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Risk in Supply Chain Management

Conference Paper · March 2009

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 Proceedings of National Conference on Advances in Mechanical Engineering (NCAME 2009)
th st
February 28 and March 1 2009
Department of Mechanical Engineering
Moradabad Institute of Technology, Moradabad

Risk in Supply Chain Management

A. R. Singha, R. Jainb and P. K. Mishrac
a,b
Research Scholar in Mechanical Engineering Department, MNNIT, Allahabad
c
Professor in Mechanical Engineering Department, MNNIT Allahabad
E-mail addresses: [email protected] , [email protected]

ABSTRACT

Current business trends are leading to complex and dynamic supply chains. Increasing
product/service complexity, out-sourcing and globalization are the reasons that have enhanced the
risk, changed its location and nature in supply chains. In this present work a review of risk
definition, its classification and holistic approach of risk assessment and management have been
made. An approach has been developed that help to identify, assess and manage the risks.
Keywords: Supply Networks; Risk; Risk assessment; Risk management

1. INTRODUCTION

Risk and uncertainty have been studied in numerous business settings and have warranted
significant investigation in corporate functions, such as managerial decision making (March and
Shapira, 1987), strategy (Ruefli et al., 1999; Sitkin and Pablo, 1992; Wiseman and Bromiley, 1991),
operations (Newman et al., 1993; Pagell and Krause, 1999), accounting (Ashton, 1998; Baucus et
al., 1993), finance (Chow and Denning, 1994; Ho and Pike, 1992) and distribution (Celly and
Frazier, 1996; Lassar and Kerr, 1996).
Current business trends are leading to complex, dynamic supply networks. One consequence
is that risk is increasing, and shifting around supply networks. Managers need to identify and
manage risks from a more diverse range of sources and contexts. In the past, when firms
manufactured in-house, sourced locally and sold direct to the customer, risk was less diffused and
was easier to manage. With the advent of increased product/service complexity, and outsourcing of
supply networks across international borders, risk is increasing and the location of risk has shifted
through complex changing supply networks. There have been numerous researches about the risk in
purchasing and supply, but little is reported for complex supply networks. This research describes
identification, assessment and management of the risk.

2. INCREASING COMPLEXITY IN SUPPLY CHAINS

Supply networks are becoming more complex, dynamically changing webs of relationships.
Whilst this complexity arises from many sources, some key drivers are increasing product/service
complexity, e-business, outsourcing, and globalization.

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2.1. Product/service complexity
Increasing demand for product/service performance and variety, combined with more
complex product/ service and process technologies, has led to increasingly complex products and
services. Various dimensions of complexity impacting on supply chains have been identified,
including: scale, technological novelty, quantity of sub-systems components, degree of
customization of components in the final product/service, quantity of alternative design and delivery
paths, number of feedback loops in the production and delivery system, variety of distinct
knowledge bases, skills and competencies incorporated in the product/service package, intensity and
extent of end user involvement, uncertainty and change of end user requirements, extent of supplier
involvement in the innovation and transformation process, regulatory involvement, number of actors
in the chain, web of financial arrangements supporting the product/service, and extent of political
and stakeholder intervention. One of the effects of increasing product/service complexity is the
recognition that single firms cannot be excellent at everything; this gives rise to outsourcing

2.2. Outsourcing
Outsourcing involves the use of specialists to provide competence, technologies and
resources to provide parts of the whole (Gomes-Casseres, 1994; Lonsdale, 1999). Outsourcing not
only impacts on the organization and its immediate relationships, but also changes supply network
structure and processes. Aggregating these changes, outsourcing changes industry structures,
shifting the ‘balance’ of supply markets. Increased outsourcing allows access to global markets, and
may cause organizations to seek international sources for perceived ‘best in class’ performance. This
has contributed to supply chains becoming globalised.

2.3. Globalization
Outsourcing is only one driver of globalization. The transnational mobility of capital,
information, people, products and services is increasing, leading to ‘global entanglements’ Strategic
intent, global brands, economies of scale and scope, management of the value chain, comparative
advantage, market access, the growth of free trade and facilitating information technologies, most
recently e-business, have all been cited by various authors as contributory reasons for globalization.

