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SUPPLY CHAIN MANAGEMENT

BBA-7
DEPARTMENT OF MANAGEMENT SCIENCES

GLOBAL OUTSOURCING AND THE RISKS ATTACHED TO IT

GLOBAL SUPPLY CHAIN


Global supply chain has been defined as: A production process that is distributed over many countries, with production in one country providing inputs to production in another, which in turn provides inputs to a third, and so on . A global supply chain refers to the network created among different worldwide companies producing, handling, and distributing specific goods and/or products.

With increased globalization and offshore sourcing, global supply chain management is becoming an important issue for many businesses. Like traditional, supply chain management, global supply chain management also faces a number of risks that pose serious threats to its performance. The big difference between the risks of the two is that global supply chain management involves a company's worldwide interests and suppliers rather than simply a local or national orientation.

GLOBAL SUPPLY CHAIN RISKS


The three main risks associated with global supply chain are: DEMAND RISK PRICE RISK EXCHANGE RATE RISK

DEMAND RISK
Demand risk is defined as the risk for a company that demand for a product will either exceed their expectations and ability to meet the demand OR fall short of their expectations or leave them with product they cannot sell. Demand risk is classified as external global supply chain risk caused by unpredictable or misunderstood customer or end-customer demand. Demand risk mainly arises due to: Increase in the prices of product or service as a result of increase in the prices of raw materials or other costs associated with the supply chain. Customers may shift to available competitors in the market offering slightly low rates thus reducing the demand of product/service. The income level of the targeted market may have shifted, thus changing their priorities and needs and thereby affecting their buying pattern.

The general trends in customers taste may also disturb the forecasted demand of supply chain. New competitors arriving in the market and introduction of substitute product/service can also lead global supply chain to face demand risk. The inaccuracy on part of supply chain in determining the appropriate quantity of goods and services to be produced may cause a shortfall or excess of inventory hence increasing the global supply chain cost.

EXAMPLE To satisfy certain country-specific requirements such as power supply and language driver, Hewlett-Packard (HP) has to develop multiple versions for each model of their DeskJet printers. Each version serves a particular geographical region (Asia-Pacific, Europe, or Americas). Due to uncertain demand in each region, HP faced the problem of overstocking certain printers in one region and under-stocking certain printers in other regions.

PRICE RISK
The risk arising due to uncertainty in the total global supply chain cost, which may be contributed by one or more of the components of supply chain or due to earnings volatility, unexpected financial performance, pricing changes, and bad management. Costs are incurred from the start of planning for each global supply chain throughout its execution and, therefore, are incurred along the entire end-to-end chain, from the suppliers supplier to the customers customer. A trade-off between global supply chain benefits and its price is to be determined so as to estimate the total cost of global supply chain. Although offshoring and other means of expanding global chain among different countries can reduce costs associated with labour, raw materials, IT proficiencies, technology and other similar costs but it also increases communication cost, transportation cost, capacity cost, facility cost, information cost, delays in receiving cashflows, operating cost, legalities cost and other hidden cost which are often overlooked by the company that opts for global supply chain. These small yet necessary costs keep piling up thus taking the total cost to a higher level and exposing the supply chain to price risk as they have been neglected in the past or due to other environmental factors. Consequently, the total global supply chain cost exceeds the estimated cost and company faces problems in managing the cost. The most important factor that gives air to this risk is the rise in fuel prices. It is the backbone of price risk as it affects all the components of global supply chain starting from rise in the prices of raw materials to transportation cost. And transportation cost is associated with each level of global supply chain. The cost of global supply chain then demands an increase in the price of

commodity that the company deals in thus forcing the cost on customer. Customers especially those who are price sensitive look for substitute or competitors product and this causes a decrease in sales volume.

EXHANGE RATE RISK


A form of risk that arises from the change in price of one currency against another. The risk that an investor will have to close out a long or short position in a foreign currency at a loss due to an adverse movement in exchange rates. Global supply chain of manufacturing companies aims at outsourcing labor to lower-wage countries generally reducing production costs it has been growing rapidly in the past decade. Or a manufacturing or merchandising company may outsource or establish their own supply chain component to some other country to reduce cost or to expand their target market. Although it can significant cost reduction opportunities it also exposes supply chain firms to various risks including: foreign exchange risk, production disruption risk, quality risk, supplier default risk, etc. Among these risks, foreign exchange risk is consistently considered to be on the list of top concerns of global supply chain executives. In todays volatile market, the exchange rate of different currencies constantly fluctuate due to the overall economic setback. This poses serious challenges to global supply chain as it spreads across different countries and thus exchange rate fluctuations has a strong impact on their cashflows. EXAMPLE In recent years, China has become BMWs fastest-growing market, accounting for 14 per cent of BMWs global sales volume in 2011. India, Russia and Eastern Europe have also become key markets. Despite rising sales revenues, BMW was conscious that its profits were often severely eroded by changes in exchange rates. The companys own calculations in its annual reports suggest that the negative effect of exchange rates totaled 2.4bn between 2005 and 2009. BMW did not want to pass on its exchange rate costs to consumers through price increases. Its rival Porsche had done this at the end of the 1980s in the US and sales had plunged.

