Supply chain risk is in the news every day now, and awareness has grown exponentially since COVID, though many risks supply chains face have been with us forever. Aon’s 2022 Executive Risk Survey involved 800 senior executives from large companies, about equally split between North America and Europe including the EU and UK. Well-prepared business leaders often express that they are looking for analysis and advice from external stakeholders and the majority see value in using external advisors and consultants.
Aon, a global professional services firm (see Aon’s home page here), has a recipe for helping firms understand what risks they’re facing and what they can do about it. Richard Waterer is a key player. He leads Aon’s Global Risk Consulting business from London. It’s a group of over 1500 colleagues worldwide, who work with firms to identify, analyze, and find solutions for the risks they face.
This year, in a Q4 2022 Global Market Insights Report, Aon has highlighted several strategies firms are using. I asked Richard about them.
- Dual Sourcing
- Changing source locations
- Improved supplier terms
- Supply chain financing
- Increasing Inventory
Are firms considering location changes for supply, like ‘nearshoring’ or ‘friendshoring’? He replied, “It’s a big decision. Companies have to be really sure they understand the consequences of changing locations.” He sets the issue in a broader context, calling it changing your posture around managing risk. This could involve various strategic choices such as changing sources, reengineering a chain, or adopting risk management controls.
He felt that choices such as placing production close to the customer are currently being made based on costs of labor, logistics, and quality controls, rather than on a risk agenda. A strategic and political element enters as well. I believe that’s particularly true since the Ukraine war; sanctions have often become a major factor. But we’ve seen it for longer, at least since 2016. Examples are the simmering trade war between the US and China, Brexit, and East-West tension over investment in developing countries.
It’s expensive and hard to manage supplier risk, it’s time-consuming, and changing sources also invites new risks. There’s a need to monitor as you are moving. Aon’s consultants strive to be of assistance in these areas. Richard indicated that Mexico was a popular place for multinationals today to consider.
He pointed out that Aon is a services firm that brokers insurance, and is not an insurer. Their business is advising clients on risk, and capital allocation to reduce it. Insurance can be considered a form of capital that can be used to address supply chain risk. Richard feels that today companies are most interested in getting products on the shelf, and don’t tend to see insurance as the main enabler of this outcome. The level of investment in big risk control strategies is much more significant, and Aon’s consulting can help there.
He pointed out that insurers themselves will be interested in the strategies their customers use. Aon doesn’t underwrite the risk, but the insurers care what the exposures and the potential performance hits are, and how they are being managed. Improving your risk profile will help you place insurance favorably.
For instance, Richard said “Dual sources are helpful if you’ve done your homework in mitigating risk”, and it can also be good news for the underwriter, from a risk management perspective. The homework includes understanding the correlations between sources, not just in terms of who they are supplying, but also their common dependencies, and even geographically, so they won’t be wiped out by the same disaster. What is the resilience of the suppliers; will it protect your business as you intend?
We talked a bit about automotive supply chains, which have been severely compromised by supply chain risk over the last few years. What advice would Richard give?
He said the industry has a very complex supply chain and a typical manufacturer has over 30,000 suppliers. Some of the common approaches tried are
- Due diligence, very hard for 30,000 suppliers;
- Contracts with improved terms, hard to write so they are resilient to change;
- Monitoring software to spot events that require a response.
Aon’s consultants help clients to understand where the risk sits. Where is the particular exposure part by part from the bill of materials? It’s not unlike the approach taken by David Simchi-Levi and his MIT-based teams. Richard tells the story of an automotive manufacturer whose critical supplier was a small firm supplying relatively cheap additives for a painting process. If that supply stopped, the entire painting line would need to be shut down. Is this risk being addressed?
Richard said, “These days in an engagement there’s a treasurer in the room in every meeting.” The days when the supply chain was simply driving efficiency and cost are gone. Companies are more adept; we are seeing more supply chain financing, covering delays and losses. For instance, Aon might be involved in placing a trade credit wrapper insuring the ability to pay off the financing. Another technique is inventory financing. buying safety stock beyond what’s required JIT, transferring cost to the lender, and then insuring the loan. These are tricky transactions to prepare.