2.4. e-business
e-business, or ‘doing business electronically’, has increased opportunities to reach new
customers and suppliers (Erridge et al., 1998) and respond to rapidly changing markets.The new
market and commercial opportunities afforded by the Internet increase the speed of change and
complexity in supply networks, and consequently increase risk.
The combined, messy, intertwined effects of increasing product/service complexity, outsourcing
globalization and e-business have caused supply networks to become increasingly complex and
dynamic (Croom, 2000). The previous, relatively simple business-to-business relationships
involving product/service and payment exchanges conducted at arms length are now embedded in
complex inter-organization network flows of intangible and tangible features; the intangible features
in networks are difficult to examine as they are ‘tangled up’ with many other features and their
accrual is highly context specific. A significant intangible feature in these chains is risk.

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3. RISK

In this section we provided an overview of theories with in risk with special focus on
organization.

3.1 Risk definitions

Risk is an ambiguous construct – the meaning varies depending on context and user. The
origin of the word risk is uncertain, but it may have come to us from the Arabic word risq or from
classical Greek via the Latin word risicum. A number of common meanings of the word can
be distinguished:
• a threat or a danger (”There is a risk of flooding”);
• a probability (”Driving a car without safety belts means an increased risk of injury”);
• the total appraisal of probability and size of the consequence; and
• a measure of dispersion (“Taking out an insurance means a reduction of the risk”)

The Royal Society in Britain describes risk in the following way:

“These definitions begin with risk as the probability that a particularly adverse event occurs during a
stated period of time, or results from a particular challenge. As a probability in the sense of
statistical theory risk obeys all the formal laws of combining probabilities. Explicitly or implicitly, it
must always relate to the ‘risk of (a specific event or set of events)’ and where appropriate must
refer to an exposure to hazard specified in terms of its amount or intensity, time of starting or
duration.”
Deloach, 2000 described the definition of risk based on firm performance is “The distribution of
possible outcomes in a firm’s performance over a given time horizon due to changes in key
underlying variables. The greater the dispersion of possible outcomes, the higher the firm’s level of
exposure to uncertain returns. These uncertain returns can have either positive or negative
consequences. The organization’s sensitivity to risk is a function of (1) the significance of its
exposures to changes and events, (2) the likelihood of those different changes and events occurring
and (3) its ability to manage the business implications of those different possible future changes and
events, if they occur.”

Risk definition by Kaplan & Garrick

The risk definition that will be used as a starting point in this study, when looking specifically at
supply chain disruption risks, is the one presented by Kaplan & Garrick (1981) and which was
further developed by Kaplan (1997). The motivations for choosing this specific definition are that it
is a commonly used (but not by all disciplines accepted) operational definition of risk and that it
explicitly splits up the concept of risk in different elements/parts, which facilitates adaptation of the
general definition to more specific risk areas.
Presented below is a condensation of the discussions on the risk concept in the two articles
mentioned above. The terms used are those presented in the articles.
“In analyzing risk we are attempting to envision how the future will turn out if we undertake a
certain course of action (or inaction). Fundamentally, therefore, a risk analysis consists of an answer
to the following three questions:
(i) What can happen? (i.e., what can go wrong?)
(ii) How likely is it that that will happen?
(iii) If it does happen, what are the consequences?”

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An answer to those three questions is called “a triplet”. There might be many triplets/answers to
those questions, and each answer can be described by the help of the following formula:
<Si, Li, Xi> [3.1]
where
• Si is a scenario identification and description;
• Li is the probability of that scenario; and
• Xi is the consequence or evaluation measure of that scenario, i.e.
he measure of “damage.”
A “set of triplets” could then be described as: {< Si, Li, Xi >} where i = 1, 2,…., N. [3.2]

Baird and Thomas (1990) have defined risk from eight different perspectives. Their arguments
incorporate views from finance, marketing, management, strategy, and psychology. The first three
definitions—variability of returns, variance, and market risk—focus on the organization’s financial
return. The last two definitions of risk as disaster and as accounting risk measures relate to the risk
of a company going bankrupt. These definitions of risk provide evidence that risk is a multi-
dimensional construct and differs according to business function.

Shapira (1995)
Shapira (1995) found that very few managers define risk in those terms. Instead, managers identify
(1) the downside of risk, (2) its magnitude of possible losses, (3) the act of risk taking involving the
use of skills, judgment and control, and (4) risk as a concept that cannot be captured with a single
numb. These findings also suggest that the term ‘‘risk’’ can be perceived in different ways, and no
single definition of risk may be appropriate in all circumstances.

Yates and Stone (1992)

Yates and Stone (1992) note that risk entails (1) the elements of loss, (2) the significance of loss,
and (3) the uncertainty associated with loss. Within the elements of loss are three additional factors.
First, risk is not limited to one specific loss that can occur. This is similar to the variance of
outcomes discussed by March and Shapira (1987), with the exception that it focuses only on losses.
For example, a fire that destroys a supplier’s plant can affect production for 1, 2 days, or even
months. The incident can result in various degrees of loss (outcomes) for the supplier as well as the
supplier’s customers. Losses are also experienced in reference to an outcome. What is important is
not the loss itself, but the actual outcome in comparison to an expected outcome. Another facet of
loss is multiplicity, in which losses can transcend multiple categories such as financial,
performance, and time loss.

