SCMG301 Week 7 DQ

5/23, 2:22 PM W7: Managing supply risk from the suppliers’ side. – SCMG301 B001 Spring 2023

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Week 7 Discussion: Managing supply risk from the suppliers’ side.

CO6: Identify emerging supply chain risk metrics.

Discussion Prompt:

1. Do organizations know how to evaluate their suppliers? Do they use the
right data? Is there a consistent approach by different departments within
an organization? The case study on pp. 248-249 shows that evaluating
suppliers is itself a risk. Table 13.1 shows characteristics of an effective
supply measurement system. Choose up to three of these characteristics
that you would prioritize as the most important and provide reasons why.
Use of real life examples is helpful, if you can obtain them.

2. The total cost of a project may not always be simple to measure or
evaluate as we have direct and indirect costs, as well as hidden costs and
opportunity costs. Please explain the value of the total landed cost model,
including your comments on Figure 13.1 on p. 256

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5/15/23, 2:22 PM W7: Managing supply risk from the suppliers’ side. – SCMG301 B001 Spring 2023

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W7: Managing supply risk from the suppliers’ side
Jennipher Armstead posted May 15, 2023 2:44 PM

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Good afternoon Class,

This week we were asked whether organizations know how to evaluate their suppliers, if

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245

13
Risk Measurement

Imagine

a.measurement.system.that,.when.working.effectively,.offers.the.
opportunity.to.reduce.supply.chain.risk..Next,. imagine.the.possible.out-
comes.when.such.a.system.fails.to.work.as.intended..A.number.of.years.ago.
a.consumer.products.company.with.$100.million.in.annual.sales.developed.a.
scorecard.system.to.measure.supplier.performance..Besides.creating.a.sys-
tem.that.was.not.validated.and.was.less.than.professional.in.appearance,.
many.larger.suppliers.challenged.their.scores,.particularly.when.the.scores.
were.lower.than.what.they.received.from.their.more.sophisticated.custom-
ers.. The. measurement. system. was. such. a. nonstarter. that. it. deterred. the.
company.from.moving.forward.with.its.supplier.measurement.objectives..
It.also.affected,.and.not.in.a.good.way,.the.company’s.relationships.with.its.
suppliers..Not.much.in.the.way.of.risk.reduction.occurred.here.

Welcome. to. the. world. of. measurement,. a. topic. that. can. enhance. or.
impede.a.company’s.risk.management.efforts..This.chapter.examines.risk.
measurement. from. a. variety. of. perspectives.. We. first. discuss. measure-
ment.validity.and.reliability,.something.that.is.critical.as.companies.create.
new.ways. to.evaluate.risk..This. is. followed.by.a.presentation.of.best-.in-.
class.supplier.performance.measurement.systems,.quantified.risk.indexes,.
and.a.system.for.measuring.risk.at.the.country.level..Next,.we.present.the.
increasingly.talked.about.subject.of.total.cost.measurement..The.chapter.
concludes.with.a.set.of.emerging.risk.metrics.

RiSk MeaSuReMent Validity and ReliaBility

As. supply. chain. risk. management. (SCRM). evolves. as. a. discipline,. it.
almost.goes.without.saying.that.measurement.will.play.an.integral.part..

Schlegel, Gregory L., and Robert J. Trent. Supply Chain Risk Management : An Emerging Discipline, Taylor & Francis Group, 2014.
ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/apus/detail.action?docID=1680353.
Created from apus on 2023-05-16 00:24:29.

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246 • Supply Chain Risk Management: An Emerging Discipline

Recall.that.measurement.is.one.of.the.key.risk.enablers.we.introduced.in.
Chapter 3..As.we.work.with.companies,.we.are. seeing.all.kinds.of.new.
measures,.measurement.models,.and.risk.indexes.emerging.that.are.part.
of.the.risk.management.process..A.basic.concept.whenever.measurement.
plays.a.central.role.is.to.ask.a.simple.question:.Is.the.measure.or.model.
valid.and.reliable?

