A Comprehensive Guide to Effective Supplier Risk Management
Table of Contents
What is supplier risk management?
Supplier risk management (which can be referred to as SRM, although this acronym more commonly means supplier relationship management) is a process that identifies, assesses and mitigates threats posed in the organization’s supply chain that have the potential to impact revenue generation and profit. It should be considered an essential part of an organization’s wider risk management strategy.
As organizations scale and increase in size, so too does the organization’s number of suppliers, which means there are more risks to be managed. Ensuring that there are processes in place to successfully manage these risks and respond to disruptions is essential for the organization’s longer-term success.
Supplier risk management should be focused on addressing the various areas where issues with suppliers may arise. These should include, but not be limited to, supplier onboarding, collaborations, supplier relationship management (lifecycle management) and the wide range of external threats to the supply chain, which should include natural disasters through to theft and fraud.
Supply chain risk management is usually focused on the following in relation to the risks posed to the organization:
In this article we shall focus on the importance of supplier risk management, exploring key aspects including risk identification, measurement and mitigation strategies. We will also touch upon the ever-increasing role of technology and include an outline of what the future may hold for supplier risk management.
What are the benefits of supplier risk management?
Supplier risk management ensures that organizations can easily identify and avoid risks associated with suppliers. Organizations that implement the most leading-edge supplier risk management principles into their business benefit from numerous advantages, including:
- Greater number of resources to assess supply chain risk
- Enhanced visibility across the supply chain as a whole
- Increased trust and stronger relationships with suppliers
How to perform a supplier risk assessment
Supplier risk management is focused on identifying and assessing the risks of working with a supplier. The process should be focused on both relatively commonplace risks and those that are less common.
Organizations should then determine the method they wish to use to understand the risks posed. This could be done by using a scoring system where the number correlates to the risk posed by the supplier: the higher the number, the greater the risk.
Alternatively, organizations can opt to create a set of criteria for assessing suppliers. This should include the financial stability of the supplier, operational performance, adherence to compliance and external risks to the supplier that are out of its control.
Undertaking a supplier risk assessment is a crucial step for organizations to understand the threats posed to their supply chain.
The following provides a starting point for organizations looking to undertake supplier risk management.
Identifying supplier risks
Ensuring that your organization is fully aware of the different types of risks that can arise at various stages of the supply chain is essential for avoiding disruption and financial losses. These could occur due to a variety of reasons, such as a supplier having financial issues, lack of quality control, natural disasters and even bad publicity about a supplier related to ESG concerns.
Disruptions in the supply chain can lead to the organization’s reputation being damaged, requiring unforeseen investment to overcome these issues and repair brand reputation in the market. These concerns have the potential to cause significant damage to the organization, which is why supplier risk management is essential for minimizing their potential impact.
Supplier Financial Risks
Any business that an organization engages with poses various financial risks that have the potential to impact the financial viability of the organization itself. The most common risks to organizations are centered around the following:
Lack of liquidity
Liquidity risks are those that occur due to a lack of cash flow within the company, and its lack of or inability to convert assets into cash. They have the ability to cause the supplier to be unable to fulfill obligations, thereby having to resort to credit and leaving it open to additional financial risks.
If a business is not adhering to relevant regulations through choice or lack of awareness, it leaves itself liable to financial penalties, which could impact its finances and ability to honor contractual terms. For instances where the supplier was not aware of a particular regulation, the issued penalty can cause immediate financial issues.
Turbulence and sudden changes in the wider market within the sector can impact the supplier and leave it vulnerable to financial issues. The ongoing wider global events that have occurred since the turn of the decade have impacted a wide range of businesses, and further downturns within a supplier’s market have the potential to lead to increased levels of financial vulnerability.
Each of these risks can limit a supplier’s ability to fulfill contractual obligations with the organization, or impact its wider operations, which in turn harm its performance. In the most serious circumstances, especially when combined, these risks can cause the supplier to cease trading and cause major disruptions in the organization’s supply chain.
How to mitigate supplier financial risks
Financial risks can be one of the most challenging areas of supplier risk management for organizations to overcome. This is especially the case in instances where the organization has existing contractual obligations with the supplier. The following provides an initial overview of how organizations can work towards mitigating supplier financial risks:
Centralize supplier data
Centralizing vendor data ensures that organizations are benefiting from high-quality supplier data and that they are best placed to assess the risks of collaborating with prospective suppliers. This should include the functionality to gain insights into the supplier based on credit checks and financial information that is available in the public domain.
Wider risk monitoring
Ideally, the organization should not limit itself to checking a prospective supplier’s credit history. Assessing the supplier from a wider financial perspective, such as mergers, legal action taken against it, negative ESG, or regulatory penalties, can provide a wealth of insight into the supplier and give a far greater understanding of the real risks posed.