3.2 Static and dynamic risks

Dynamic risks are risks that can have either a positive or a negative outcome, e.g. market
reactions. Static risks are risks that can only have a negative outcome, i.e. the outcome does not
bring an economic advantage. An example of a static risk is a fire. Dynamic risks are often more
interesting for companies, as they can bring in a profit as well as a loss. But the better a company is
grasping its static risks, the bigger dynamic risks it can take. By taking bigger risks, bigger profits
can in many cases become possible.

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Another aspect of risk is risk relativity, i.e. risk compared with your competitors, meaning that even
though a certain event, e.g. a hurricane, leads to negative consequences it can give you a
competitive edge if you can ensure to be less affected than your competitors by that same event

3.3 The circle of risks

Traditionally the main focus within risk management has been insurable risks, but in a wider
perspective commercial risks have been separated from non-commercial risks. Commercial risks
include decisions that can lead to profit but also to a negative outcome, as opposed to
noncommercial risks that can only lead to losses. Another classification of risks is into dynamic
risks and static risks, where dynamic risks more or less correspond to commercial risks and static
risks correspond to non- commercial risks. Hamilton presents the “circle of risks” as a
comprehensive view of all risks that can threaten an organization
The circle of risks is divided into two natural halves. The right half includes operational,
static risks within production where the risk with most impact is disruption in the production flow.
Most of the work the risk manager is conducting is represented on this half. The left half includes
dynamic risks found outside the production such as inflation, new laws and terrorism. This half is
included in the circle of risks to offer a comprehensive view of the risk situation of the organization

3.4 Risks within the production

Employee risks include such things as working injuries, problems related to stress and drugs
and bullying among colleagues. A company with an inferior working environment produces
discomfort and working injuries that result in increased absence and unwanted employee turnover.
This creates disruptions in production, which can result in poor quality. In the long run this is a
major threat to the organization. Property risks represent damages to property such as can be caused
by fire, water, storms and inadequate maintenance. For a long time fire has been the most dreaded
risk. Lately though, new technological advances have released new forces that may be difficult to
control. Hence fire is no longer as feared as before. Still, however, the damage from fire is a big
problem. Environmental risks include pollution and leakages. The environmental problems are
gaining more and more attention. Criminal acts include sabotage, industrial espionage, theft and
fraud. During the last decade there has been a significant shift from outside criminal acts to inside
operations. Today the employees in a company are responsible for most of the economic crimes in
the organization. Some ways to prevent this are clear routines and running of internal records.

3.5 Risks outside of production

Market risks cover inflation, trade agreements, changed terms of competition, currency risks
and so forth. Financial transactions have become a considerable risk lately. Speculations in stocks,
foreign currencies and other financial means have led to most big companies now having some form
of finance policy to limit the associated risks. Liability risks include among other things
responsibility for the environment and product and also risks involving contracts. Product liability
means that a company is liable to pay for the damage when their product has caused injury to a
person or a property. The risks of damage claims are by far most substantial in the USA, since the
amounts demanded for compensation are generally very high. To avoid risks associated with
product liability, it is important to have a quality assurance system in the company that results in
products and services fulfilling the quality expected by the customer. Political risks involve new
laws, terrorism, nationalization, social revolution etc. Countries with political instability are more
affected by alterations that can change the conditions of economic life overnight. Hence there are

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great political risks in owning companies situated in such countries. The most obvious political risk
is considered to be confiscation or nationalization of property.

3.6 Closing comments

It is important to put operational and dynamic risks in relation to each other to get a
meaningful judgment of the company’s risk environment and to be able to act rationally. But the
risk manager often lacks the requisite knowledge about risks associated with the market. It is
essential for every company to chart their own circle of risks to fully grasp the risk environment that
is specific for each organization. There are some risks that are not represented in the circle of risks,
such as the human factor and loss of trust.