BMW took a two-pronged approach to managing its foreign exchange exposure. One strategy was to use a natural hedge meaning it would develop ways to spend money in the same currency as where sales were taking place, meaning revenues would also be in the local currency.

However, not all exposure could be offset in this way, so BMW decided it would also use formal financial hedges. To achieve this, BMW set up regional treasury centers in the US, the UK and Singapore.

EFFECT OF THESE RISKS ON SUPPLY GLOBAL CHAIN


All the three risks discussed above mainly increase supply cost, decrease supply capability, create discrepancy between forecast and actual demand, etc. Secondly, when all the factors including transportation cost, handling, inventory, lost sales and market blocking are factored in, the total cost may not be as attractive as the headline advantage for opting global supply chain. As global supply chain involves extended and complex supply chain network, it cannot be responsive to demand as local supply chain thereby leading to opportunity cost to be afforded by the company due to loss of sales. Demand Forecasts are typically a key input to global supply chain operations processes. Unless the total time it takes to source, make and deliver product is less than the time customer is willing to wait for delivery, an accurate forecast is needed. Demand risk results in insufficient production levels, resulting in a shortage. While this may seem less damaging than an inventory surplus, it still represents a lost opportunity for the global supply chain. When demand risk frequency increases global supply chain fails to enjoy more efficient production, improve asset utilization, and reduce or eliminate disruptions. Global supply chain operating costs are under pressure today from rising freight prices, more global customers, technology upgrades, rising labor rates, expanding healthcare costs, new regulatory demands and rising commodity prices. Rising fuel prices have affected most supply chains through fuel surcharges or increased component and operating costs. Ultimately total global supply chain cost increases. Exchange rate risk negatively effects the revenue of the global supply chain.

RISK MITIGATION STRATEGIES


In order to reduce the impact of risks on global supply chain, one of the following or a mixture of these strategies can be adopted. FLEXIBLE SUPPLY STRATEGY Global supply chain can make use of multiple suppliers to reduce cost risks. Specifically, when firms have the flexibility to order from the supplier with the lowest cost. The firm has more supply flexibility as the number of suppliers increases HP faced demand risk in their global supply chain as they were not allowed to change their order quantity once submitted Canon for the raw material of HP laser printer. To reduce the

demand risk arising due to inflexibility on part of ordering, Canon agreed to allow HP to adjust their order quantity upward or downward by no more than a few percent. In this case, the upward/downward adjustment limits capture the flexibility level of this supply contract. MULTIPLE SUPPLIERS OR DITRIBUTORS

Having multiple sources of supply for a raw material reduces the impact of one source failing to deliver materials. Specifically when demand rate risk is involved, firms can protect their global supply chains by associating with more than one supplier. FLEXIBLE CAPACITY

A global supply chain that has flexible capacity can reduce price, demand and exchange rate risk as multiple products are now being stored at the same place which makes coordination and communication much easier. Price reduces as one capacity provides room for many products thereby reducing the price associated with each products capacity. The nature of installed capacity and its ability to respond to demand and price risk can be improved by using flexible manufacturing strategies include short yet fixed cycling horizons. INVENTORY TIME CYCLES

The positioning of inventory in the global supply chain to buffer against demand risk, price and exchange rate risk is very critical. With extended lead times associated with long distance supply chain, more inventory piles up in the chain. Therefore TQM and JIT concepts can play an important role in preventing such risks. GENERIC MATERIAL INVENTORY

Using this strategy, firms intend to add only those products or unfinished items that can be converted to a number of products or disposed at a fair price thereby provide shielding effect against price, demand and exchange rate risks. POSTPONEMENT

Global supply chain should be so designed that the major assembling or manufacturing plant is established in one of the main hubs of target markets. This helps better forecast the demand and also saves the firm from adverse affects of exchange rate risk.