Valid.means.that.an.indicator.or.model.measures.what.it.is.supposed.to.
measure..If.we.had.to.replace.the.word.valid.with.another.word,.that.word.
would.be.accurate.. If. a. social. scientist.develops.a. scale. to.measure. indi-
vidual.happiness,.for.example,.does.that.scale.actually.measure.happiness?.
In.the.risk.arena,. if.a.measure.is.supposed.to.measure.the.probability.of.
a.supplier.failing.financially,.does.the.measure.actually.measure.financial.
distress?.Or,.an.index.might.translate.risk.scores.into.a.system.that.assigns.
red,.yellow,.or.green.risk.indicators..Is.the.cutoff.value.defining.red.versus.
yellow.actually.where.the.cutoff.should.be?.If.a.supplier.measure.indicates.a.
supplier.is.high.risk,.is.it.really.a.higher.risk.compared.with.other.suppliers?

We. do. not. want. to. give. the. impression. that. validating. a. measure. or.
model.is.easy.to.do..Our.concern.is.that.far.too.often.risk.measures.and.
indicators.are.developed.but.not.sufficiently.tested,.usually.because.valida-
tion.can.be.a.time-.consuming.process..In.the.social.sciences,.and.many.
observers. consider. business. to. be. a. social. science,. researchers. have. to.
address. many. kinds. of. measurement. validity. or. risk. having. their. work.
rejected. by. external. reviewers.. Different. kinds. of. validity. can. include.
construct,. convergent,. face,. internal,. predictive,. statistical. conclusion,.
content,.criterion,.and.concurrent.validity..Validity.has.many.dimensions,.
enough.to.give.a.person.a.serious.headache.

A.second.important.dimension.of.a.risk.measure.is.reliability..Reliability.
is.the.extent.to.which.a.measure.provides.results.that.are.consistent.from.
use.to.use..A.watch.could.measure.time.(it.has.validity),.but.it.could.be.
inaccurate.as.its.battery.wears.down..Or,.the.same.piece.of.equipment.used.
to.measure.blood.pressure.is.not.reliable.if.it.gives.different.readings.when.
no.real.change.in.a.person’s.blood.pressure.occurred..Something.that.is.
reliable.means.that.we.have.confidence.in.its.use.time.and.time.again.

Possible.problems.with.risk.measures.and.indexes.are.similar.to.Type.I.
and.Type.II.measurement.errors.in.quality.management..A.risk.measure.
or.index.may.be.so.sensitive.that.it.raises.a.red.flag.when.no.unusual.prob-
lem. or. risk. exists. (i.e.,. a. false. positive,. or. Type. I. error).. After. receiving.
enough.false.warnings,.trust.in.the.system.erodes.as.users.become.desen-
sitized.to.what.the.measure.conveys..Another.possible.outcome.is.similar.

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Risk Measurement • 247

to.Type.II.quality.errors—the.measure.says.there.is.no.problem.when.in.
fact.there.is.a.risk.event.pending.or.likely..Unfortunately,.when.this.is.the.
case.we.are.lulled.into.a.false.sense.of.security.when.the.system.should.be.
picking.up.various.signals..Perhaps.the.model.supporting.the.risk.mea-
sure.is.not.sensitive.enough..Or,.perhaps.the.right.factors.are.not.part.of.
the.model,.causing.the.model.to.miss.some.important.clues.

If.measurement.validity.is.so.important,.how.do.companies.ensure.their.
risk.measures.are.valid?.Perhaps.the.best.way.to.validate.a.risk.measure.
or.measurement.approach.is.through.simulation.testing.using.historical.
data,.similar.to.what.occurs.when.validating.forecasting.models..After.all,.
any.measure.that.is.forward.looking,.and.most.risk.measures.should.be.
forward.looking,.is.essentially.a.forecasting.tool.

Validity and Bridge Safety Measures

Here.is.an.example.of.model.validity.that.fell.out.of.nowhere..When.an.
oversize.truck.traveling.in.Washington.State.hit.a.bridge.girder,.causing.
an. entire. section. of. Interstate. 5. to. fall. into. the. Skagit. River,. it. was. not.
long.before.the.system.that.calculates.sufficiency.ratings.for.bridges.came.
under.scrutiny.1.And.the.verdict.of.this.scrutiny.was.that.the.sufficiency.
rating.system.to.assess.bridge.safety.has.some.serious.shortcomings.