Figure 1: The circle of risk (Hamilton, 1996, p.16)

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4. RISK ASSESSMENT

Risk assessment is the general term used to describe the study of decisions subject to uncertain
consequences. It can be sub-divided into risk estimation and risk evaluation. If we consider the
information on which the assessment has to be based, risks can fall into at least three different
classes:
• Risks for which statistics of identified casualties are available;
• Risks for which there may be some evidence, but where the connection between suspected cause
and injury to any one individual cannot be traced; and
• Expert’s best estimate of probabilities of events that have not yet happened.
Risk assessment includes deciding values for different risks. However, it might not be possible to
collect all the information necessary to do a solid risk calculation because the information is not
there or it takes too much time or is too costly to get. We are then faced with a choice. Either we
choose to only assess those risks that we have enough information about to be able to do
calculations based on “hard”, objective facts like statistics. Or we choose to say that it is better to
consider all risks, although some of those risk assessments have to be based on “soft” data like
subjective judgments by individual experts within the relevant area.
Risk assessment is what we as private persons do every day, e.g. when we decide to take the
car instead of the train for a certain trip or when we choose to cross the street outside instead of
inside the pedestrian crossing. Those decisions are partly based on objective information and partly
based on our subjective judgments. Professionals would probably have taken other decisions in
some of the situations because they have access to more knowledge, especially within their own
special area, e.g. traffic safety. But although they are the experts, they cannot avoid subjectivity –
but the degree of subjectivity ought to be lower than for a layman.
Generally, From the definitions of risk provided earlier, it appears that in order to assess risk
there are two main questions to be answered:
1. How likely (probable) is it that an event will occur?
2. What is the significance of the consequences and losses?
The first question can be divided further. The likelihood of an event occurring depends partly on the
extent of the exposure to risk and partly on the likelihood of a trigger that will realise the risk. The
realisation of risk may be partly influenced by an organisation and individuals within it and partly
by things beyond their influence; this relates to categorization of direct and indirect risks. Clearly,
however, this categorisation is not universal— some very powerful organisations and individuals
will be in a position to influence regulation, politics and markets. Others will only be able to cope
and react to these business environmental influences.
The second question can also be divided. Some of the significance of the consequences can
be estimated reasonably accurately if there are regulations or laws in existence that you must
comply with; non-compliance often carries known penalties. Some of the significance of the
consequences depends on different circumstances; a local figure of repute is more likely to have
their court case publicised in the local press than someone who is less known.
Aspects of risk such as exposure to risk, consequences, non-compliance, business impacts
and the magnitude of losses are illustrate an example (Table 1) of a taxi company, and the risks it
faces in the broader environment it operates in, compared to the customer of the taxi company.

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 Table1. Illustrative example of different aspects of risk
Benefit Exposure Event Consequence Business Magnitude
Impairment of loss
Example1. Parking Parking ticket Fine Increase Cost Can range
driver illegally Vehicle towed Fine and time to Increase Cost from minor
Income for taxi collect vehicle & Time to major
firm and driver Speeding Caught by Fine Increase costs
Running a police or Points (possible Possibly cease
red light camera loss of licence) trading
Drink Caught by Fine Increase costs
driving police
Faulty Fails MOT Vehicle off road Temporarily
products while remedial cease
fitted to action trading
vehicle
Example 2- Company Taxi involved CEO misses Business lost Can range
customer uses taxi in Crash meeting from minor
CEO can work to get to major
in transit and CEO to
low stress important
meeting

5. RISK MANAGEMENT

Risk management was defined as “The process whereby decisions are made to accept a
known or assessed risk and/or the implementation of actions to reduce the consequences or
probability of occurrence”
No human activity can be considered to be risk free. Therefore risk management is of
relevance and interest to everyone. In today’s society, many of the traditional risks have been
eliminated or substantially reduced. At the same time, new risks have emerged that are difficult to
explore and interpret – risks that often have very severe consequences.
Borge, 2001 was defined as, “Risk management means taking deliberate action to shift the
odds in your favour – increasing the odds of good outcomes and reducing the odds of bad
outcomes.”
That is why risk management is of interest to all of us. Since there normally is a cost linked
to a risk handling action, and also the possibility that other risks might be spun off by that action, it
is probably not optimal to try to cover all risks. Expected result impacts have to be balanced against
risk handling costs. What are the elements of the risk management process? There are many
different definitions depending on what academic field is addressed. The basic objective of all risk
management processes is after all the same, i.e. to prevent undesirable and detrimental events from
taking place and, if they do take place, to mitigate the consequences, thereby saving lives, property,
environment, financial resources or something else considered “valuable”. It includes all types of
risks – from the risk of loss of competence when key employees leave the company to the risk of a
harmful discharge into the external environment from production facilities or processes.
Figure2 presents a detailed description of the process. This process is proactive, i.e.
preventive, compared to what is usually called crisis management. Crisis management, although a

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crisis group might have been established and resources and routines decided upon in advance, is
primarily reactive, that is events or incidents that develop into something critical to the organization
are addressed ad hoc, i.e. separately and in each specific situation.
The risk management process identifies the existing risks and their possible consequences.
By quantifying them in economic terms, you acquire an effective instrument by means of which you
can communicate with management.
The International Electrotechnical Commission (IEC) has developed the following model of the risk
management process and its different parts.

