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Chapter 5

Supply Chain Risk Management

D.L. Olson and D. Wu

Global competition, technological change, and continual search for competitive

advantage have motivated risk management in supply chains.

1

Supply chains are

often complex systems of networks, reaching hundreds or thousands of participants

from around the globe in some cases (Wal-Mart or Dell). The term has been used

both at the strategic level (coordination and collaboration) and tactical level (man-

agement of logistics across functions and between businesses).

2

In this sense, risk

management can focus on identification of better ways and means of accomplishing

organizational objectives rather than simply preservation of assets or risk avoid-

ance. Supply chain risk management is interested in coordination and collaboration

of processes and activities across functions within a network of organizations. Tang

provided a framework of risk management perspectives in supply chains.

3

Supply

chains enable manufacturing outsourcing to take advantages of global relative

advantages, as well as increase product variety. There are many risks inherent in

this more open, dynamic system.

Supply Chain Risk Management Process

One view of a supply chain risk management process includes steps for risk identi-

fication, risk assessment, risk avoidance, and risk mitigation.

4

These structures for

handling risk are compatible with Tang’s list given above, but focus on the broader

aspects of the process.

Risk Identification

Risks in supply chains can include operational risks and disruptions. Operational

risks involve inherent uncertainties for supply chain elements such as customer

demand, supply, and cost. Disruption risks come from disasters (natural in the

form of floods, hurricanes, etc.; man-made in the form of terrorist attacks or wars)

and from economic crises (currency reevaluations, strikes, shifting market prices).

D.L. Olson, D. Wu (eds.) New Frontiers in Enterprise Risk Management, 57

© Springer-Verlag Berlin Heidelberg 2008

58D.L. Olson, D. Wu

Most quantitative analyses and methods are focused on operational risks.

Disruptions are more dramatic, less predictable, and thus are much more difficult

to model. Risk management planning and response for disruption are usually

qualitative.

Risk Assessment

Theoretically, risk has been viewed as applying to those cases where odds are

known, and uncertainty to those cases where odds are not known. Risk is a prefera-

ble basis for decision making, but life often presents decision makers with cases of

uncertainty. The issue is further complicated in that perfectly rational decision mak-

ers may have radically different approaches to risk. Qualitative risk management

depends a great deal on managerial attitude towards risk. Different rational individ-

uals are likely to have different response to risk avoidance, which usually is

inversely related to return, thus leading to a tradeoff decision. Research into cogni-

tive psychology has found that managers are often insensitive to probability esti-

mates of possible outcomes, and tend to ignore possible events that they consider

to be unlikely.

5

Furthermore, managers tend to pay little attention to uncertainty

involved with positive outcomes.

6

They tend to focus on critical performance tar-

gets, which makes their response to risk contingent upon context.

7

Some approaches

to theoretical decision making prefer objective treatment of risk through quantita-

tive scientific measures following normative ideas of how humans should make

decisions. Business involves an untheoretical construct, however, with high levels

of uncertainty (data not available) and consideration of multiple (often conflicting)

factors, making qualitative approaches based upon perceived managerial risk more

appropriate.

Because accurate measures of factors such as probability are often lacking,

robust strategies (more likely to enable effective response under a wide range of

circumstances) are often attractive to risk managers. Strategies are efficient if they

enable a firm to deal with operational risks efficiently regardless of major disrup-

tions. Strategies are resilient if they enable a firm to keep operating despite major

disruptions. Supply chain risk can arise from many sources, including the

following:

8

Political events

Product availability

Distance from source

Industry capacity

Demand fluctuation

Changes in technology

Changes in labor markets

Financial instability

Management turnover


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