Part.of. the.problem.is. the.complexity.of. the.sufficiency.rating.

system.

developed.in.the.1970s..About.20.factors,.almost.half.of.which.have.noth-
ing.to.do.with.a.bridge’s.actual.condition,.are.put. into.a.magic.formula.
that.generates.a.single.sufficiency.bridge.rating..Mathematically,.it.is.pos-
sible.that.a.bridge.that.is.more.vulnerable.to.collapse.has.a.higher.suffi-
ciency.rating.than.a.bridge.that.is.less.vulnerable..A.sufficiency.rating.less.
than.80. is.necessary. to.qualify. for. federal. funding. for.bridge.modifica-
tions,.while.a.rating.under.50.qualifies.a.bridge.for.replacement..In.other.
words,.serious.decisions.are.made.because.of.the.sufficiency.rating..And.it.
appears.that.the.rating.system.may.not.be.doing.what.it.is.supposed.to.do.

Compiling. so. many. factors. into. one. rating. increases. the. probabil-
ity. that. serious. deficiencies. are. overshadowed. by. other. factors,. such. as.
average.daily.traffic.and.detour.length.if.a.bridge.is.taken.out.of.service..
Shortcomings.in.the.current.rating.system.are.causing.engineers.to.look.at.
new.ways.to.measure.bridge.risk,.including.using.software.to.predict.how.
bridges. will. change. and. possibly. fail. over. time,. along. with. cost-.benefit.
analysis. to.optimize.spending.on.maintenance.and.repair..However.the.
measurement. of. bridge. hazard. risk. eventually. turns. out,. the. one. thing.

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248 • Supply Chain Risk Management: An Emerging Discipline

that. is.becoming. increasingly.clear. is. that.bridge.sufficiency.ratings.are.
not.all.that.sufficient.

SupplieR peRfORManCe MeaSuReMent—
dOing it Right

Most.firms,.particularly.larger.ones,.will.say.they.have.some.sort.of.sup-
plier.performance.measurement.system.in.place..Many.companies.call.the.
output.from.these.measurement.systems.supplier scorecards..Our.discus-
sion. here. is. not. a. how-.to. on. supplier. performance. measurement;. other.
sources.have.covered.this.topic.quite.well..Rather,.we.address.the.issues.
that.tend.to.affect.supplier.measurement.systems.at.most.companies..Let’s.
highlight.these.shortcomings.through.a.case.example.

The Case of the Deceptive Scorecards

During.a.review.of.a.supplier.scorecard.system.at.a.global.logistics.company,.
a.training.instructor.asked.a.buyer.to.name.one.of.his.best-.performing.sup-
pliers.in.terms.of.its.performance.score..Without.hesitation.the.buyer.pro-
vided.a.supplier’s.name..Another.participant.in.the.room.responded.quickly.
by.saying.that.in.the.operations.facility.this.is.one.of.the.worst.suppliers.his.
group.deals.with.on.a.day-.to-.day.basis..How.can.one.person.say. this. is.a.
supplier.worthy.of.a.preferred.status.while.another.person.would.like.to.see.
this.supplier.go.away?.And,.perhaps.most.importantly,.what.are.the.risks.of.
a.measurement.system.that.awards.high.scores.(and.likely.future.business).
to.what.may.be.poorly.performing.suppliers?.The.irony.here.is.that.a.system.
that.is.designed.to.reduce.supply.chain.risk.could.actually.be.increasing.risk.

These.differences.of.opinion.resulted.in.a.spirited.discussion.among.the.
participants. in. the. room.. During. this. discussion. the. group. reached. con-
sensus. about. a. number. of. important. points.. First,. the. group. agreed. that.
although. the. measurement. system. is. supported. by. an. extensive. database.
that.allows.all.kinds.of.on-.demand.analyses,.the.data.to.support.that.system.
are.largely.collected.and.input.manually..Furthermore,.many.performance.
items.require.subjective.judgments..Second,.most.buyers.had.responsibility.
for.inputting.data.quarterly.for.about.25.suppliers,.a.heavy.burden.that.is.in.
addition.to.their.normal.workload..Many.in.attendance.also.agreed.that.the.
data.are.input.just.before,.and.sometimes.after,.the.quarterly.cutoff..Third,.
attendees.acknowledged.that.supplier.scores.are.used.as.one.indicator.of.a.
buyer’s.job.performance,.potentially.creating.a.conflict.of.interest.

The.group.also.agreed.that.all.suppliers.are.essentially.held.to.the.same.
criteria.with.the.same.assigned.weights,.even.though.no.one.believes.that.
suppliers. are. equally. important. or. similar.. Participants. further. agreed.

