E-Supply—Opportunity and Risk
September 2000
Supply chains powered by the Internet are
changing organizational structures and business practices. While these changes
have resulted in new manufacturing opportunities, they have also brought about
increased risk and new insurance challenges. This article addresses these issues.
by Gary
J. Bausom
Bausom & Associates, Inc.
Supply chains powered by the Internet are changing organizational structures,
business practices, and shifting selected risks. The explosion of the Internet
engine has driven, and will continually cause, many changes in our daily lives--some
good, others not so good; some obvious, and others quite subtle.
Personal Perspective: Business to Consumer ("B to C")
From a personal perspective, the Internet has made it very easy to find and
obtain replacement parts for home repairs. For example, I have a 17-year-old
large picture window that contains a small gearbox which operates a slim blind
sandwiched between two panes of glass. Recently, the gearbox broke and had to
be replaced.
Where do I find the nearest Pella store that might carry this small component?
With the Internet, the search for the Pella Web site was easy, convenient, and
practically free. So I was able to order the replacement part and, consequently,
the blind in my window now works like new. The alternative would have involved
a search through the phonebook, a trip to the regional store, detailing the
order specifications, filling out forms, and waiting. Meanwhile, we would have
had the inconvenience of having a large plate of glass propped up against a
wall, trying to protect it from breakage until the repair was completed.
Business Perspective: Business to Business ("B to B")
Businesses have been aggressively reducing their plant, property, and inventory
levels to improve financial performance. Financial performance has been helped
by selling productive assets to outsource suppliers who have lower overhead
costs, which notably improve the primary manufacturer's return on assets. This
improvement has resulted in significant reductions to property, plant, and equipment,
and inventory balance sheet accounts, accelerated with the help of management-consulting
firms with supply chain practices.
Fixed assets have been sold to contract manufacturers and logistics suppliers
who are under specific contract to the manufacturer who spun off the assets
and/or business units. These supply chain partners are likely to have contracts
with numerous firms in a given industry, which have traditionally been considered
competitors. If they are operating with lower overhead costs and maintaining
quality standards, it is a win/win situation for the primary manufacturers and
their outsource partners.
Insurance Implications
From an insurance perspective, a portion of the premium has shifted from
the manufacturer to the supply chain partners. Managing a virtual supply chain
requires notable care and sophisticated "tools." These tools provide for tracking
the quantity, quality, delivering points, and times so the primary manufacturer
can deliver to customers as demanded.
From an insurance underwriting view, these emerging exposures need to be
addressed. The restructured supply chains have reduced the number of suppliers,
moved to just-in-time inventory, changed from paper to digital format, and provided
for automatic reorder. Significant cost reductions have occurred, including
lower transaction costs and a reduced number of suppliers, all of who operate
via e-commerce conductivity. Corporate benefits have ranged from hundreds of
millions of dollars to more than $1 billion of cost reduction for each enterprise.
Many insurance companies underwrite property programs covering business assets,
business interruption, and contingent business interruption. Therefore, a loss
experienced by the extended supply chain "partners" would be included in the
definition of a loss to the primary manufacturer, even though manufacturers
may not be affected by a direct peril.
Has the overall risk/exposure changed from a pre- to a post-outsourcing operating
structure? One factor to consider when answering this question is the management
separation relative to outsourced suppliers. If the primary manufacturer is
dependant on the supply chain to assure timely delivery of their completed products
to customers, they will have to communicate expected quality control standards
for component parts, as well as production and warehouse environments, and closely
manage compliance.
Insurers' Solutions
Individual insurance companies may no longer be able to insure the entire
reconfigured manufacturer. With e-supply, the manufacturer's extended supply
chain and improved gross margins most likely have increased its business interruption
exposure. Most underwriting rating plans focus mainly on reported insurance
values based on tangible fixed assets. In many cases, business interruption
values are reported and reviewed for exposure growth, but are not always included
in the rating process. Currently, business interruption worksheets do not reflect
the net exposure resulting from outsourced suppliers. The worksheets simply
do not capture critical information necessary to understand the exposures and
how well they are being managed.
Questions such as the following need to be asked.
- Are outsourced operating standards clearly defined and communicated?
- How do outsourced standards compare to the primary manufacturer's standards
for its own core vertically integrated processes?
- Do the outsourced suppliers comply with the required standards based
on audit results?
- Is there an executive report card for outsourced suppliers, contract
manufacturers, or logistics partners that is available for review?
- At what point are supply chain partners replaced due to lack of performance?
- What are the contingency plan's sources for alternative sources of suppliers?
Remember that most corporations will have hundreds to thousands of partners
in their supply chain network that source thousands of products into global
distribution channels. Underwriters cannot hope to manage the process, but they
can understand the key risks and how well their clients are managing them.
Underwriters need to ask for supply chain exposure information to assess
how these exposures are being managed. Supply chain risk assessment may not
lend itself to a quantification process, but after reviewing 10 to 20 different
risks, one can determine on a relative basis the quality of risk management.
In building a database over time, there may be the ability to quantify and rate
the process. Risk managers need to stay on top of these exposures, and the better
ones have answers to the necessary questions.
Conclusion
Supply chain risks deserve at least as much attention as underwriters give
to earthquake accumulation risk. If a critical supplier goes down as a result
of an insured peril, there may be 10 to 15 primary name-brand manufacturers
who will sustain a measurable business interruption loss. Other suppliers could
also be running at full capacity, leaving few if any alternative supply sources
in the short-run. Given these circumstances, a business interruption loss can
be far greater in a fast-paced industry that has significantly reduced its owned
productive capacity in order to enhance financial performance.
Insurers need to understand these key exposures and be able to assure themselves
they are receiving a fair premium relative to the degree and quality of the
exposure. Insurers should consider hiring a management-consulting firm with
supply chain experience to assist in constructing a knowledge model surrounding
accumulation risk associated with supply chain interdependencies. It is far
better to plan ahead than to merely react to stakeholders' interests and/or
personal deliverables.
Opinions expressed in Expert Commentary articles are those of the author and are
not necessarily held by the author’s employer or IRMI. This article does not purport
to provide legal, accounting, or other professional advice or opinion. If such advice
is needed, consult with your attorney, accountant, or other qualified adviser.