A major aerospace and defense (A&D) company had a problem: with an average of two significant supplier failures per year and no proactive supplier risk management process, the firm faced costs of $10M or more a year, and had no systematic way to reduce risk in its supply base of 11,000 suppliers.

So what did it do?

The company redesigned its process, moving risk management responsibility out of the ivory tower of finance and distributing it among the real owners of the process?the buyer community for supplier selection and supply risk management, and program managers to rally the need for proactive risk management.

The business problem
Like most A&D companies, this firm operates under industry dynamics that can exacerbate supply risks. The business is characterized by a high volume of material-intensive engineer-to-order projects that are often at the leading edge of technology and materials science.

Because of the specialized nature of A&D products, the number of parts and suppliers in the supply base is extensive. At the same time, specialized material and expertise requirements often require that critical parts and assemblies be single-sourced from specialist suppliers. The associated risk of a supplier failure or inability to supply promised parts and materials can ripple through the business, affecting projects as small as a component subassembly or as large as a missile or aircraft system.

For purposes of building a business case for action, the managers quantified that the two significant supplier failures cost the company $5M or more, although the impact could be far greater. Here are two examples:

* In one case, the firm had become so reliant on a specific supplier, funneling $800M in orders to it, that when significant financial and manufacturing quality problems surfaced and business failure was imminent, it had no choice but to take over the company. It also had to relocate several critical resources onsite to run the operations.
* A foreign-owned substrate supplier literally ceased operations one day with no warning. Workers came to the factory in the morning and found the gates locked. This component was vital material for several solid-state devices, and was very disruptive on ongoing projects.

In 2005 alone, the A&D firm had submitted 5,300 project proposals (approximately 17 per day) and had been awarded 3,200 contracts (about 10 per day). The reliability and quality of supply is critical to profitably deliver on these commitments.

A call to action
To this point, the risk management approach had been a loose, ad-hoc process. But an energized CEO-level directive with the motto ?No Surprises? has galvanized the company to develop a proactive, rigorous, and predictive method for analyzing and remediating supply risk.

Before this project, existing supplier master data was not consistently updated with timely data, and risk managers looked at historical information of supplier health that was rarely updated by the buyer community within the company.

The firm took two steps to shore up its supply risk management process:

* Consolidated the supplier masters and proactively linked in Dun & Bradstreet (D&B) data on the supply base. This step required rigor, mapping several tiers into the supply base to make sure risk managers understood parent-child relationships and the risk relationships between first-tier suppliers and their parents and siblings.
* Purchased and implemented Open Ratings, an online system that uses machine-learning and pattern recognition technologies to assimilate and process financial and quality data to score suppliers based on predictive analytics on the risk of supplier failures. In effect, Open Ratings works as an early warning system to flag supplier risks before they become problems, based on pattern recognition of early warning indicators.

Using the two seems to make sense. In fact, Dun & Bradstreet just acquired Open Ratings (see the AMR Research Alert article ?Dun & Bradstreet Acquires Open Ratings: 1 + 1 = 3??).

The power of two
By combining two distinct sources of supplier data that complement each other, the A&D firm uses supplier estimated risk (SER) scores from D&B (primarily derived from financial data) and supplier stress indicator (SSI) scores generated by Open Ratings (derived from financial, quality and other predictive data) to create a composite score for every one of its suppliers.

Based on that composite score, suppliers are rated as the following:

* SAFE?Proceed with no restrictions.
* MONITOR?You can place the order, but you must monitor the supplier closely.
* ACT?You may only place an order if you have an established risk mitigation plan in place, and approved prior to your order.

The firm then uses a proprietary spreadsheet-based visual representation to map out the distribution of its supplier base across the three categories to visually highlight suppliers which require immediate action. At any given time, the firm could have up to 400 suppliers requiring action?some because of valid deterioration of their scores, and some due to data issues such as incorrect DUNS numbers as a result of an acquisition. The visual system helps the firm proactively monitor and manage the risk profile of the supply base.

Making everyone risk-aware
The firm made the strategic decision to distribute risk management responsibility across the buyer community rather than centralizing power within a specific risk group. The company recognized the trade-offs inherent in this approach, but by pushing responsibility to the buyers, the company can assure more active supplier management.

Thorough process controls are critical to the success of this approach. As a first step, all of the firm?s 14,000 suppliers were first accounted for in the system, and then assigned to a risk manager. The process of assigning a new supplier is automatic, with responsibility falling to the buyer placing the first order with that supplier.

Within the Open Ratings online system, the company has a dedicated section with scores, alerts, research, and quality ratings for all of its suppliers. Here?s how it works:

* When indicators or ratings change, the system generates an alert. In recent months, up to 10% of the supply base has generated alerts. When ACT alerts are generated, risk managers must investigate the supplier to determine if risk mitigation action is required, or determine if it was a false alarm but further monitoring is warranted.
* In addition to responding to alerts, buyer/risk managers are required to proactively research a specified number of suppliers per month and refresh the data by updating qualitative ratings on delivery performance, quality, and such.

Program success
The firm?s risk management process has been in place for approximately 11 months. While the program has not reached full compliance across the buyer community, the results thus far have been impressive. Fifteen new suppliers have been blocked for being high-risk, avoiding potential unanticipated cost and/or supply disruption. And 300 orders across 100 suppliers were stopped and redirected to new suppliers. As an ancillary benefit, intimacy and knowledge of the supply base is greatly enhanced and no new $5M supplier blowups have occurred.

By its own admission, the firm recognizes that risk management benefits can be difficult to measure. The leader of this program compares it to the value of insurance. Was your policy worth owning even if you did not have to use it? Yet despite this conundrum, the results from the proactive risk management program are impressive.

This firm?s experience provides many key lessons for successful supply chain risk management:

* Understand your supply base. Map out the parent/child relationships in your supply base and understand their risk profiles.
* Monitor the supply base for changes in risk profiles.
* Identify ownership for risk management and define processes when supplier risk increases.
* Consider technologies that allow for transparent and predictive monitoring of the supply base.

Source: AMR Research, Mark Hillman, John Hagerty

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