Committing to this level of risk monitoring on an ongoing basis can ensure that the organization is identifying these risks for both prospective and current suppliers and nullifying any risks before they have wider financial consequences.
Analysis of the vendors’ relationships
As global supply chains become increasingly complex, those businesses that have an awareness of their own suppliers’ supply chains are at an advantage. Even if an organization is not directly involved with these companies, any associated risks also have the potential to disrupt the organization.
Any wider disruption can affect your suppliers’ supply chains and leave them unable to fulfil their contractual obligations, despite their best efforts. Mapping out these wider supplier networks can provide enhanced levels of insight into wider risks and ensure that the organization can fully understand and mitigate them before they impact its supply chain.
Supplier operational & performance risks
Supplier management operational and performance risks are the potential disruptions in the organization’s supply chain that could occur due to issues related to internal processes, stakeholders, systems or external events.
These should also encompass risks associated with third parties in your supply chain. They should not only be limited to suppliers but should also include partners and external service providers.
These include situations in which suppliers are unable to honor agreements to deliver goods or services on time. These disruptions can occur due to problems with logistics and transportation, or due to issues with the suppliers’ internal processes. Each of these issues has the potential to impact the production or delivery of services by the organization, which in turn impacts its perception and relationship with its own clients.
Not only are there risks related to suppliers’ delivery timeframes but there are also risks posed by lack of product quality control and checks. This can result in products or parts being delivered that are not up to the required standard.
Organizations that fail to notice these defects before the product goes to market run the risk of reputational damage and financial losses due to products having to be recalled or replacements provided. In addition to the outlay of replacing products, organizations will also have to invest in repairing their reputation.
Impact on scalability
As an organization scales, it will require increased quantities of goods or services from its suppliers. Failure to effectively communicate with suppliers or assume that they have the means to meet the demand can lead to disruptions in production and delivery schedules. Again, this can halt the organization’s ability to scale and cause reputational issues within the market.
How to mitigate supplier operational risks
There are various ways in which organizations can mitigate supplier operational risks and protect themselves against market reputational damage.
Improve supplier communication & set regular audits
Ensuring the organization has regular communication with suppliers helps identify any operational issues before they escalate into significant problems that can damage the business.
This should be complemented by a holistic overview of the supply chain with ongoing supplier performance reviews and audits to ensure pre-agreed standards and expectations are adhered to.
Source a wider range of suppliers
To avoid a single point of failure, organizations should strive to have backup suppliers that might be relied upon at short notice in case of unprecedented issues. This ensures that any disruption is kept to a minimum and the organization can maintain its service levels and time to get products to market.
Organizations that are looking to scale should also ensure that they are analyzing their performance and researching and sourcing new suppliers that can keep up with their growth. Once these suppliers have been identified, managing relationships with them for mutually beneficial success should be considered a priority.
Flexible Supply Contacts
Flexible supplier contacts allow organizations to request changes in volume or delivery timelines in the event of unexpected situations and help make sure safeguards are in place to minimize risk. Ideally, flexible supply chain contracts should also include clauses that penalize the supplier in the event of parts not being up to the required standard and delays in delivery.
Supplier compliance risks
Supplier compliance risks in supplier management are the potential legal, regulatory, and ethical breaches that can occur due to a supplier’s actions or processes. While these issues may not be caused by the organization directly, they have the potential to impact it via association. Therefore, organizations should define and develop ESG policies that are adhered to when sourcing suppliers.
This should be extended to having internal guidelines on standards suppliers should comply with, considering these while sourcing suppliers, and managing supplier compliance once the working relationship has commenced. The following are key areas that organizations must be aware of if they are to avoid reputational damage, potential legal penalties and a lack of customer trust:
The last decade has seen increased awareness of and a focus on the impact of climate change with consumers starting to gain a greater interest in choosing brands that display an awareness of environmental issues.
In addition to developing internal ESG processes and policies, organizations should be engaging and working with suppliers who follow similar standards. Suppliers may neglect to follow regulations related to emissions or waste disposal or use practices that can cause damage to the environment.
In the event of this occurring and attracting widespread media coverage, those organizations that have a working relationship with these suppliers are also going to be prone to long-term reputational damage.
Employment law compliance
As well as not obeying environmental regulations, there can also be risks associated with suppliers not respecting labor laws within their country or even engaging in practices that include exploitation.
As with issues related to environmental standards, organizations that fail to research and ensure that potential suppliers are not falling foul of employment laws and engaging in exploitative practices risk reputational damage by association and a loss of consumer trust in their brand.
