William Grey and Dailun Shi
IBM T.J. Watson Research Center
November, 2001
Key Business Trends
• The pace of business is accelerating, and there has
been a dramatic increase in uncertainty
• A difficult business climate is exacerbated by
heightened competition
• Supply chains are not only more efficient – but also
riskier
Enterprise Risk Management is an integrated
approach for managing risk across the firm
Enterprise
Risks
Market Risks
Foreign exchange
Interest rates
Equity prices
Commodity prices
Business Risks
Economic
Reputational
Supply Chain
Technological
Legal risk
Regulatory risk
Environmental risk
Operational Risks
People
Processes
Systems
Procedures
Policies
Supply Chain
Credit Risks
Accounts receivable
Vendor financing
Notes receivable
Liquidity
Value Chain Risk Management Applies this
Approach to the Extended Supply Chain
distribution
customers
store
point of sale
local delivery
outbound
inbound
manufacturing
suppliers
design
Three key value chain flows are subject to risk
Design
Buy
Build
Sell
Ship
Support
Financial Flows
S
u
p
p
lie
rs
C
u
st
o
m
e
rs
Information Flows
SCM
Enterprise Risk Taxonomy
quality
quantity
price
complexity
serviceability
timing
Value Chain Risk
systems
policies
procedures
processes
people
Operational Risk
Core Business Risk
legal
regulatory
political
hazard
economic
natural
reputational
Event Risk
liqudity risk
vendor financing
debt risk
covenant violation
account receivable
account payable
Credit risk
interest rate
commodity prices
equity prices
foreign exchange
Market risk
Tax Risk
Recurring Risk
Non-core Business Risk
Studies in Risk
• Nokia / Ericsson (Supply risk)
• Cisco Systems (Supply-demand management risk)
• Lucent Technologies (Credit risk)
• IBM (Supply risk)
• Micron Technologies (Price risk)
• Nike / i2 (Technology risk)
Value Chain Risk Management Process
Risk
Management
Strategy
Formulation
Risk
Identification
Risk
Characterization
Strategic Changes
Planning/Executio
n Changes
Financial Risk
Management
Insurance
Organizational
Changes
Risk Identification
• Techniques
– Scenario Analysis
– Historical Analysis
– Process Mapping
• Basis for consistent framework to uniformly identify,
assess and manage risks
• Dynamic process - requires periodic reviews
• Standard categories for identifying risks
Risk Characterization
• Assess the nature, impact and importance of risks
• Balance quantitative vs. qualitative analysis
• Measurement Metrics
– Probability of occurrence
– Severity of the potential impacts
– Loss distribution function
– Value at Risk
Risk Categorization
High Severity
Low Likelihood
I
High Severity
High Likelihood
II
Low Severity
Low Likelihood
III
Low Severity
High Likelihood
IV
S
e
v
e
ri
ty
o
f
Im
p
a
ct
Probability of Occurrence
Too expensive to insure: Take steps to
reduce frequency or severity. Consider
divesting if returns
don’t
justify risk.
Establish mitigation measures and
contingency plans; insure
Deploy operational changes and
controls to reduce frequency of
occurrence
Interactions between risks and value chain
processes (examples)
Sourcing Manufacturing Marketing andSales Distribution andLogistics Support Quantity - Component
shortfalls impact production, hurting sales, and potentially damaging reputation for service and reliability.
- Poor capacity planning constrains production output.
- Poor production planning result in production
constraints or excess inventory.
- Poor demand forecasts result in either missed revenue
opportunities, or excess inventory throughout the supply chain.
- Poor supply chain design and execution leads to excess inventory.
- Poor inventory positioning prevents products from
reaching customers, hurting revenue.
- Poor warranty forecasting leads to under stocking spare parts. This causes poor customer satisfaction and loss of market share.
Price - Unexpected price volatility in procured components
increases revenue and profit variability.
- Excess capacity increases production costs.
- Poor pricing
decisions hurt market share, resulting in foregone profit margins, or excess inventory.
- Poor supply chain design and execution increase the need for expediting, thus increasing logistics costs.
- Poor support network design and execution increase expediting, causing higher logistics costs.
Quality and
Serviceability - Low-qualitypurchased parts impact manufacturing yields, hurting sales. Also affects customer satisfaction and reputation, and increase warranty and support costs. -Selecting suppliers with poor or erratic service affects production, reducing revenue and
damaging reputation.
- Low yields can constrain production output, reducing revenue.
-Poor quality affects customer satisfaction and reputation, and increases warranty and support costs.
- Poor quality affects obsolescence, and creates obstacles for marketing and sales
-Certain sales processes work well for certain customer segments, but are too costly to address other segments. Revenue and profit decline.
- Poor supply chain design or execution results in poor serviceabiliy, reducing customer satisfaction, and limiting ability to fulfill service models such as VMI and JIT.
