Risk Metrics: Supply Chain Cost of Risk

In an earlier post I mentioned that we are currently working with Professor Alex Triantis of the Robert H. Smith School of Business to develop a new set of risk metrics. One the metrics we have developed for use in our work is what we call “Supply Chain Cost of Risk” or SC CoR. SC CoR refers to the sum of all costs incurred by the supply chain as a result of risk. For most companies this would include items such as:

  • Safety stock
  • Secondary and tertiary supplier costs
  • Business Continuity insurance cost
  • Maritime and property insurance costs
  • Forecast error costs that result in write-downs
  • Excess and obsolescence material costs
  • Cost of risk management programs/activities
  • Etc.

In our work we are beginning to use this metric to gain an understanding of the typical risk cost ratios by industry. We are doing this to begin to quantify the risk profiles of the sectors in which we typically work. In other words, most people assume that an industry such as fashion is “riskier” than, say, consumer goods, but is that really the case? Intuition says so, but to date no one has actually quantified the risk ratio of these sectors vis-a-vis the operational side of the business. Of course, risk components in share price are calculated but there is often a disconnect, in my opinion between the operational risk of a typical global company and the cash flow risk factored into a share price. Consequently, by looking at the standard aggregate risk cost borne by supply chains in telecom, pharma, consumer electronics, etc. we hope to begin to confirm quantitatively what many SC risk specialists believe anecdotally.

The output of this work will not only be useful in an of itself, but it will also be an input to making the right risk mitigation investments. After all, without understanding the cost or risk, it is quite difficult to calculate the return on investment of risk mitigation in SCM. Indeed, this is a common complain among SC executives faced with making multi-million dollar SCRM investments. CoR is one step toward quantifying risk management in SCM. In future posts, I will continue to write about other metrics we are currently developing.

Carlos Alvarenga

Founder and CEO at KatalystNet and Adjunct Professor in the Logistics, Business and Public Policy Department at the University of Maryland’s Robert E. Smith School of Business.

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