small companies

Supply Chain Risk Management for SMEs in Automotive SCs

Daniel Dumke — Mon, 30 Apr 2012 14:02:46 +0000

When it comes to supply chain management some positions within the network have better chances of fighting supply chain risks, due to structural and negotiating-power-related issues.

In this case the focus is on a supplier of a automotive OEM. Natural hedging, as defined below, is the core strategy analyzed in this study.

Natural hedging

The author utilizes a literature review to found his conceptual approach.

He defines natural hedging as “an instrument of real economical risk management, where transactions are hedged through real economic counter deals.”

The term “natural” is seen as a contrast to immaterial hedging using financial derivatives.

This strategy can be employed to mitigate price risk of commodities.

Theoretical case

The author develops the following theoretical case study with three echelons: tier 2 supplier, tier 1 supplier (focal company) and the OEM.

Tier 2 supplier is located within a different currency area.

In the short run there are no substitute products available for the OEM and vice-versa there is no other demand for the tier 1 supplier than the OEM.

For the tier 1 supplier the following risks can be observed:

Owing to relatively small purchase quantities, a potential risk of unavailability exists for the SME-supplier. This could probably be expected if the Tier 2-commodity supplier has capacity constraints and thus prefers to supply larger customers.

Because of volatile commodity prices on the world market, the SME-supplier faces a price risk for the required raw materials. An adequate hedge of single components with “classical” financial derivatives is difficult, due to limited management capacities and lack of know-how. In addition, respective fees for listed hedges hamper an economic execution of futures or options contracts.

Continuous fluctuations on the derivative markets, as well as exclusive activities in currency area B on the purchasing side, and on the sales side in currency area A, lead to a currency risk for the SME-supplier. Cost-intensive development of currency management or billable usage of hedging instruments prevents an economic reduction of currency risks.

The OEM on the other hand also faces risks:

The SME-supplier’s accumulated risks could lead to non-availability of input goods for the OEM, due to supply bottlenecks or even insolvency. This would trigger unemployment, damage the company’s image or force the award of supplementary grants, in order to finance damage limitation activities.

Like the supplier, the OEM is exposed to many commodity price and currency risks. It does, however, possess larger resources to deal with single risk sources within the scope of supply chain risk management.

The flow of goods and money in the initial situation is displayed in figure 1.

Figure 1: Case Study Supply Chain (Hofmann, 2011)

Figure 2 shows the implementation of a financial hedge. If the OEM also has end-customers in the currency area B, it would be possible to have the OEM directly pay the tier 2 supplier in currency B using the money obtained by the customers.

Figure 2: Natural Hedge using an purely Financial Angle (Hofmann, 2011)

In figure 3 a natural hedge is conducted which focusses on a re-design of the supply chain structure:

Figure 3: Natural Hedge using a Physical Angle (Hofmann, 2011)

The OEM shall (for now) not be active in the currency area B. Nonetheless, it takes over currency risk and pays the Tier 2-commodity supplier directly in the respective currency. The flow of materials is also “reorganized and not carried out through the Tier 1-supplier, but initially through the OEM. This alternative, which corresponds to a “vertical purchasing cooperation” or a centralized purchasing approach on the network level […]. Due to the modified flows of materials, it is called “physical component of natural hedging in supply chains” or for short: “physical hedge”. In this version, the OEM carries the sole supply risk for purchased commodities.

Overall, the risk management costs in a supply chain section can be reduced through die natural hedging approach on the network level, since the costs to hedge single risks arc higher for one actor than the costs for harmonized hedging of bundled risks.

Results

Beside this theoretical foundation the author calculates an example with figures for the steel-price-fluctuations in 2008.

The following advantages can be summarized (figure 4):

Figure 4: Advantages of Natural Hedging for the Stakeholders (Hofmann, 2011)

The author prescribes the following process to implement the natural hedging.

Preparation of managerial prerequisites, as well as examination of contractual and legal framework.

Business model decision and concept evaluation.

Ramp-up and organizational integration.

Performance measurement of results.

The following issues should be considered:

Framework contract model. The OEM signs the contract with the pre-material Tier 2-suppliers. Part of the framework contract is usually a quantity purchasing structure, serving as a target figure for a certain amount of time.

Coaching model. The OEM takes on the role of the “purchasing advisor”, supplying his SME-suppliers with information about purchasing sources and prices of the needed raw and prc-material, as well as financing alternatives.

Trade model. Within this resale or buy-sell approach, the OEM is the broker for prc-material. Thereby, he typically waits to purchase from the commodity Tier 2-supplier until an order from the Tier 1-supplier-basis comes in (order pass-dirough).