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Risk Measurement • 249

that.internal.customers.have.no.way.to.provide.input.into.the.measurement.
process,.even.though.this.group.has.the.best.perspective.regarding.a.suppli-
er’s.day-.to-.day.performance..Some.participants.were.even.confused.about.
how.to.rate.a.supplier.since.some.suppliers.provide.material.from.more.than.
one.site..Finally,.no.clear.agreement.emerged.that.the.measurement.process.
was.contributing.to.better.supplier.performance..It.was.taken.as.an.article.of.
faith.that.measurement.is.a.worthwhile.pursuit..

Table 13.1.provides.a.set.of.guidelines.for.assessing.whether.a.supplier.
performance. measurement. system. is. likely. to. satisfy. its. intended. use..
Evaluating.a.measurement.system.against.these.criteria.will.help.ensure.
the.system.is.leading-.edge..In.fact,.the.items.that.appear.in.this.table.essen-
tially.define.the.characteristics.of.a.world-.class.supplier.performance.mea-
surement.system..If.supplier.measurement.is.an.important.objective,.then.
let’s.at.least.do.it.right..Measuring.performance.incorrectly.is.an.invitation.
to.trouble,.and.we.all.know.that.trouble.and.risk.are.best.friends.

taBle 13.1

Characteristics.of.an.Effective.Supplier.Measurement.System

•. The.measurement.system.allows.scoring.flexibility.so.all.performance.categories.and.
suppliers.are.not.measured.the.same.way.

•. Internal.customers.evaluate.supplier.performance.through.an.online.portal.that.
feeds.information.directly.to.the.measurement.system.

•. Performance.reports.are.forwarded.electronically.to.suppliers.with.review.and.
acknowledgment.required.by.executive.supplier.management.

•. Each.location.at.a.supplier.receives.an.operational.performance.report.while.the.
supplier’s.corporate.office.receives.a.“relationship”.performance.report.

•. Supplier.performance.reports.include.total.cost.measures.wherever.possible.instead.
of.price.measures.

•. Supplier.performance,.particularly.cost,.quality,.and.delivery,.is.updated.in.real.time.
as.transactions.occur.

•. The.measurement.system.separates.critical.suppliers.from.marginally.important.
suppliers.

•. The.supplier.measurement.database.allows.user.flexibility.when.retrieving.and.
displaying.data.

•. The.measurement.system.provides.early-.warning.performance.alerts.such.as.
predicted.late.deliveries.from.suppliers.

•. Suppliers.have.the.ability.to.view.their.performance.online.with.comparisons.against.
other.suppliers.

•. The.measurement.system.is.regularly.compared.against.best-.practice.companies.
•. Real.performance.improvement.can.be.demonstrated.as.a.result.of.the.measurement.

system.

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250 • Supply Chain Risk Management: An Emerging Discipline

Quantified RiSk indexeS

This.approach.scores.risk.events.or.suppliers.using.algorithms.that.model.
risk..Risk.indexes.are.quantitative.models.that.consider.multiple.factors.
to.arrive.at.a.single.risk.indicator.score,.similar.to.the.bridge.sufficiency.
rating.discussed.earlier..These.indexes.consider.more.than.simply.a.sup-
plier’s. financial. status. when. arriving. at. a. risk. score.. To. date. most. risk.
indexes.or. indicators.have.been. internally.developed.since. third.parties.
have.been.slow.to.respond.with.new.tools.and.approaches,.something.that.
will.likely.change.

It.is.no.surprise.that.risk.indexes.range.from.basic.to.complex..On.the.
basic. side,. some.companies.use.a.variety.of. simple.algorithms. to.arrive.
at.a.single.risk.score.or.index..A.company.might.consider.the.probability.
of.a.potential.risk.event.occurring.using.a.1–10.scale..That.figure.is.then.
multiplied.by.the.effect.a.risk.event.would.have.on.a.1–10.scale..Other.fac-
tors.can.be.introduced,.such.as.the.ability.to.detect.the.risk.on.a.scale.of.
1–10.(a.higher.score.means.less.ability.to.detect.the.risk)..The.three.scores.
would.be.multiplied.together.to.arrive.at.an.overall.risk.index,.with.higher.
scores. representing. higher. risk. exposure.. A. later. example. will. further.
highlight.this.approach..A.concern.about.the.validity.of.these.simple.risk.
indexes.measures.is.particularly.relevant.here.

