Supply Risk

Contents
1 Introduction ............................................................................................................................................. 2
2 Risk Likelihood Metrics.......................................................................................................................... 3
A. Management Risk ............................................................................................................................... 3
B. Operations Risk ................................................................................................................................... 5
• Labour Risk..................................................................................................................................... 5
• Power Risk ...................................................................................................................................... 5
• Machinery Risk ............................................................................................................................... 5
• Safety Risk ...................................................................................................................................... 6
C. Financial Risk ..................................................................................................................................... 6
• Funding Risk ................................................................................................................................... 6
• Liquidity Risk ................................................................................................................................. 6
• Profitability Risk ............................................................................................................................. 7
D. Geopolitical / Regulatory Risk ............................................................................................................ 7
3 Risk Impact Metrics ................................................................................................................................ 8
A. Supplier Leverage ............................................................................................................................... 8
B. Product Criticality ............................................................................................................................... 9
C. Demand-Supply Imbalance ................................................................................................................. 9
D. Production Impact ............................................................................................................................... 9

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1 Introduction
Objective of an operations manager is to minimize the risk (demand side and supply side) in supply chain.
From empirical results, supply side risks are the major contributors of risk in supply chain. We will focus on
supply side risks in the document.

Supply risk can be analyzed based on:

(i) risk likelihood (probability of risk) which is composed of supplier risk (1)
(ii) risk impact which is composed of product criticality (2) and supplier leverage (3)

1. Supplier Risk
Parameters that can be used to evaluate supplier risk are:
1. Management risk – Board run vs promoter run
2. Operations Risks- Labour risk, Machinery risk, Power risk, Safety risk
3. Financial Risk - Funding risk, Profitability risk, Liquidity risk
4. Geopolitical / regulatory risk

2. Product criticality
It is used to rank different products on the basis of their criticality. A product's criticality is evaluated on the
basis how much buffer capacity is available across the product's suppliers and the time taken to add capacity.

3. Supplier Leverage
It is a way to categorize suppliers based on dependence between supplier and customer

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2 Risk Likelihood Metrics
A. Management Risk
A change in top management (CEO, COO) or the company changing owners etc. would be covered by this
metric.
The type of change (positive / neutral / negative) can be assessed as below:
Positive
Relationship towards Vendor's attitude has
customer improved towards
customer compared to
before
• Vendor giving
customer first right to
buffer capacities in
case of emergencies
compared to before
• Vendor more
responsive to
customer's requests
than before
Interest in product Vendor's keenness in
product has improved
compared to before
• Vendor more keen on
further investment in
capacities in this
comp. than before
• Vendor quoting more
competitive bids in
RFQs than before
Company's management Company's management
capability ability has improved
compared to before
• The new CEO is a
turnaround expert
• The new CXO /
Chairman of the
Board is very
experienced
• Addition of activist
shareholder will
ensure that
management is
focused on growth
Company's financial Company's financial
capability ability has improved
compared to before
• Company has been
acquired by a
financially strong
group
Neutral negative
Vendor's attitude towards Vendor's attitude towards
customer is the same as customer has deteriorated
before compared to before
• Vendor favoring
other competitor over
customer for access
to buffer capacities in
case of emergencies
compared to before
• Vendor less
responsive to
customer's requests
than before
Vendor's keenness in this Vendor's keenness in this
product is the same as product has deteriorated
before compared to before
• Vendor less keen on
further investment in
capacities in this
product than before
• Vendor quoting less
competitive bids in
RFQs than before
Company's management Company's management
ability is the same as ability has deteriorated
before compared to before:
• Experienced CXO /
Chairman of the
Board / board
members have exited
the company
Company's financial Company's financial
ability is the same as ability has deteriorated
before compared to before:
• JV partner (which
provided financial
support) has exited
• A major shareholder
has exited the
company
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Management risk can be gauged through:
1. Management conflict

Any kind of conflict in top management / board members should be captured here. A conflict in top
management could make the future direction of the company uncertain.

Instances of management conflict would include:

1. family in-fighting (father-son / brothers etc.) over the company,
2. fall-out between the board members (CEO, Chairman, activist shareholder, JV partner etc.)
a. Conflict of CUSTOMER with its JV partner would also be covered here
3. fall-out between the CXO level (between CEO and CFO etc.)

2. Management diversification into other businesses & interest in this product

Management diversification into other businesses can be calculated using the formula below

(Vendor's total investments – Vendor's investments for this product)

=
Vendor's total investments

In case, getting data on investments is difficult we can use the proxy below:

(Vendor's total revenues – Vendor's revenues from this product)

=
Vendor's total revenues

3. Management loyalty towards customer

a. Does the vendor use customer's high dependence on it as a lever to extract price increases?
b. Does the vendor NOT support customer in case of sudden demand spikes?