Risk Analysis
•System border
•Hazard Identification
•Risk Estimation
Risk
Assessment

Risk Evaluation
•Acceptable risk Risk
•Analysis of alternatives Management

Risk Reduction/Control
•Decision making
•Implementation
•Monitoring

Figure 2. A risk Management Model by IEC

Risk analysis is the initial phase in the risk management process. First the system border of
the project/study is set. Then the hazards are identified and estimated. The second phase is risk
evaluation i.e. to evaluate those risks compared to a defined acceptable risk level. Risks under this
level are sorted out and not further considered. The third and final phase in the risk management
process is risk reduction and risk control. This includes decision making, implementation and the
following up of the action plan. These are important activities. Without an effective change exertion
with continuous feedback, the time and resources spent on risk analysis and risk evaluation can be
wasted.

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6. SUPPLY NETWORK RISK TOOL

A tool for helping to identify, assess and manage risk is provided in Figure 3. The tool is
divided into boxes, commencing with the first box involving mapping the supply network. Here the
supply network to be mapped would be defined by the problem or concern. For example, the
network might be the product supply network for a particular product where it is felt there is some
exposure to risk. In this stage a diagrammatical representation of the supply network enriched with
appropriate data is created. Mapping this supply network is likely to involve understanding who
owns what, and what are the key measures currently in place, i.e. clarity of role and responsibility
within the network

Map supply network

- structure ofactors
- key measures
hi 1

Identify risk and

Implement supply its current location
network risk strategy - type
6 t ti l l 2

Form collaborative Assess risk

supply network risk - likelihood of
strategy occurrence
5 - stage in life cycle
- exposure
lik l t i
Manage risk
- develop risk
position
d l i

Figure 3. Supply Network Risk Tool

In the second box the map is enriched with information concerning the type of risk and its
location. A prompt list can be provided from those compiled from the literature review, i.e. Strategic
Risk, Operations Risk, Supply Risk, Customer Risk, Asset Impairment Risk, Competitive Risk,
Reputation Risk, Financial Risk, Fiscal Risk, Regulatory Risk, Legal Risk. The specific risks that
will be considered for the particular problem/product should be identified, through brainstorming
with other actors in the supply network. At this stage only those with a significant potential loss to
any actor in the network should be considered.

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 In the third box the chosen types of risk are assessed for the likelihood of their occurrence,
exposure in the network, potential triggers of the risk, at what stage in the life cycle the risk is likely
to be realised, and what likely potential losses to whom might occur.
Risk management occurs in box 4, where the assessment information is analysed and
alternative interventions are proposed. Here the risk position is determined—whether, for this
particular problem/product and the particular actors involved, the position will be reactive,
defensive, prospective or analytical. Alternatively, some organisations might feel more comfortable
using such terms as ‘cautious’ or ‘risk averse’. Depending upon the risk position, scenarios of
alternative network structures and relationship strategies can be developed to realign risk, exposure
to it, likely losses and location of those losses.
In boxes 5 and 6the chosen redesign of the network and relationships within it are effected
through a reformulated collaborative supply network risk strategy. This strategy is implemented and
gives rise to a remapping of the network, i.e. back to box 1. It is intended that this tool is used in
collaboration with other key network actors. Individual focal firms can use this tool independently.
However, their own view of how to deal with risk in the network may not coincide with other actors
and is likely to give rise to destabilizing of the network at some point.

7. CONCLUSION

Risk exists in virtually all firms, and has been extensively studied in various business
contexts. The current business trends of increasing product/ service complexity, outsourcing,
globalisation and e-business that have lead to more complex, dynamic supply networks have
resulted in risks shifting around supply networks. Managers need to identify, analyse and manage
risks, as well as potential opportunities, from a more diverse range of sources and contexts.
Supply networks are undoubtedly becoming significantly more messy units of analysis to
deal with. The tangled up changes that cause the dynamics of supply networks to be complicated to
understand, also impact on risk. Whilst there has been substantial research attention to date on risk
and on supply networks, there has only been limited empirical research on risk in supply networks.
This paper provided a brief review of risk, its assessment and management. It summarized a tool of
risk in supply network

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