Global supply chains used to be the concern of a select group of operational risk managers overseeing complex manufacturing systems. But today the responsibility for this multi-layered risk is much more widespread.
Indeed, disruptions caused by the COVID-19 pandemic moved supply-chain risk into the spotlight for a wide array of businesses, governments and households who previously gave little thought to availability of the commodities or finished goods they needed.
Cristian deRitis
While the pandemic disruptions to the global supply chain have subsided, new threats have arisen to take their place. Trade tensions between countries and the threat of a full-scale global tariff war highlight vulnerabilities in the system. Businesses ranging from manufacturers to retailers must now take seriously the threat that they may be cut off from critical inputs with little warning.
From natural disasters to geopolitical tensions, the potential for unforeseen events to cripple businesses has grown significantly. In addition to the threat of interruptions due to trade and deglobalization, risk managers need to consider other potential sources of disruption, as illustrated by the recent strikes at Boeing and at major U.S. seaports.
As we enter an era of seemingly permanent supply-chain threats, let’s consider the steps that risk professionals can take to measure and mitigate potential risks.
Recent Supply-Chain Threats
Threats to the supply chain can come from numerous sources. The Moody’s Analytics Supply-Chain Stress Index soared in 2021 due to the lockdown measures taken during the COVID-19 pandemic. The Russian invasion of Ukraine put additional stress on the system given dependencies on Russian commodities – including natural gas, helium and neon used in the production of semiconductor chips.
Figure 1: Supply-Chain Stress (2019 – 2024)
Sources: Multiple sources, BLS, Moody's Analytics
While the stress index has retreated from its pandemic highs, it remains notably higher than it was in 2019. Other bottlenecks, including droughts and hurricanes, have reshaped the pattern of agricultural imports and exports in both developed markets and the global South. Regional conflicts have disrupted trade routes, while tariff policies have put additional pressure on established supply chains.
The recent labor strike by workers at Boeing highlights the exposure of businesses to events outside of trade and climate. The strike may cause significant delays in aircraft production, which, in turn, impacts airlines, suppliers and the broader economy.
Moreover, U.S. manufacturers and retailers continue to be rightly concerned about the potential impact of labor strife – including dockworker strikes at seaports on the U.S. East and Gulf coasts that began this week. As the peak holiday shipping season approaches, disruptions to port operations could lead to shortages, higher prices and delays in the delivery of goods.
Strategies for Mitigating Supply-Chain Risk
Risk managers play a critical role in identifying, assessing and mitigating supply-chain risks. Here are three steps that risk managers can take to protect their organizations:
- Conduct a thorough risk assessment or inventory of supply-chain dependencies. This is the most important step a risk manager can take to reduce supply-chain risk. Risk teams can use comprehensive assessments to identify potential threats to the supply chain, including natural disasters, geopolitical events, supplier failures and disruptions to transportation.
After potential threats are identified, risk teams should assess both the likelihood and severity of each risk. By evaluating the probability of each risk occurring and the potential consequences if it does, managers can create risk matrices to prioritize risks and to determine which ones require the most attention. - Develop contingency plans for each identified risk and outline specific actions to be taken in the event of a disruption. Once plans are drawn up, risk teams will want to consider testing their plans regularly to ensure their effectiveness and to identify areas for improvement. Communication is essential to ensure that all relevant stakeholders are aware of the contingency plans and understand their roles in implementing them.
- Look for ways to diversify supply chains. This may involve reducing the dependence on single suppliers (or regions) and fostering stronger relationships with alternative suppliers to facilitate a pivot in procurement, if needed. Enhancing supplier management is an important part of this process. Regular assessment of suppliers’ capabilities and financial stability can ensure they can meet the organization's needs. In addition to drawing up contingency plans, firms can also require key suppliers to share their own contingency plans for potential disruptions.
Quantitative Approaches to Supply-Chain Risk Management
Aside from focusing on processes and contingency planning, risk managers should also find ways to enhance their quantitative processes around supply-chain risk.
First and foremost is the need to have direct line of sight into potential supply-chain disruptions. Real-time data on delays and timely delivery of shipments is mission critical, but may need to be supplemented with other metrics, such as country-risk indicators that can account for government (in)stability and environmental projections that assess the risk of storms, hurricanes and floods. As demonstrated by the recent drought that reduced traffic through the Panama Canal, the supply-chain impact of weather events is not solely restricted to agricultural commodities.
State of the art quantitative analysis, moreover, can facilitate the purchase of insurance coverage to protect against financial losses due to supply-chain disruptions. This will help companies evaluate the need for different types of insurance, such as property and casualty, business interruption insurance, and cargo insurance.
Finally, risk teams should consider incorporating supply-chain risk assessments into their risk models for forecasting revenues and losses. Quantitative techniques, such as Monte Carlo simulations, can be used to model the probability distribution and assess the impact of supply-chain disruptions to help managers make informed decisions.
Given that we’re living in an era of exponential risk, risk teams need to scrutinize interdependencies between different components of the supply chain to accurately assess the total risk exposure to a business or portfolio. Supply-chain threats are often symptomatic of other risks, ranging from geopolitical to climate to domestic policy.
Parting Thoughts
By incorporating supply-chain risks into their models, risk managers can gain a deeper understanding of the potential consequences of disruptions. This can help organizations develop more effective mitigation strategies that minimize the impact of supply-chain disruptions on their operations and bottom line.
As with all threats, the single most important step an organization can take to address supply-chain risks is to foster a culture of resilience. By promoting awareness of supply-chain risks – and by providing training on risk management, contingency planning and problem-solving skills to employees – risk teams can ensure that their organizations are equipped to mitigate anticipated threats and quickly respond to new and emerging risks.
Cristian deRitis is Managing Director and Deputy Chief Economist at Moody's Analytics. As the head of econometric model research and development, he specializes in the analysis of current and future economic conditions, scenario design, consumer credit markets and housing. In addition to his published research, Cristian is a co-host on the popular Inside Economics Podcast. He can be reached at cristian.deritis@moodys.com.
Topics: Third Party Risk, Resilience