It.is.not.unusual.to.translate.risk.index.figures.into.a.red/.yellow/.green.
visual.system.(recall.from.Chapter 6.this.method.is.used.with.the.Z-.Score)..
This.should.also.happen.during.new.product.development.as.specific.risks.
are.identified,.something.that.Chapter 4.addressed..Product.development.
teams. will. work. to. address. red. and. even. yellow. items. prior. to. product.
launch..The.goal.should.be.to.launch.new.products.with.as.few.red.risks.as.
possible..Why.wait.until.after.the.fact?

Interestingly,.a.body.of. research. is.emerging. that.counters. the.notion.
that.complex.algorithms.and.models.are.automatically.more.effective.than.
simple. rules. of. thumb. or. guidelines. when. making. organizational. deci-
sions..This.is.something.to.keep.in.mind.when.developing.risk.indexes..A.
hypothesis.put.forward.is.that.complex.situations.create.so.many.possible.
courses.of.action.and.become.so.complex.to.use.that.individuals.become.
confounded,. often. to. the. point. where. they. delay. decisions,. default. to.
the.safest.option,.or.avoid.making.choices.altogether.

Research.suggests.that.simple.rules.can.equal,.and.at.times.exceed,.the.
effectiveness.of.more.complicated.analyses.across.a.range.of.decision.areas.2.

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Risk Measurement • 251

While.the.analysis.and.data.that.lead.to.the.rules.may.be.sophisticated,.and.
at.times.will.even.be.complex,.the.rules.that.result.should.be.elegant.in.their.
simplicity.as.they.provide.guidance.to.users..When.the.up-.front.work.to.
develop.the.risk.index.is.rigorous,.the.chances.are.good.the.risk.index.will.
have.validity..This.is.something.to.keep.in.mind.when.the.temptation.exists.
to.develop.overly.complex.algorithms,.models,.and.risk.indexes.

a Risk index example

Consider.the.following.example,.which.is.a.technique.used.by.a.food.man-
ufacturer.to.develop.risk.indexes.to.support.its.risk.management.efforts.3.
This.company.examines.specific.risks.from.three.dimensions:.severity.of.
the.risk,.the.probability.of.the.risk.occurring,.and.the.probability.of.early.
risk.detection..This.approach.is.consistent.with.the.FMEA.(failure.modes.
and.effects.analysis).approach,.a.widely.used.quality.management. tech-
nique.that.considers.these.three.factors..Let’s.look.at.an.example:

Risk: Poor Product Freshness

Severity.(1.low–10.high) . . 7
Probability.of.Occurrence.(1.low–10.high) . . 5
Probability.of.Early.Detection(1.high–10.low) . . 3
Risk.Index.(7×5×3) 105

Companies.that.use.this.approach.identify,.evaluate,.and.then.rate.all.
possible. risks,. which. are. then. addressed. in. terms. of. priority.. As. men-
tioned,.with.any.risk.index.we.must.be.concerned.about.its.validity..Here,.
what. defines. the. incremental. values. in. each. scale. (i.e.,. low. to. high. is. a.
broad.range.with.a.great.deal.in.between)?.Is.the.incremental.difference.
between.a.score.of.3.and.4.in.a.scale.the.same.as.between.5.and.6.or.8.and.9?.
Should.the.three.categories.be.equally.weighted,.which.is.the.case.here?.
Would.three.people.looking.independently.at.the.same.risk.arrive.at.the.
same.or.similar.score.using.this.tool?.(This.is.called.inter-rater.reliability)..
Too. many. companies. use. tools. such. as. the. one. presented. here. without.
fully.performing.the.up-.front.work.necessary.to.validate.the.tool..The.vir-
tue.of.this.approach.is.its.simplicity..It.is.easy.to.understand.and.use.

Country Risk indexes

A.variety.of.risk.indexes.are.available.that.evaluate.country.risk..One.of.
the.more.comprehensive.of. these. indexes,.and.one.that.will.be. featured.