How to mitigate supplier compliance risks
There are various steps that organizations can take to ensure they are avoiding risks associated with suppliers not adhering to standards and laws. These require the organization to remain proactive and take a strategic approach:
Organizations should never assume that suppliers have an awareness of every piece of legislation and an understanding of regulations. Training programs can be implemented to create awareness among suppliers about laws, regulations, and ethical standards. It is also essential to emphasize the detrimental impact of non-compliance on all involved parties.
Ideally, this should include an in-depth focus on the specific compliance standards related to the sector that are required by the organization to ensure that no misunderstandings or issues due to gaps in legislation knowledge occur.
Supplier training should be provided in an easy to reach location for the suppliers, made relevant for different types or categories of supplier or locations where the supplier is based, kept up-to-date, and monitored to encourage and ensure completion.
Processes should be put in place to ensure that organizations are aware of any issues that may arise from the supplier before the working relationship has commenced.
These should involve undertaking in-depth audits of the supplier to identify any compliance risks before they occur. Information gathered from such audits should be centralized and available to other business units as appropriate.
Compliance contract clauses
Contracts should include clauses to ensure that suppliers adhere to relevant laws and regulations to meet the agreed compliance standards defined by the organization.
These should be accompanied by penalties in the event of the supplier not obeying the terms of the contract to ensure that the organization can take legal action if there is any impact on its reputation should the supplier breach the agreement.
By prioritizing compliance risk management, organizations can make sure that suppliers are adhering to relevant laws and regulations, while also ensuring that they are protecting their reputation and not risking losses in consumer trust.
Events or conditions can occur that are out of the control of both the organization and supplier, but the organization can take steps to ensure that the impact of disruptions is kept to a minimum.
These risks are events or conditions in the external environment that prevent the supplier from providing products or services. While a selection of suppliers will have plans in place to avoid excessive disruption, organizations should also be proactive to guard against events to reduce the risk this poses to their own business.
Such risks most often lead to the supply chain being disrupted with delays in both the production and delivery of goods. If these risks occur during transportation, this can impact the quality of goods by the time they have been delivered to the organization and lead to increased costs for all associated parties.
When relying on a global supply chain, organizations are most likely going to have suppliers based in countries or regions that are prone to natural disasters. These include earthquakes, wildfires and floods. Each of these can severely disrupt a supplier’s operations and leave suppliers unable to produce or deliver goods.
Theft & fraud
Theft and fraud can occur at various stages of the supply chain and can occur in a variety of forms. This can include theft of goods during transportation and even complex cyberattacks that target the theft of data.
Certain regions are more prone to political unrest and instability than others and this instability can have the potential to impact supply chains. However, issues could also arise due to wider political issues, including trade disputes between countries that could lead to increased tariffs and costs for the organization. Changes in government also pose the risk of there being changes to regulations within a country that can impact the supply chain and can sometimes be unforeseen.
How to mitigate external risks to suppliers
Diversify supplier locations
Rather than relying on a particular region, organizations should ensure that they are sourcing goods and services from a variety of locations to ensure that disruption due to localized external events is kept to a minimum.
While this may increase costs initially, failure to diversify can prove to be more costly in the long term, especially if reputational damage occurs and the organization needs to repair the way it is perceived in the market.
Monitoring geopolitical changes
Having an awareness of previous geopolitical changes should be accompanied by a focus on monitoring any changes in the geopolitical landscape in areas where suppliers are based. This ensures that any potential disruptions can be identified, and a plan of action put in place to avoid issues for the organization’s supply chain.
Invest in supply chain security
If operating in areas where supply chain theft and fraud is commonplace, organizations should engage with their suppliers about investing in supply chain security measures. This ensures that theft is kept to a minimum and that unnecessary costs are avoided.
This can include implementing more robust security measures, both physical and digital, as well as investing in more secure packing and methods of transportation. Ideally, these should be accompanied by suitably comprehensive insurance policies to protect the organization against instances of fraud and theft.
In the digital era, supply chains are particularly vulnerable to breaches and leaks in data, meaning that robust cybersecurity measures are essential to fully protect the supply chain and the wider organization.
The Role of Technology in Supplier Risk Management
In today’s complex global supply chains, technology should play a key role in vendor risk management. Relying on manual processes to manage supply chains and the associated risks is no longer sufficient and ensures a lack of scalability while leaving the organization open to decreases in revenue as competitors choose to rely on supply chain management software.
This technology empowers organizations by providing the functionality to monitor and engage with suppliers in different regions and sectors and provides a holistic view of supplier risks. Through the utilization of technology, organizations ensure their understanding of supplier risk management is comprehensive and they can respond to any unexpected changes as they occur.
