Risk mitigation strategies lie at the heart of corporate governance. What is the contribution to these mitigation strategies from the procurement and supply chain management function? It is rare to find robust methodologies in place that will, in a structured way, identify the potential risks that exists in contracts with third parties. A failure to manage the risks leaves the organisation vulnerable to reputational damage, disputes, threats to service performance and diminishing profit margins.
Contractual risk is one such key area. There are organisations who have not reviewed their contractual terms and conditions for many years. There are others who trade on the suppliers’ terms, or worse still, trade without formal written contracts in place.
Price management risk is another vulnerability. Risk can exist when the basis of contract prices are not understood because the supplier’s cost drivers were neither requested nor negotiated. Some contracts have automatic year-on-year escalation where the price is linked to an index, such as the Retail Price Index.
Intellectual capital risk exists because of a failure to invest in developing human capital and failing to require the procurement and supply chain team to engage in continuous professional development. This is particularly important with the increasing demand to deploy a long-term strategy of developing relationships with strategic suppliers, encouraging innovation and positive change that maintains the buying organisation at the cutting edge of performance. For instance the ability to negotiate long-term contracts that include novel initiatives and reward the supplier through an incentivised payment structure.
There are many business benefits to be derived from an increased focus on managing procurement and supply chain risk. These include a higher profit margin through recognising where risks can be reduced. Outcomes may include paying lower insurance costs; guaranteeing supply chain excellence and contract performance; managing intellectual property rights and dramatically enhancing the negotiation of contract terms and conditions. The reputational benefit from being able to demonstrate effective procurement and supply chain risk management will be a business differentiator when the organisation is tendering for new contracts or retaining existing contracts.
Unfortunately, complacency abounds with regard to ensuring robust due diligence is undertaken both pre- and post-contract award. A relevant example is the financial health of strategic suppliers. The ability to conduct appropriate due diligence at the pre-qualification stage is vital. There are suppliers who actively engage in misrepresentation to win contracts. The potential suppliers’ financial performance is often only subjected to a cursory check.
Supply chain risk management is a high-level skill. Procurement leaders need to understand how they are key to improving the profitability and reputation of their companies by successfully managing these risks.
☛ Stephen Ashcroft is a procurement coach at Brian Farrington. He will be speaking at The COG International Conference in York on 25 June.