallas-based assistant vice president at FM Global's business risk consulting group.

“It's tough enough for them to figure out their own supply chain and the risks that are within that,” he said. “When they acquire a new company ... they don't always have a good handle on what risks they just purchased, particularly in the supply chain,” Mr. Jones said.

An improving economy also adds pressure to provide more products, said Richard J. Coyle, executive director of the Emerging Markets Institute at the Samuel Curtis Johnson Graduate School of Management at Cornell University in Ithaca, N.Y.

Increased demand for a product could result in suppliers substituting components, said Mr. Coyle, also former senior director for international corporate affairs at Bentonville, Ark.-based Wal-Mart Stores Inc.

“Anytime you have more pressure in the system to produce more products, you have risks of corners being cut in order to meet the schedule,” he said.

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Such risks are not new, but are accentuated in an improving economy.

“What's different is the increased interdependency,” said Gary S. Lynch, managing director and global leader of risk intelligence and supply chain resiliency solutions at Marsh Inc.'s risk consulting practice in New York.

Such interdependencies are complex and some may seek out emerging markets that could provide similar goods for a lower cost, but also lower quality, Mr. Lynch said.

That leads to the issue of “velocity,” he said. “If the ramp-up occurs quickly, then we have the issue of how to qualify these alternate suppliers and these alternate business partners.”

With the Japanese earthquake and tsunami, floods in Thailand and Superstorm Sandy, vetting potential suppliers is critical, experts say.

“With demand going up there's a need to increase capacity, but there's also a degree of nervousness around the information in terms of suppliers that could be added to the supply chain,” said Tom Teixeira, London-based partner in the global solutions consulting group for Willis Group Holdings P.L.C.

Organizations want to know where their suppliers are really manufacturing parts and what catastrophe risks they could face, so “we're now beginning to see companies dual source a considerable part of their supply chain,” Mr. Teixeira said.

In the past, dual sourcing was kept to a minimum due to overhead and administrative issues, Mr. Teixeira said. While dual sourcing may seem expensive, “there's no doubt it could increase the overall capacity and also create quite a level of resilience should one of the initial primary key suppliers stop producing.”

A growing economy also raises reputational risks, he said.

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“There's a growing concern too about making sure that whatever's done in the supply chain in terms of the supply chain design aligns with a corporate sustainability or corporate social responsibility strategy,” Mr. Teixeira said.

A supplier's carbon footprint, geopolitical risk levels and other environmental considerations can affect an organization's reputation since many state their “green” strategy in their annual statement.

“Getting that right in the supply chain is quite challenging,” Mr. Teixeira said.

Despite a potential budding of economic improvement, risk management departments aren't seeing additional resources, FM Global's Mr. Jones said.

“I'm just really surprised at the turnover that we've seen within the risk management function in the last 18 months or so,” he said. “Those pressures haven't gone away and, if anything, it's actually kind of increased.”

In the current uncertain economy, organizations have kept a tight lid on investment, said Randy Nornes, Chicago-based executive vice president of Aon Risk Solutions' crisis management group.

“The problem is it doesn't leave you much room for error,” Mr. Nornes said, noting that many companies have cut resources that could have modeled such risks.

“I think for now that's probably the biggest risk — that people aren't convinced there's an economic recovery happening, so they're playing it conservatively,” he said.

Senior Editor Rodd Zolkos contributed to this story.

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