4. Roles clearly divided among key stakeholders?

A clear roles division would include

1. no overlap of roles between stakeholders – only one person managing the financial function
2. role distribution commensurate to the stakeholder's investment

For partnership companies:

1. Who are the stakeholders and what is their respective equity stake?
2. What are their roles in the company?

For family-owned companies:

1. What is the role of each family member?

5. Is there a succession plan in place?

A succession plan exists if:

1. A clearly laid out succession plan
2. Successor already working in the business
3. The CXO level positions are filled with professionals

6. Is there a professional management team in place?

Professional management is defined as:

1. Decision-making is decentralized
a. Instead of only 2-3 key people running the business, there are several decision makers
2. Decision makers are competent
a. The top/middle management is competent

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B. Operations Risk

• Labour Risk
Types of labor unrest include:
1. Go slow (intentional)
2. Tool down
3. Physical protests: boycotting meals provided by the company, refusal to adhere to company dress
code, processions or demonstrations
4. Damage to company property/personal property by workers
5. Violent break-outs between groups (management and workers or between worker groups)

Issue is considered resolved when corrective action was taken to address the underlying cause, and if no
other disruption (even minor <1 day) has occurred due to the same underlying cause.
Corrective actions include:
1. Provided increase in wages or incentives
2. Formation of a new union
3. Removal of a manager causing the issue
4. Putting better safety practices in place
5. Taking disciplinary action against some workers
6. More equitable distribution of wages
7. Contract worker regularization

• Power Risk
Power backup is considered adequate only when the vendor has 100% backup for required operations for
the particular product.

Backups required:
• List of DG sets / other backup sources and their kW
• List of machinery equipment required to be run and their kW requirements

Calculate:
Total kW requirements for all operations
% power back-up =
Total kW capacity of DG sets / other backup sources

• Machinery Risk
Machinery risk can be gauged through:

1. Is m/c preventive maintenance followed?

Maintenance schedules are created to ensure preventive maintenance is followed in a timely manner.

Number of times preventive maintenance

M/c preventive maintenance compliance % = conducted in last 4 scheduled checks
4

2. What is the vendor's Overall Equipment Effectiveness (OEE)?

OEE = Availability × Performance × Quality

OEE has three basic products:

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 1. Availability: (Actual production time/Planned Production time). Planned production accounts
for breaks, planned shifts etc. To calculate actual production time subtract tool change
overtime, downtime, shift change times
2. Performance: ({Total produced parts/Actual production time}/ideal run rate) Ideal Run rate is
the maximum number of parts produced per minute
3. Quality: (Accepted parts/Total Parts produced)

3. Does the vendor have trained manpower to maintain SPMs/robots/imported machines?

• If maintenance done by internal staff/employees
• If AMC purchased for maintenance or maintenance and technical support available locally
• If no AMC purchased and technical support only present outside the country

4. Does the vendor have a tool room/ tool maintenance shop?

• Safety Risk
Major accidents are accidents that either caused a severe injury (required medical aid from hospitals) or
caused a loss in production in order to avoid severe injury.

C. Financial Risk
• Funding Risk

1. Long term credit rating (Crisil, ICRA, SMERA (D&B), CARE, ONICRA)

Note: Please ignore the '+' or '-' appended to the rating while using the risk-mapping available below.

Risk Score Crisil ICRA SMERA CARE

High B to D LB to LD B to D B to D
Medium BBB to BB LBBB to LBB BBB to BB BBB to BB
Low AAA to A LAAA to LA AAA to A AAA to A

2. Debt / Equity ratio

From the balance sheet,

Debt = Long term liabilities + Short term liabilities*

Equity = Shareholders Funds + Reserves & Surplus

• Liquidity Risk
1. Short term credit rating (Crisil, ICRA, SMERA (D&B), CARE, ONICRA)

Risk Score Crisil ICRA SMERA CARE

Low A4, D A4, D A4, D A4, D
Medium A3 A3 A3 A3
High A1, A2 A1, A2 A1, A2 A1, A2

2. Current ratio (current assets / current liabilities)

Current assets
Current ratio =
Current liabilities

3. Interest coverage ratio (PBIT / Finance charges)

PBIT can be calculated from the vendor's P&L statement using PBT and finance charges.