Forecasting is at the heart of supply chain planning, and I asked Richard what his consultants are seeing companies do. Do the firms rely too much on ERP forecasting rather than risk-based forecasting? or common sense?
He said that today, ERP sits alongside increasingly complex risk assessment software not found in ERP systems. Most large clients have at least one platform, most often used as a monitoring tool rather than actual decision-making. He feels it is important for companies to build their own software models for risk assessment, sensitive to their own operating philosophy and intentions. Richard noted, “Aggregation of the data over a period of trading can give a really good insight on frequency of events.” If a loss can be really big, exposure is high, and it may not be clear how to mitigate it. The aggregated data can give comfort and confidence in how to proceed, by understanding the frequency of the risk.
I asked him how a typical engagement with a firm of his set of experts works. Those in the room are usually procurement, supply chain managers, treasury, and risk. Aon brings expertise in both management and capital-based solutions, different from a standard supply chain consultant.
“We aren’t going to tell them how to run their supply chains, but we are going to bring our expertise on risk in the supply chain to the table”, Richard said. The Aon team helps with mapping supply chains through the tiers; who are the suppliers we most depend on. Spend is too often used as a proxy for risk. Next comes profiling the significant risks. Clients want to understand that. Consultants can also help them match capital to the risks. The consultants have seen a lot of similar risks play out in the past for different firms, and can advise on how to handle a problem.
Many clients seek to buy contingent business interruption insurance. It can be more challenging to buy the cover and capacity a company needs today, because insurance companies have problems with “accumulation” and “aggregation” at present. The basic principle of insurance is the many paying for the losses of the few. In the increasingly connected business world, an event at a supplier could end up disrupting many policyholders. This creates accumulations, and has impacted the appetite of insurers to provide certain types of coverage. Claims adjudication could also drag out, so that the timing of payouts is bad for the insurer’s cash flow. It’s not surprising that insurance companies are selective about the risks they choose to insure, and look for solid supply chain risk management in their insureds.
The Aon team can give business continuity and contingency planning advice, help quantify a loss for pursuing a claim, or work out how to respond to a situation. As Richard put it, “Our work wraps around the supply chain management programs they are already running.”
I specifically asked Richard about Environmental, Social, and Governance (ESG) risks, which are big in the news now, as countries move to regulate disclosure by companies. Aon’s Q4 2022 Global Market Insights Report says that ESG and climate change continue to dominate risk agendas. Are public relations and management controls adequate as responses?
Richard said that for industries such as retail, ESG is already the biggest supply chain risk. He mentioned a retailer who in 2021 suffered two business interruptions from fires at major storage facilities and had cargo stuck in the Suez Canal when it was blocked by a ship. But these were well within its ability to handle the costs. However, modern slavery anywhere in its supply chain would be a sizeable here-and-now risk, costly to business and reputation.
Richard said, “We’ve got to deconstruct ESG”. The social part is very important already; then environment, decarbonization, and long-term exposure to climate change. He believes companies should first and foremost invest in understanding and assessing the risks. The best way is to prevent an ESG problem in the first place, by reducing the likelihood of exposure. That’s the most important part of ESG risk control, particularly social.
Richard thinks ESG disclosure, starting to be required for stock listings, is helpful, but it’s not everything. He says “Firms must think about the promises they make to stakeholders and communities, and the extra value that they will unlock from proper handling of ESG concerns, and conversely the reputation risks if they don’t” Like the classic newsvendor, if she’s stocked out she’s lost future business, perhaps forever, far worse than the cost of extra inventory. By doing right with ESG concerns, you can keep customers coming to you.
Richard says companies are thinking hard about this. It’s much broader than supply chain risk, where there is still much attention on more traditional forms of disruption, which often need addressing promptly. But the ESG posture and risk profile, more broadly understood, is important for executives, both in Europe and the US, Richard believes. It’s good news for those who think improving ESG around the world helps to manage risk.