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252 • Supply Chain Risk Management: An Emerging Discipline

here,.is.the.International.Country.Risk.Guide.(ICRG).composite.risk.rat-
ing.produced.by.the.Political.Risk.Services.(PRS).Group.4.This.composite.
risk. rating.by.country,.which. is.updated.monthly,. includes.22.variables.
across. three.subcategories.of.country.risk—political,.financial,.and.eco-
nomic..A.separate.detailed.scoring.and.weighting.methodology.is.created.
for.each.of.the.22.subcategories.

The.composite.risk.rating.by.country.is.based.on.100.total.points.with.
the.political.risk.rating.comprising.50%.and.the.financial.and.economic.
risk.ratings.contributing.25%.each..The.composite.scores,.ranging.from.
zero. to. 100,. are. then. broken. into. categories. from. very low risk (80. to.
100.points).to.very high risk (0.to.49.9.points).

At.the.enterprise.risk.management.(ERM).level,.country.risk.index.rat-
ings.are.valuable.when.a.company.is.thinking.about.making.foreign.direct.
investments..At.the.SCRM.level,.this.information.can.influence.logistics,.
sourcing,.and.selling.activities..Our.advice.is.to.not.even.bother.creating.
country.risk.indexes..Third-.party.indexes.are.available.that.are.more.com-
prehensive.than.anything.a.company.could.construct.acting.on.its.own.

uSing tOtal COSt MeaSuReS tO Manage RiSk

Total.cost.is.a.topic.that.companies.cannot.ignore.as.they.search.for.new.
and.better.ways.to.manage.supply.chain.risk..What.exactly.is.total.cost?.
Total.cost. includes. the.expected.and.unexpected.elements. that. increase.
the.unit.cost.of.a.good,.service,.or.piece.of.equipment..The.logic.behind.the.
development.of.total.cost.systems.is.that.unit.cost.or.price.never.equals.
total.cost..And,.as.the.gap.between.unit.cost.and.total.cost.becomes.pro-
gressively.larger,.so.does.a.company’s.risk.exposure..Regardless.of.where.
a.company.applies.total.cost.models,.these.models.all.attempt.to.capture.
data.beyond.unit.price.

In.uncertain. times,. the.need. to.understand.every.element.of.cost.has.
never.been.greater..Total. cost. systems.help.management. to. identify. the.
impact.of.different.cost.elements,.to.track.cost.improvements.in.real.terms.
over.time,.and.to.gain.management’s.attention.regarding.where.cost.reduc-
tion.efforts.will.have.their.greatest.payback.across.the.supply.chain..While.
there.is.some.overlap.between.sources.regarding.which.cost.elements.to.
include.in.total.cost.models,.no.agreement.exists.regarding.exactly.what.
these.models.should.contain..This.issue.becomes.more.complex.once.we.

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Risk Measurement • 253

understand. that,. like. forecasting.models,.different. types.of. cost.models.
exist..And,.like.forecasting.models,.total.cost.models.almost.always.have.
some.inherent.inaccuracy.to.them.

types of total Cost Models

Every.total.cost.model.is.part.of.a.family.of.measurement.systems.called.
cost-.based.systems..Like.any.measurement.system,.cost-.based.systems.offer.
advantages.and.disadvantages..These.systems.can.be.extremely.challenging.
to.develop.and.use.(if.they.were.not.challenging.then.everyone.would.rou-
tinely.use.them).5.Some.of.the.challenges.include.(1).relying.on.data.that.are.
derived.across.global.supply.chains,.(2).maintaining.the.discipline.across.
the.supply.chain.to.use.the.models.routinely,.and.(3).using.data.that.are.not.
known.with.certainty.or.are.estimates.of.what.might.happen..A.mean.time.
between.failures.(MTBF).estimate,.for.example,.is.often.used.when.evalu-
ating.the.total.expected.cost.of.capital.equipment..How.close.is.the.estimate.
to.what.actually.happens.in.terms.of.equipment.reliability?

Across.a.supply.chain.we.generally.see.three.kinds.of.total.cost.models.
in.use,.regardless.of.whether.this.involves.a.domestic.or.international.sup-
ply.chain..These.include.total. landed.cost.models,.supplier.performance.
index.models,.and.life-.cycle.cost.models.

