Broken chains in dire need of repair

The supply chains of some of the world’s biggest groups  have been hit in recent years by events as varied as factory  fires in Bangladesh, tsunamis, horsemeat  contamination in food products, strikes, droughts, floods and volcanic ash  clouds.

The effects on businesses around the world – and therefore on the returns of  their investors – have been profound, yet, “until a few years ago, most people  in the financial community did not even know what a supply chain was,” says the  CEO of a US-based investment house that runs a portfolio of companies it has  identified as having superior supply chain management, who did not want to be  named.

The range of these effects is so big – and hits so many different sectors of  the economy – because “we live in the most complex, interdependent era in  history and business is becoming ever more global and immediate,” says Stefano  Tranquillo, vice-president for northern Europe at FM Global, a supply chain risk  management group.

A laptop, for example, “can have components sourced from 39 different  countries and be put together in a 40th,” says Jennifer Bisceglie, president of  Interos, a supply chain consultancy that has just launched a Global Threat  Information Center (GTIC) to help companies identify their supply chain risks  better. “There are two types of organisation – those that have been hit by  supply chain disruption and those that do not know they have been hit,” she  adds.

“The last decade has seen the expansion of supply chains  to a global level, and more recently an increase in the global scrutiny of these  supply chains due to growing global digital connectivity,” says Richard  Stathers, head of responsible investment at Schroders. “In addition the impact that economic  growth and an increasing population are having on ecological systems means that  environmental factors are playing an increasingly prominent role in supply chain  management.” About two-thirds of the cost structure of many groups is located in  their supply chains, according to risk management association Airmic, and  economic losses from supply chain disruptions are estimated to have increased  465 per cent between 2009 and 2011.

Despite this, some companies have a limited knowledge of their supply chains,  says Adrian Chamberlain, CEO of supply chain management group Achilles. “It’s  not unusual for a very large multinational to overestimate the number of  suppliers they have by 30-40 per cent.” Many companies have only recently woken  up to the risks within their supply chains, Mr Stathers adds. “The complexity of  supply chains means that most supply chain management programmes are only just  dealing with tier 1 suppliers and the ability to look through and manage  relationships further down the supply chain is only just being explored.”

In addition, in the face of recession, pressure on margins and demand for  cheaper products from consumers, “many companies have not treated their  suppliers well,” Mr Chamberlain adds.

The US automotive industry is a perfect example of this, says the anonymous  investor. “Companies were saving money by squeezing their suppliers on costs.  They became more and more dependent on those suppliers, which were becoming less  and less capable, often as a result of what the automotive company was doing to  them.”

His firm has for several years been running a portfolio based on companies  with superior supply chain management “and that has outperformed nicely”, he  says. At first, he tried to persuade companies with poor practices to improve,  but “getting a big enterprise to change its ways was very difficult, so now I  just want to know if the company is doing a good job or not,” he adds. “If value  is destroyed by bad supply chain management, then it can be added by good  practice.”

There is evidence of this in the food sector. After the  horsemeat scandal that struck retailers all over Europe earlier this year, Tesco CEO Philip Clarke was forced to apologise  to customers and vowed to “create a supply chain that customers can understand  and have confidence in”.

Meanwhile, fast-food chain McDonald’s was able to say “at no time has there  been any suggestion of horsemeat in our burgers”, adding “all of our beef is  traceable, from the British and Irish farmers we buy from to our  restaurants”.

Agribusiness supply chains have seen “an incredible transformation in the  last 10 years,” says Justin Sherrard, global strategist at Rabobank, as the  sector has moved from an era of surplus to one of scarcity.

The increase in demand for meat and dairy as a result of emerging market  growth has led to the industrialisation of supply chains. Many people believe  that the inevitable result is a scandal like the horsemeat affair. “You can see  it as a simple case of supplier dishonesty of the type that will always happen,”  says Mr Sherrard. “Or you can see it as an example of how supply chains can  really fundamentally break down when you have such an acute focus on price and  so little apparent interest in other issues.”

Relationships need to change so there is much closer co-operation along the  supply chain, Mr Sherrard adds. “In the past, supply chains were organised step  by step so the downstream end had very little information about what was  happening upstream and vice versa. There has to be a flow of information from  one end of the supply chain to the other.”

Many companies are seeking to map their supply chains and benchmark their  risks in order to have greater transparency – and events such as the tsunami in  Japan and floods in Thailand have focused attention on the need for greater  diversity in supply chains.

There are key points to consider in making supply chains  more robust, says Bruce Proctor, head of Global Trade & Supply Chain Finance  at Bank of America Merrill Lynch. “You need  flexibility – do you have the ability to react to unexpected events? There must  be a periodic re-examination of supply chain links because things change all the  time. And you need to look at how management of these risks is embedded in the  company. It needs to be an important part of senior management  responsibilities.”

Investors can help to ensure that this is so. “There is no downside to  investors putting pressure on investors to improve in this area,” says Ms  Biscegle, while Andrew Underwood, head of supply chain at KPMG, says that if  investors were not interested or aware of the risks in the physical supply  chains of their investments in the past they are now.