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Supply chain disruptions frequently result in a direct financial hit for businesses, but the damage a disruption can inflict on an organization's reputation can have much longer term consequences.
Global sourcing strategies such as just-in-time inventory, competitive wages and cheap raw materials also can pose hard-to-quantify risks from second- and third-tier suppliers that could subject businesses to Foreign Corrupt Practices Act penalties, environmental violations and regulatory actions as well as reputational damage, experts say.
A recent example is the November fire at a Bangladesh factory that killed more than 100 garment workers, many of whom reportedly were locked in the building. The factory was making clothing for Wal-Mart Stores Inc., Sears Holdings Corp. and The Walt Disney Co., among others.
“Any time there's a catastrophe of any sort, it usually involves supply chain to one degree or another,” said William Montanez, director of risk management for Ace Hardware Corp. in Oak Brook, Ill. “We have a business continuity process in place ... that could respond in the case of a crisis. We include reputational (damage) as one of those crisis situations.”
In 2011, Wal-Mart audited more than 9,000 factories and the factory in Bangladesh was not authorized to produce merchandise for the Bentonville, Ark.-based retailer due to safety standards. However, a supplier reportedly continued to subcontract work with the Bangladesh factory.
“If a supplier or an agent chooses to subcontract without informing us, then that is a problem,” Rajan Kamalanathan, Wal-Mart's vice president of ethical sourcing, told Reuters. “We can put all kinds of controls in place, but if they don't tell us where they're putting our order, then that is a problem.”
Wal-Mart, Disney and Sears did not respond to Business Insurance's requests for comment.
Once a negative opinion is formed about a company, it can be difficult to change, said Linda Locke, a principal at Reputare Consulting L.L.C. in St. Louis.
Workplace issues have been part of the public dialogue for Wal-Mart, “so this factory fire reinforces an existing perception for many,” she said.
“The companies that build trust go beyond legal requirements and take an ethical approach to managing their entire supply chain,” Ms. Locke said, noting that monitoring social media channels to understand public perception should be part of a company's enterprise risk management efforts.
“I do believe it's a very difficult problem to solve,” said Gary S. Lynch, managing director and global leader of risk intelligence and supply chain resiliency solutions at Marsh Risk Consulting in New York. “Without being able to really measure reputational damage, somebody can't put it into a formula” in making supply chain decisions.
An organization's “ability to have some level of sustainability to come out from and manage the press — and also do what's right for the community — that seems to be the difference for those that survive,” he said.
David Closs, the John H. McConnell chaired professor of business administration in the Department of Marketing and Supply Chain Management at Michigan State University in East Lansing, Mich., said supply chain risks causing reputational harm are “a significant risk.”
“Most firms usually can go up one level or down one level in terms of their supply chain,” Mr. Closs said. Even companies with strong controls rarely track more than two tiers in their supply chain, he said.
“Particularly if you're dealing with commodities, that's usually outside that range. Firms don't really know (who) their supplier's suppliers are,” Mr. Closs said.
Agreements with direct suppliers requiring them to inform an organization of major changes down the supply chain is one step to mitigate reputational risks, said Randy Nornes, executive vice president at Aon Risk Solutions in Chicago.
For example, audit, environmental, health and safety teams can look at potential trouble spots along the global supply chain to consolidate and connect information to see the totality of risks.
“The challenge is you've got a lot of information now that has to come back to a central place so that someone can understand and look at it and connect the dots,” Mr. Nornes said.
Gathering such information often is difficult and costly, but it can help pricing (see related story).
As a merchandiser and distributor, “Our risk management philosophy is really to transfer the risk back to the responsible party,” Mr. Montanez said. “We have no choice because, at the end of the day, it's our customer that's being adversely affected.”