Total Landed Cost Model. A. total. landed. cost. model. is. used. when.
evaluating.suppliers.prior.to.making.purchase.decisions,.although.that.is.
not.the.only.time.when.a.landed.cost.model.should.be.used..Total.landed.
cost.is.the.sum.of.all.costs.associated.with.obtaining.a.product,.including.
acquisition.planning;.unit.price;.inbound.cost.of.freight,.duty,.and.taxes;.
inspection;.and.material.handling.for.storage.and.retrieval.6.Each.of.these.
cost. categories. will. also. contain. numerous. subcategories.. Best-.practice.
companies. require. their. commodity. teams. or. buyers. to. attach. spread-
sheets.that.show.the.total.landed.cost.of.a.purchase.requirement.whenever.
they.propose.a.supply.strategy.or.make.a.supplier.selection.decision.

Total.landed.cost.models.should.also.be.used.when.doing.business.with.
suppliers.on.an.ongoing.basis..The.factors.that.affect.the.sourcing.decision.
in.the.first.place.are.dynamic.and.subject.to.change.(think.transportation.
and. exchange. rates. here).. Furthermore,. actual. costs. should. replace. any.
estimated.or.forecasted.costs.in.the.model.as.they.become.available..This.
helps.to.validate.the.assumptions.in.the.model.

When. developing. total. landed.cost.models. it. is.best. to. start.with. the.
unit.price.and.then.build.up.the.total.cost.as.goods.move.from.origin.to.

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254 • Supply Chain Risk Management: An Emerging Discipline

destination.. Ideally. every. cost. element. is. presented. in. the. same. unit. of.
measure..If.a.product.is.priced.by.the.pound,.then.every.corresponding.
cost.element.in.the.model.should.appear.as.a.cost.per.pound..The.cost.ele-
ments.in.landed.cost.models.should.be.divided.into.categories.that.reflect.
a.logical.progression.through.the.supply.chain:

•. Unit.price—unit.price.usually.appears.on.the.first.line.of.the.cost.model
•. Within.country.of.manufacture.costs—includes.materials,.storage,.

labor,.quality,.overhead,.obsolescence,.packaging,.risk.or.disruption,.
exchange.rates,.inventory.carrying.charges

•. In-.transit.to.country.of.sale.costs—includes.transportation.charges,.
fuel. surcharges,. insurance,.port. charges,.handling,. security,.bank-
ing. fees,. broker. fees,. potential. detention. charges,. duties,. handling.
agency.charges,.inventory.carrying.charges

•. Within.country.of.sale.costs—includes.local.transportation.and.han-
dling,. storage. fees,. taxes,. safety. stock,. inventory.carrying.charges,.
yield,. productivity. implications,. maintenance,. quality,. overhead.
allocation,.payment.terms

Supplier Performance Index (SPI) Model. Various.models.attempt.to.
capture. the.true.cost.of.doing.business.with.a.supplier.on.a.continuous.
basis.. Perhaps. the. best. known. of. these. models. is. something. called. the.
Supplier. Performance. Index. (SPI).. SPI. calculations,. which. focus. largely.
on. supplier. nonconformance. costs,. are. helpful. when. tracking. supplier.
improvement. over. time,. quantifying. the. severity. of. performance. prob-
lems,.deciding.which.suppliers.to.eliminate.from.a.supply.base,.and.when.
establishing.minimum.acceptable.levels.of.supplier.performance.

The.SPI.is.a.total.cost.model.that.presents.its.output.in.the.form.of.an.
index.or.ratio..It.assumes.that.any.quality.or.other.infraction.committed.
by.a.supplier.during.the.course.of.business. increases.the.total.cost.(and.
hence.the.total.cost.performance.ratio).of.doing.business.with.that.sup-
plier..This.approach.is.more.applicable.after.supplier.selection.because.it.
is. populated. with. cost. occurrences. that. have. happened. rather. than. are.
expected.to.happen..The.SPI.calculation.for.a.specific.period.is.a.straight-
forward.formula:

. SPI.=.(Cost.of.material.+.Nonconformance.costs)/(Cost.of.material)