Ideally, organizations should be afforded the functionality of undertaking detailed risk and performance assessments of a single supplier or segmenting at scale, if necessary. This allows the organization to have the necessary agility to identify and overcome risks as and when they occur.
Technology provides a wide range of functionalities for organizations, as outlined below:
Real time tracking & monitoring of suppliers
A key advantage of using technology as part of a supplier risk management strategy is the ability to monitor supplier performance in real-time. Instead of being able to rely on time-consuming periodic manual assessments, which do not usually identify sudden changes, organizations can identify risks as they occur and ensure that action is taken to mitigate repercussions.
Another benefit is that organizations are provided with accurate and up-to-date data that reflects recent performance and includes incidents that could translate into risks to the organization.
Integrating automation in a supplier risk management strategy ensures that the organization can streamline operations and improve its efficiency. There are a wide range of tasks involved with supplier risk management that can be automated, including:
- Risk data collection
- Supplier performance tracking
- Compliance monitoring
Not only does this streamline operations but it also significantly reduces instances of human error. It ensures that more time can be spent analyzing data and risk managers can focus on risk mitigation strategies.
It also ensures that businesses are regularly conducting risk assessments across each supplier, helping make sure that risk management processes are as accurate as possible.
Advanced supplier data analytics is another powerful and essential component of effective supplier risk management. It provides organizations with vast amounts of supplier data to identify trends and use these insights to mitigate risk.
It can also be used for forecasting future supplier risk based on previous supplier performance data, ensuring that organizations can remain as proactive as possible.
It is possible to enhance this data further by integrating it with external risk data related to financial markets and global events to gain a more in-depth understanding of both internal and external risks to the supplier and organization.
Communication and collaboration are essential for all parties for effective supplier risk management. However, when dealing with thousands of suppliers across hundreds or thousands of locations, it can be particularly challenging for organizations.
To make the process more streamlined, both parties should ideally have access to a supplier portal where relevant information related to risks can be exchanged and collaborative mitigation strategies put in place for the benefit of both parties. Organizations can utilize supplier information management, supplier profiling and initiatives to ensure effective communication when it is more important.
This ensures that both parties focus on fostering a mutually beneficial and transparent relationship. This approach not only proves advantageous for both sides but also positions risk assessment as a shared responsibility.
Organizations also have the possibility of providing suppliers with constructive feedback on their performance and guidance on areas that could be improved within the supplier’s organization to ensure that it is adhering to the pre-defined standards. Taking this approach ensures that a mutually beneficial relationship is being developed and that the supply chain is as robust as possible.
The Future of Supplier Risk Management
As technology related to artificial intelligence and machine learning continue to gather pace, there will likely be increased levels of predictive supplier risk management with potential risks being identified and mitigated before they become causes for concern.
This will likely be accompanied by further levels of increased digitalization and automation within supply chains with more granular and real-time risk assessments available for organizations to guard against financial ramifications.
As previously discussed, the continued trend towards greater consumer awareness related to climate change and environmental issues will likely continue to grow with organizations having to ensure they are adopting more ethical business practices and moving towards greater levels of sustainability.
Increased volatility around the globe does not show any signs of abating in the short-term, therefore organizations must be aware of wider political instability and the risks that this could pose to their supply chains in the long term. It is imperative to foster a culture within the business that is open to change and understands the need to invest in adaptive supplier risk management strategies.
How can organizations prepare for these changes?
Organizations must be focused on ensuring that their supplier risk management processes are as agile and robust as possible. If they have not done so already, investing in technology, such as supply chain management software that includes supplier risk management reporting, along with platforms such as a supplier portal, will ensure they have access to the digital tools to monitor supply chain risks in real-time and measure and manage risks.
Taking the time to engage with suppliers and managing the supplier relationship help drive the necessary collaboration and transparency to foster a mutually beneficial relationship. This means that both parties can be working towards the same goals and assisting in generating increased revenue for both parties.
Organizations should also ensure that their company culture is focused on keeping pace with changing technologies and values continuous learning. By adapting to changes in the market, they will be better positioned to respond to uncertainties in the risk landscape effectively.
In conclusion, supplier risk management should be an essential component of any organization’s risk strategy. The ever-increasing complexity of global supply chains means that potential disruptions and financial losses for businesses are becoming increasingly prevalent. Through the identification of supplier risks, organizations can assess the impact on their business and ensure that they are mitigated and their reputation unaffected.
Considering the significant impact that supplier risks can have on an organization, organizations must put in place comprehensive and effective supplier risk management practices. Not only does this provide a great deal of protection and avoid financial losses, but it also ensures that businesses that embrace supplier risk management can take advantage of new opportunities and further grow their organization.