Supply Chain Management: Risk Management and Sustainability
One definition of supply chain management (SCM) is the process of planning, implementing, and controlling the materials, information, and finances as they move from supplier, to manufacturer, to wholesaler, to retailer and then to consumer. Supply chain management involves coordinating and integrating these flows both within and among companies.
As a result of globalisation, the scope of supply chain management is changing. Risk management is becoming more important as global supply chains expand in size and location. In addition, corporates are confronted with a growing importance of sustainability in terms of the environment and social corporate responsibility. This article examines these issues and how corporates can ensure they are effectively managing their supply chains.
Traditionally, companies focused on the physical supply chain rather than the financial supply chain in terms of cost reduction and improving efficiencies. During recent years, the focus was on better use of information in the physical chain. As a result, the focus has been away from optimising finance in the value chain. It is also clear that corporations have made far more progress attacking the physical component of the chain than in attacking its purely financial component. The focus is typically from inventory-to-sales, rather than from receivables-to-sales.
Corporates are now starting to realise the benefits of taking an integrated approach to managing the physical and financial supply chain together. This level of integration needs greater cooperation within and between organizations. This requires finance to become more involved with supply chain management and work more closely with supply chain staff. However, supply chain management staff does not speak the language of finance. In general, they lack the ability to link supply chain management to key financial metrics and to articulate how SCM drives financial performance.
Within the physical supply chain, supply chain managers usually work with sales and marketing, purchasing, operations and logistics departments in order to improve efficiencies. As the focus shifts towards the financial supply chain – and components such as the cash conversion cycle, initiating orders and paying suppliers – finance can start to take a leadership role in making the financial-logistics connection. They need to help SCM staff to understand how SCM business processes and strategies impact key financial metrics and the overall performance of the company.
If, for example, we look at the food and agriculture industry’s global supply chains we need to consider multiple (international) players and processes involved – growers, pickers, packers, processors, storage, transportation, exporters, importers, distribution, wholesalers and retailers. All of this was previously considered from a physical supply chain perspective. Now finance staff is getting more involved in increasing efficiencies in the area of cash settlement, letters of credit, supplier financing and receivable financing opportunities.
Technology has allowed more efficient information exchange between suppliers, manufacturers, distributors and customers. This improvement in information logistics has translated directly into better physical logistics.
It is vital that companies should shift their focus to improving the finance side and look at integrating the information, physical and financial logistics. This level of integration exists within most companies on a basic level but the exchange and integration of information between companies still needs improvement. For example, within a global supply chain in the food and agriculture industry, as discussed above, there are multiple companies in different regions with very different attributes and functionality. The ability to link these counterparties together from a finance perspective is a complicated task. Banks can play an important role here as a trusted third party.
Banks can enable access and visibility of information for all counterparties, which is particularly important in the final settlement of transactions. They can also help drive forward the integration of the physical and financial supply chains, as part of a wider collaborative effort by using third party technology.
For instance, software companies that deliver the technology to connect parties within the supply chain can play a significant role in improving efficiencies in supply chain management. Some companies will use standard software to link their ERP systems together. When this level of connectivity is not possible, simple Internet connections can be used. The industry is not yet at the stage of seamless systems integration or standardisation of messages. There are however significant initiatives under way, such as e-invoicing and the introduction of the single euro payments area (SEPA) that will be hugely supportive in this area.
The harmonisation of the credit transfers and direct debit schemes under SEPA will pave the way for initiatives such as e-invoicing. E-invoicing will dramatically reduce costs by optimising processes within the supply chain. In the Netherlands, for example, there is the e-invoicing initiative in the form of digital invoicing (Notabox). This has proved to be a huge benefit for companies in terms of substantially reducing the cost of invoices.
While many countries still have cheque payment systems in place, the environment is changing with the development of hybrid e-invoicing solutions. This will advance further with SEPA.
E-invoicing also enables companies to monitor and access information about payments much more efficiently and quickly. This is an advantage from a working capital perspective. Corporates can also consider outsourcing this function to a bank in order to optimise the process.
As we have highlighted, SCM is constantly under change and working on improvements. Within the agriculture industry for instance, it is vital that products are fresh and delivered on time. Therefore this industry has worked particularly at optimising the physical logistics processes in their supply chains. In the automotive industry, the supply chain is rooted in the assembly lines and supported by the numerous companies that supply the parts. When most of the automotive companies moved to Eastern Europe (e.g. Peugeot to Slovakia, Renault to Romania and Fiat to Poland), their suppliers also moved to Eastern Europe. This was done in order to ensure the supply chain remained as efficient as possible with short delivery times.
One common denominator among global supply chains within all industries is the growing importance of risk management. As they expand globally, supply chains are becoming more complicated. Factors such as outsourcing, economic volatility and the movement towards managed services increase the need for effective risk management. Corporates need to make sure they have visibility and transparency across their whole supply chain. This has to be done in order to mitigate any risks and therefore companies should take an enterprise-wide approach to supply chain risk management. Below are some examples of risk management issues that corporates face today.
Before the industry giant Mittal Steel merged with Arcelor, the company consisted of numerous subsidiaries that managed their trade finance individually through arrangements with banks and credit lines. This obviously created a complex web of credit lines, and one that was prone to risk without adequate visibility. In order to address this problem, Mittal Steel created a five-year trade facility line of US$800m. As a result, subsidiaries could use just one trade facility. A significant point is that all subsidiaries that issued a letter of credit or bank guarantee could do so with one of the three banks involved in the trade facility’s syndicate – Rabobank, Citi and ING. This reduced the risk of being involved with numerous credits lines and bank arrangements.
Corporates should optimise the information available to them in order to gain ‘added value’ in terms of mitigating customer risk. Global companies sell to many different customers but what if one of them becomes bankrupt? Corporates have to make sure that they are aware of this as soon as possible and act quickly in order to recoup their money. This requires an overview of exposure to their customers globally. A customer going bankrupt may not necessarily affect your turnover. It could however affect your share price if you cannot provide an adequate answer as to why you didn’t anticipate this happening, or why you didn’t take swift action when it did happen.
Corporates should also be aware of the risk associated with paying suppliers as late as possible in order to improve their own working capital, because it could negatively affect the supplier’s liquidity and cause problems for sourcing your supply chain. If a supplier develops a credit problem, as a result of extended payment terms, there is an increasing risk along the entire supply chain. It will adversely affect delivery of the end product. This is another reason why finance staff should be involved with supply chain management in order to make sure the chain is optimised and managed prudently.
Companies also need to establish a ‘sustainable’ supply chain when they map their risk management and identify drivers for sustainable development. (Rabobank will discuss this issue in greater detail in an article published later this year). Apart from sustainability in terms of avoiding supplier or customer risk as discussed above, sustainability is also relevant in terms of social corporate responsibility and environmental issues, such as climate change.
It is important to take into consideration the use of green energy and how to reduce energy consumption alongside the supply chain, as well as the use of sweat shops or child labour in supply chains. These issues are particularly important from a reputation risk perspective. They can significantly affect a company’s share price if that company is not seen to be adopting sustainable policies.
Sustainability should not be a cost burden. Cradle to cradle design protocols, energy and materials assessment and clean-production qualification will all help in supporting sustainable supply chains and reduce cost as well.
Supply chain management is changing rapidly. Risk management is becoming increasingly important within the supply chain. Corporates must balance this with achieving their working capital and sustainability objectives. Corporates can make sure they address these issues effectively with the right risk mitigation tools and banking partners.