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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Erik Hofmann

Supply Chain Risk Management for SMEs in Automotive SCs

Natural hedging

Theoretical case

Results

Conclusion