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International business management

The weakest link in a global supply chain

Phil Cotter  Managing Director, Thomson Reuters Risk business

Phil Cotter  Managing Director, Thomson Reuters Risk business

A multinational organization’s supply chain is only as strong as its weakest link.

Good global supply chain management should focus on sustainability, utilizing a risk-based approach to ensure resources are deployed in the most efficient manner.  It must be robust enough to expose weak links that may be hiding within complex webs of relationships and interrelationships.

Today’s multinational organizations tend to have multi tiered global supply chains including vendors, partners, subcontractors and sponsors, all linked together in complex webs of interrelationships traversing multiple jurisdictions. These complex networks can mask dangerous vulnerabilities: A problem in one area can quickly ripple up and down the chain, leading to severe reputational damage. One of the most effective methods of coping with complex, often hidden risks, especially for companies active in multiple jurisdictions, is to adopt the risk-based approach (RBA) outlined in the Financial Action Task Force’s (FATF) February 2012 “Recommendations for International Standards on Combating Money Laundering and the Financing of Terrorism & Proliferation.” These should be included in the organization’s Know Your Supplier (KYS) processes.

Areas of risk

Management of business relationships in the supply chain should be as important to organizations as managing their business relationships in the sales chain, a point underscored by both the US Foreign Corrupt Practices Act and the UK Bribery Act. Effective supply chain management should address two key areas of risk:

  1. Supply and price risk
    Physical supply disruption can have a major impact on the price of raw materials obtained globally. Poor weather across the grain belt of Argentina, a hurricane blowing into the Gulf of Mexico and damaging oil refineries, port congestion in Rotterdam, interruptions suffered by utilities producing finished goods – all have the potential to affect supply and, ultimately, impact price.
  2. Supplier and third-party risk
    Supply chains commonly consist of many diverse links, each vulnerable to different degrees and types of risk. Compliance professionals should be aware that their organizational risk is not limited to Tier 1 suppliers, but can reach far down the chain, even beyond Tier 3.

Both areas of supply chain risk can significantly impact the organization’s ability not only to act responsibly but also to operate profitably. Often, however, it is not the complexity of the supply chain but lack of attentive management, transparency and consistent monitoring of suppliers from the beginning of the supply chain through to the end consumer that leads to damage.

Webs of complexity

Every supply chain has a distinctive profile, with activity and geography as the principal variables. Certain activities and geographical regions are more likely to expose the organization to such risks as corruption, fraud and human trafficking. Misconduct even by a relatively minor supplier or internal operation can significantly impact the organization’s reputation. The need to operate an ethical business must be factored into the equation when assessing risks associated with the supply chain. Lapses that can expose the organization to ethical concerns, as a 2013 article by McKinsey & Company notes, can include incomplete supplier databases and lack of necessary, comprehensive intelligence about risk at the supplier. Protecting the organization begins with a review of KYS data to ensure it contains all the information needed to make an informed decision on the amount of risk a supplier may pose. Two areas that have become particularly sensitive to governments are:

  1. Conflict minerals
    Ensuring that your supply chain is free of the recognized conflict minerals – tin, tantalum, tungsten and gold – is difficult because these minerals are also available from legitimate sources that participate routinely in compliant supply chains. The 2010 Dodd-Frank Act requires public companies to determine whether they use conflict minerals obtained from the war-torn Democratic Republic of the Congo and neighboring countries; the rules are intended to expose atrocities associated with the mining of these minerals, in particular sexual and gender-based assaults.
  2. Modern-day slavery
    Far from being a thing of the past, slavery in the form of exploitative labor is alive and well in many parts of the world.  In the UK, the Modern Slavery Bill introduced in the House of Commons in June 2014 “would provide law enforcement with stronger tools to stamp out modern slavery, ensure slave drivers can receive suitably severe punishments and enhance protection of and support for victims.” Effective supply chain management must ensure that the organization is “slavery proof.” Ethical sourcing protects organizations from severe reputational damage if they are found to be dealing with suppliers that use exploitative labor. On the flip side, organizations that actively promote ethical procurement benefit from an enhanced reputation and effectively protect themselves from regulatory action.

Visibility and traceability

Achieving sufficient visibility into the organization’s Tier 1 suppliers is difficult enough; the task only becomes more arduous with Tiers 2, 3 and beyond. Yet supply chain disruptions in the past five years have shown how critical it is to have visibility at the sub-tier supplier level. Food manufacturers, for example, have cut corners to meet tight schedules or price margins, highlighting the difficulty of tracking materials from origin to finished product. This can result in quality deficiencies that have significant knock-on effects throughout the supply chain, including reputational damage to customers.

Creating sustainability

Addressing the dangers posed by a complex global supply chain begins with sustainability. Creating sustainability within the global supply chain goes hand in hand with a thorough KYS program. The best route to sustainability is through adoption of a holistic approach that delves more deeply into the supply chain. The reputational risks to supply chains that do not embrace sustainable principles are far too onerous to be ignored; moreover, incorporating socially responsible practices into the supply chain may be the quickest route to creating a profitable business with long-term viability.

Enforcement actions by country, 2005-2014 sees an exponential increase
Source: Gibson, Dunn & Crutcher LLP

Regulators

Consistently meeting regulatory requirements is a vital element of sustainability. Regulators are adopting a zero-tolerance policy toward organizations that don’t keep track of where their supply chains operate and with whom they do business. The chart above from Gibson, Dunn & Crutcher LLP details the countries that have encountered the most enforcement actions since 2005. Many countries that have become major suppliers to developed-world businesses in recent decades — China, Nigeria, Mexico, India — are conducting more frequent enforcement actions, making extra vigilance imperative.

Mitigating risks and keeping a step ahead

Ideally, companies should follow a continuous RBA process that begins with:

  • Assessing the current state of the supply chain
  • Pinpointing critical vulnerabilities
  • Creating a prioritized road map for improvement

An important part of this assessment is capturing all third-party data, frequently updating the systems that store it, and then constructing real-time, visual, value-chain networks. By mapping value flows, geographical locations of operations and transportation links, the organization can more easily identify its greatest potential value losses.

It is not enough to screen a supplier at the onboarding stage. Routine screening of an organization’s supplier databases is vital to ensure that its suppliers are not on any sanction or watch list. Moreover, an ethical background check or enhanced due diligence (EDD) should be conducted on the supplier to ascertain that it has not been involved in unlawful conduct. Although organizations most often carry out EDD checks on the supplier before commencing business, circumstances can change at any time; industry experts advise routine screening of existing suppliers as best practice. Risk-based factors weighted into the screening program will flag any concerns, allowing the organization to concentrate resources where they are needed most.

Conclusion

Customers, consumers and governments hold companies accountable not only for their own actions, but for the actions of suppliers, vendors and business partners.  Remember, your organization is only as strong as its weakest link. Being aware of the risks your organization faces – supply, supplier and price – and adopting a best-practice supply chain management process, building on an accountable, risk-based approach, will keep your organization out of trouble. It will also keep you on the right side of regulators whilst ensuring supply-chain sustainability and allowing you to move forward with confidence.

Sources
Managing when vendor and supplier risk becomes your own
Modern Slavery Act 2015


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