Risk Propagation in the Supply Chain
Example 1: Price risk is comparatively well-behaved as it
propagates through the supply chain
Computer Chip
price +$1
Circuit Board
Cost: +$(1+/-є)
High-end Computer
Cost: +$(1+/-є)
Component 1
Component N
Risk Propagation in the Supply Chain
Example 2: Quantity risk is amplified at the point of Bill of Material
assembly
Computer
Chip
shortage
–100 units
Circuit Board
Shortage
–100 units
High-end Computer
Opportunity cost:
-100 units of lost
sales, customer
ill-will
Component 1
Cost: excess
inventory
Component N
Cost: excess
inventory
Risk Propagation in the Supply Chain
Example 3: Quality risk is amplified as it propagates through the
supply chain
Computer Chip
defect
Circuit Board
Cost: Rework
High-end Computer
Cost: field failure,
damage to
brand/reputation
Component 1
Component N
Value Chain Risk Management Process
Risk
Management
Strategy
Formulation
Risk
Identification
Risk
Characterization
Strategic Changes
Planning/Executio
n Changes
Financial Risk
Management
Insurance
Organizational
Changes
Financial Risk Management
• Use of financial instruments
– Forward contracts
– Futures
– Options
– Swaps, caps and floors
Insurance
Probability of
loss
Controllable Loss
Size of loss
Catastrophic Loss Leading to Default
Losses Managed
by Strategic,
Operational, and
Financial Means
Losses Covered
By Insurance
Strategic Risk Management
• Application of financial management analogues to the
value chain
• Value chain restructuring
Relationship between the Value Chain and
Shareholder Value
Value
Creation
Value Allocation
Cost of Capital
(Required equity return)
Shareholder Profit
Shareholder Value
Capital Structure
(Debt-equity mix)
Cost Drivers
Operating Performance and
Profit
Linkages between Strategic Risk Levers and
Shareholder Value
Financial
Leverage
Financial
Diversification
& Hedging
Shareholder Profit
Cost of Capital
(Required equity return)
Shareholder Value
Capital Structure
(Debt-equity mix)
Cost Drivers
Operating Performance and
Profit
Revenue
Drivers
Value
Creation
Value Allocation
Operational
Leverage
Operational
Diversification
Linkages between Supply Chain Decisions and
Shareholder Value
Value
Creation
Value Allocation
Cost of Capital
(Required equity return)
Shareholder Profit
Shareholder Value
Capital Structure
(Debt-equity mix)
Cost Drivers
Operating Performance and
Profit
Revenue
Drivers
•
Outsourcing
•
Strategic Alliances
•
Supply Chain Design
•
New product introduction
•
Revenue Management
•
Transportation &
Logistics
•
Inventory Policies
•
Sourcing
Examples of Strategic Risk Management
Leverage
Diversification
Hedging
Execution
Supply Chain
Design
Modify using
changes in
production
technology
Modify by
outsourcing
production
Geographical
diversification
to reduce
hazard risk
Political unit
diversification
to reduce
political risk
and tax risk
Geographical
diversification
to reduce
labor price
risk
Natural
hedging of
foreign
exchange risk
Matching
inbound and
outbound
supply chain
capacity and
flexibility
Matching
supply chain
capacity to
marketing
capability
Value Chain
Restructuring
Alternative
supply chain
interactions
Supply chain
designed to
reduce cycle
time and
inventory
Supply chain
simplification
to reduce
complexity
risk
Strategic
Sourcing Strategy
Increase by
selecting
vendors
requiring
capacity
commitments
Reduce by
consolidating
spend to
improve
flexibility
terms
Vendor
diversification
to reduce
supply, price
and quality
risk
Vendor
diversification
to reduce
hazard risk
Hedge
demand
volatility with
supply-demand
matching
Natural
hedging of
foreign
exchange risk
Strategic Risk Management Analytics
Low Uncertainty
High Uncertainty
• Discounted Cash Flow
Analysis
• Sensitivity Analysis
• Scenario Analysis
• Decision Trees
Example of Improved Visualization
EPS
P
ro
b
a
b
il
it
y
Target
Investment 1
EPS
P
ro
b
a
b
ili
ty
Target
Risk-enabled Planning and Execution
• More accurate specification of decision objectives,
deeper analytics
• Richer, more complete information
– Extensive usage of uncertainty data
– Leveraging financial data in supply chain decisions
– Leveraging supply chain data in financial decisions
• Risk-based measurements and metrics
• More timely and effective response to risk events
• Extend financial risk management concepts and
Evolution of Value Chain Risk Analytics
Data Integration
ERP
SCM
PLM
Real-time Risk
Management
Integrated Risk
Management
Standalone
Risk Analytics
Real-time Risk
Monitoring
Risk Extensions
CRM
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