In today’s interconnected and volatile world, supply chain risks are on the rise. Raw material shortages, tougher regulatory regimes, armed conflicts, IT breakdowns and cybercrime have all tested supply chain resilience and adaptability. And while disruptions like the COVID-19 pandemic may be officially over, climate change will ensure supply chain disruption stays at the top of every business executive and risk professional’s corporate agenda for decades to come.
The impact of climate-related disasters is already extensive. Marsh McLennan analysis shows that the number of flood disasters has increased by 181% worldwide since the 1980s. Heatwaves are becoming more common and wildfires more devastating, scorching almost 23 million acres of land in 2021, according to a report from the World Resources Institute using data from University of Maryland research — a number that is likely to be exceeded in 2023, as record wildfires across the globe are leaving a trail of destruction. In Canada alone, this year’s wildfires have burned a record-breaking 20 million acres across the country — 21 times above the average over the last decade. The World Economic Forum’s Global Risks Report names “Natural disasters and extreme weather events” as the second-most severe risk over the next two years. As these events become more frequent and widespread, the cost to business from supply chain disruption is increasing.
In this new normal, many companies, especially those in industries with particularly high supply chain risk exposure (e.g., Automotive and Manufacturing, Energy and Utility or Retail and Wholesale), must prioritize and act on supply chain resilience.
Here are five steps that will help begin the effort:
Create a transparent supply chain
It seems obvious, but a stunning 82% of businesses do not have full visibility into their supply chain and logistics operations.10 Few can see beyond their first tier of suppliers, yet the biggest disruption risks often reside in the second and third tiers. Achieving full visibility is far from straightforward, however. Getting suppliers to complete surveys can be incredibly time-consuming and will likely still only result in partial information that soon goes out of date. A common challenge cited by supply chain managers is that suppliers may be reluctant to provide data about their own suppliers for fear of being is intermediated. While new analytical solutions are emerging to help companies map supply chains, the results still require rigorous verification. Our work with clients has shown how innovative, AI-based analysis based on shipping and customs data combined with remote sensing and open source intelligence can achieve comparable levels of supply chain visibility to survey-based approaches in a small fraction of the time, shortcutting a painful 18+ months process.
Uncover hidden vulnerabilities by asking “what if”
Mapping the supply chain can reveal critical vulnerabilities, exposing less-visible nodes that, if impacted, have the potential to disrupt downstream production or trigger wider brand and reputational consequences. Beyond mapping, the exercise requires a deep-dive evaluation to identify the nodes on which revenue continuity most depends. Examples include suppliers for which there are limited alternative options or that are dependent on critical infrastructure, such as roads or waterways, which could act as logistical chokepoints if they became unusable. Bloomberg reported that the 2022 drought on the Mississippi River could have resulted in a $20 billion economic loss involving food, wood, coal and steel supplies. Our work with an automotive company identified a high-risk exposure at a tier 1 supplier of a critical component where a disruption would have resulted in significant production downtime, as the part was used early in the assembly process and the supplier could not be replaced easily due to regulatory constraints. Regulation and brand constraints frequently limit optionality and tie companies to key suppliers or production regions. For example, labelling and provenance-based marketing in the food and beverage sector can leave companies critically dependent on climate-exposed suppliers. This scenario applied to a Florida orange juice producer when extreme weather forced it to source juice concentrate from Mexico, which went against its marketing strategy and claims on packaging.
Use the right tools to assess risks
At any one moment, there will be multiple threats with the potential to shut down activity and paralyze downstream production. There are climate-related perils, such as flood, storm, extreme temperature, wildfire, and drought; geophysical threats from events such as earthquakes or tsunamis; and man-made hazards, such as war and other geopolitical instability or cyberattacks. Because they are evolving, climate-related risks need to be understood in current and future terms. What is an acceptable likelihood of a flood event today may become unbearable in 10 years. This longer-term view of risk is important not just for risk management, but also supply chain strategy.
This diversity of risk is a challenge for risk managers. Disparate data sources are hard to collate, harder to compare, and even harder to aggregate. Converting different risk data into a common currency, such as a standardized score or financial metric, can support decision-making and simplify risk management. Scoring risk can provide a basic level of insight about the level and nature of risk at critical vulnerabilities as well as providing points of comparison and weighting. At a more advanced level, risk modelling techniques can be used to stress test the supply chain and estimate potential financial impacts in terms of damages, downtime and revenue loss. For example, our work to quantify flood risks in the supply chain of an automotive client revealed how over 90% of revenue at risk was driven by seven critical suppliers, several at lower tiers. Understanding concentration of risk exposure proved crucial in informing mitigation options for this client, who prior to this tech-driven mapping and quantification exercise had no visibility beyond tier 1.
Pre-empt risks through mitigation
History shows how businesses that proactively manage supply chain risks hold a competitive advantage. Global supply chains are often dependent on regional hubs where suppliers of a key component or material are clustered. For instance, consider the impact of COVID-19 on semiconductor factories in Taiwan and electric vehicle battery manufacturers in Eastern China, which led to shutdowns of assembly lines in the United States. When disaster strikes, companies that have taken action to mitigate risks suffer less disruption and are quicker to recover, providing them with an opportunity to seize market share while competitors struggle to get back on their feet. Companies can work with suppliers or local authorities to reduce risk near supplier facilities by investing, for example, in flood prevention or reinforcement of buildings and infrastructure. Risk assessments and resilience measures can be introduced into supplier-selection criteria.
Preparedness measures can include real-time monitoring and early warning systems, recovery plans for critical suppliers, and contingency plans for alternative supply lines. Quantification of risks allows companies to establish their appetite for operating with risk, define thresholds and optimize risk management strategies by comparing the cost of different measures to the reductions in risk that they offer.
Transfer risks where possible
Risk transfer can supplement risk reduction. For some vulnerabilities, it may not be possible or practical to reduce the risk to an acceptable level. In these cases, it may make sense to transfer the risk. Historically, this hasn’t always been easy. While companies can buy business interruption insurance to protect against revenue losses arising from damage to their own operations, it’s more difficult to secure coverage against losses from damage suffered by upstream suppliers. This becomes even more complicated when the business interruption involves suppliers beyond the first tier. The key is to identify the level of exposure to various suppliers, understand the most material hazards at those facilities, quantify the level of risk, and work with brokers to develop a risk transfer program. In addition to contingent business interruption, parametric insurance can be designed to protect companies against specific supply chain risks. For example, we worked with an agribusiness to develop a parametric solution to protect its revenue from transportation disruptions. The company depended on US waterways to transport grain, which exposed it to periods when the waterways might become unnavigable because of drought or flooding. The solution was a parametric cover with pay-outs tied to water levels and revenue at risk.