PBIT = Profit before tax + Finance charges

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 PBIT
Interest Coverage ratio =
Finance charges

4. Employees paid in time?

• Profitability Risk

1. Net forex exposure as a % of total revenue

2. Cumulative spike in input cost over last 1 year

Input cost = Labor cost + Power cost + Raw Material cost + FE cost

To calculate spike in input cost, set the baseline cost of the product at the start of a financial year. Calculate
the increases given to the vendor (over the baseline cost) for each of the cost buckets mentioned above.

Increase of cost in product

Cumulative spike in input cost =
Baseline cost of product

3. Average ROCE (Return on capital employed) for the last three years

To calculate ROCE, the buyer requires both the balance sheet and the P&L statement of the company

PBIT = PBT (Profits before tax) + Finance charges

PBIT
ROCE =
Total Assets – Current Liabilities

D. Geopolitical / Regulatory Risk

Geopolitical risks can be gauged by:
1. Does the vendor operate in a regulated industry?
Regulated industries are defined as industries which have a safety or environmental impact.

2. Seismic, cyclone, tsunami, flooding zone score for vendor's location

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3 Risk Impact Metrics

A. Supplier Leverage

Supplier leverage matrix groups vendors according to customer's ability to influence them.

Customer’s ability to influence the vendor depends on:

1. Supplier's dependence on customer i.e. customer's share in the supplier's overall revenue (%):

Total revenue to supplier from customer

Supplier's dependence on customer =
Supplier's overall revenue

2. CUSTOMER's dependence on the supplier (supplier's share of business for a particular sub-
category)

Supplier Customer's dependence Supplier's dependence on Explanation

Leverage on supplier customer
We should work closely with these
Key supplier High High
set of suppliers
These vendors can be influenced by
Lever supplier Low High customer because of their high
dependence
The balance of negotiation power
Critical
High Low lies with the vendor instead of
supplier
customer
Non-critical
Low Low These can easily be replaced
supplier

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B. Product Criticality

Product criticality matrix is used to group products on the basis of their manageability.
Product criticality can be categorized based on:

1. Lead time to capacity addition: The time taken to add new capacity (typically time required to add
new machinery) for a particular category.

2. Available buffer capacity: To calculate buffer capacity for a sub-category add up all the buffer
capacities available with different vendors supplying that sub-category i.e.

Extra units that a vendor can supply calculated

on the basis of the bottleneck process
Buffer capacity of a subcategory-vendor combination =
Customer demand for the particular sub-category

Scoring
Product Lead time to add Available buffer capacity Explanation
Criticality capacity (in months) (in %)
Critical category as there is low
existing buffer capacity and the
High (greater than 6 lead time to add capacity is high.
Critical Low (less than 20%)
months) The manageability of this sub-
category is low (i.e. high-risk
impact on customer)
Moderate category as there is low
existing buffer capacity but the lead
time to add capacity is low too. The
Moderate Low (less than 6 months) Low (less than 20%)
manageability of this sub-category
is moderate (i.e. moderate risk
impact on customer)
Moderate sub-category as there is
high existing buffer capacity
although the lead time to add
High (greater than 6
Moderate High (greater than 20%) capacity is high. The manageability
months)
of this sub-category is moderate
(i.e. moderate risk impact on
customer)
Non-critical sub-category as there is
high existing buffer capacity and
Non-critical
Low (less than 6 months) High (greater than 20%) the lead time to add capacity is low.
supplier
This sub-category is highly
manageable.

C. Demand-Supply Imbalance

Demand-supply imbalance is used to calculate the capacity available next year in a particular sub-category.

𝐷𝑒𝑚𝑎𝑛𝑑 𝑠𝑢𝑝𝑝𝑙𝑦 𝑖𝑚𝑏𝑎𝑙𝑎𝑛𝑐𝑒

= 𝐴𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑏𝑢𝑓𝑓𝑒𝑟 𝑐𝑎𝑝𝑎𝑐𝑖𝑡𝑦 + 𝑈𝑝𝑐𝑜𝑚𝑖𝑛𝑔 𝑎𝑑𝑑𝑖𝑡𝑖𝑜𝑛𝑎𝑙 𝑐𝑎𝑝𝑎𝑐𝑖𝑡𝑦
− %𝑔𝑟𝑜𝑤𝑡ℎ 𝑒𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑖𝑛 𝑛𝑒𝑥𝑡 𝑜𝑛𝑒 𝑦𝑒𝑎𝑟

D. Production Impact

Delay in supply may lead to below impacts for:

a) Backorder
b) Temporary loss of customer
c) Permanent loss of customer

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