Procurement service provider model. The use of a procurement service provider constitutes the intersection point between the supplier and his assortment and the OEM. The OEM signs a framework contract with the service provider about die purchase of materials or product groups. This could also include financial aspects (e.g. prc-financing conditions or payment terms for the Tier 1-suppliers).

Marketplace model. Within such an “infomediary” model, the OEM initiates a platform (often a web-based E- marketplacc), through which suppliers can mutually access pre-material suppliers or pre-material offers. This model could also include payment processing in the

supply chain.

Conclusion

Not only natural disasters pose risks to supply chains. Also ordinary price changes can pose a threat to the profitability of a company.

But those risks have been on the risk management agenda for quite some time now. Still, supply chain risk management enables companies to handle some risks differently and natural hedging as described here may be one option.

Even though the empirical support for this strategy presented in this paper is quite weak, it should give food for thought and using some concrete figures should help with the decision if and how such a strategy might help your company, be it OEM or supplier.

Reference:

Hofmann, E. (2011). Natural hedging as a risk prophylaxis and supplier financing instrument in automotive supply chains Supply Chain Management: An International Journal, 16 (2), 128-141 DOI: 10.1108/13598541111115374

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small companies

Strategies

hedging

Supply Risk Management from a Small Company's Perspective

Daniel Dumke — Mon, 14 Nov 2011 15:53:00 +0000

This study takes a closer look at supply risk management, but this time from the perspective of several small companies. This article tries to answer the questions what risks small company owners (SCOs) see and how SCOs mitigate those risks.

Method

A case study with eleven small companies was conducted. The companies had between 1 and 12 employees. Overall 26 interviews were conducted (90 minutes on average). In addition, two seminars were held, to present the preliminary results and discuss the findings. The seminars were also used to generate additional data and validate existing results.

Informants rarely used terms such as supply risk, risk management, probability reduction, supply chain or even purchasing. [… So] Instead of forcing risk management terminology upon informants, possibly provoking misunderstandings and incomplete accounts, the idea was to let the SCOs provide rich accounts of their purchasing and SCM practices in layman’s terms. In the dialogue information was sought out that allowed plausible interpretations of supply risk management practices.

Figure 1 summarizes some facts about the companies.

Figure 1: Facts on the Case Study Companies (Ellegaard, 2008; click to enlarge)

Risk mitigation approaches

From literature the author develops three types of supply risk management / mitigation activities, namely: increased knowledge, reduced probability and reduced impact (figure 2).

Figure 2: Risk Management Alternatives (Ellegaard, 2008)

Knowledge

Knowledge increasing practices were infrequent among the studied SCOs. They spend limited time and resources actively acquiring knowledge about suppliers and supply markets and therefore possessed limited information […]. Only one SCO interacted with suppliers often.

Probability reduction

Probability reduction had the highest priority in these companies. Elimination of severe risks formed the backbone of SCO practices. […] In order to eliminate certain severe risks, the SCOs sourced locally, exhibited source loyalty, and were careful not to reveal proprietary product knowledge to suppliers.

Effect reduction

None of the SCOs held reserve capacity and practiced mainly single sourcing, with the aim of tying up as few resources as possible. The very limited reserves left the SCOs quite vulnerable to certain types of risks. Any specific events with the potential to obstruct delivery capabilities of suppliers, such as a fire, take-over, bankruptcy, up-stream material shortages etc. could bring SCO production to a halt.

All results are summarized in figure 3.

Figure 3: Supply Risk Mitigation Approaches (Ellegaard, 2008; click to enlarge)

Lessons learned

Despite the autodidact and informal purchasing practices of

the studied SCOs, there may be much to learn from these practices, even for state-of-the-art purchasing/SCM departments. The SCOs specialised in a few supply risk management practices that seemed to complement each other well. The study suggests that effective supply risk management is not only about adopting a wide range of sophisticated risk reduction practices. The challenge may be more connected to finding the right mix of practices, which fits the available resources and is sufficient to secure against supply risks. Supply chain managers should realise that:

different supply risk management practices require different levels of expertise and resources;

only a limited number of potential supply risk management practices may be necessary; and

supply risk management means adopting the exact mix of practices that provides security.

Conclusion

This study provides some missing insights into risk management practices of small enterprises. As the author, I do think that there are still things even larger companies can learn from their mitigation strategies: Prioritization and focus of risk management activities which deem to be most effective with the given resources may be one of those.

Reference:

Ellegaard, C. (2008). Supply risk management in a small company perspective Supply Chain Management: An International Journal, 13 (6), 425-434 DOI: 10.1108/13598540810905688

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