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Risk Measurement • 255

Assume.a.supplier.delivers.$1.million.worth.of.parts.to.a.company.in.the.
third.quarter.of.a.year..The.supplier.also.commits.three.infractions.that.quar-
ter—a.late.delivery,.missing umentation,.and.a.parts.shortage..Further.
assume.the.buyer.assigns.$30,000.in.total.nonconformance.charges.to.these.
infractions..The.supplier’s.SPI.for.the.third.quarter.is.1.03,.or.(($1,000,000.+.
$30,000)/$1,000,000)..The.SPI.of.1.03.means.the.total.cost.of.doing.business.
with.this.supplier.is.3%.higher.than.the.unit.price..If.the.unit.price.of.a.sup-
plier’s.good.is.$127,.then.the.estimated.total.cost.of.that.item.is.really.$130.81.
($127.×.1.03)..Because.the.SPI.is.a.standardized.metric,.it.allows.compari-
sons.between.suppliers..A.supplier.with.a.higher.SPI.has.a.higher.total.cost.
than.one.with.a.lower.SPI..It.is.important.to.compare.suppliers.within.the.
same.commodity.to.ensure.“apples.to.apples”.comparisons.

SPI Drawbacks. Although. the. SPI. can. be. an. effective. tool,. it. is. by. no.
means.perfect.. In. fact,. it.has.some.potential.drawbacks. that.users.must.
understand..First,.because.it. is.an.index,.the.actual.unit.cost.of.an.item.
from.a.supplier.is.not.considered.directly.in.the.SPI.calculation—only.the.
value.of.the.total.shipments.and.infractions.are.considered..A.higher.sup-
plier.unit.cost.inflates.the.value.of.the.shipments.compared.with.a.supplier.
that.has.a.lower.unit.cost,.making.any.infractions.look.smaller.given.the.
shipment.value..Mathematically,. this.makes.the.SPI.value. lower,.all.else.
equal,.for.the.higher-.price.supplier..Let’s.illustrate.this.with.two.suppliers.
that.ship.the.same.number.of.units.with.the.same.infraction.charges.but.
with.different.unit.costs:

Supplier A Supplier B

50,000.units.@.$9.00.per.unit 50,000.units.@.$10.50.per.unit
$27,500.non.conformance.charges $27,500.nonconformance.charges
SPI.=.((50,000.×.$9).+.$27,500)/$450,000 SPI.=.((50,000.×.$10.50).+.$27,500)/$525,000
=.1.06 =.1.05

The.difference.here.is.a.mathematical.artifact.of.the.different.unit.costs..
Ideally,.the.buying.company.would.employ.a.total.landed.cost.model.dur-
ing. supplier. selection. so. any. issues. regarding. differences. in. unit. costs.
would.have.already.been.considered.

The.SPI.calculation.also.has.a.built-.in.bias.against.small.volume.sup-
pliers.. Assume. three. suppliers. within. a. commodity. group. commit.
the. same. infraction. that. resulted. in. a. $3,000. nonconformance. charge..
The. first. supplier.provided.$15,000.worth.of.goods.during.a.quarter,. the.

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256 • Supply Chain Risk Management: An Emerging Discipline

second. supplier. provided. $10,000. worth. of. goods,. and. a. third. sup-
plier. provided. $30,000. worth. of. goods.. The. SPI. for. the. first. supplier. is.
1.20.(($15,000.+.$3000)/$15,000),. the.SPI. for. the.second.supplier. is.1.30.
(($10,000. +. $3,000)/$10,000),. and. the. SPI. for. the. third. supplier. is. 1.10.
(($30,000.+.$3,000)/$30,000)..Even.though.each.supplier.committed.the.
same.infraction,.the.smaller.supplier.appears.worse.from.an.SPI.perspec-
tive,.particularly.compared.with.the.larger.supplier.

This. bias. requires. the. calculation. of. a. Q. adjustment. factor,. which. is.
essentially.a.weight.applied.to.the.nonconformance.costs..The.adjustment.
factor.allows.valid.SPI.comparisons.by.removing.the.bias.against.suppliers.
with.a.lower.total.value.of.deliveries..It.makes.sense.to.calculate.an.adjust-
ment.factor.that.removes.this.bias.if.suppliers.within.a.commodity.provide.
widely.differing.volumes..If.we.want.to.make.total.cost.models.as.accurate.
as.possible,.then.we.have.to.think.about.the.Q.adjustment.factor..Figure 13.1.
illustrates.the.step-.by-.step.calculation.of.the.Q.adjustment.factor.

A.final.drawback.to.the.SPI.approach.is.that.it.requires.a.great.deal.of.
discipline.and.cross-.functional.support.to.stay.on.top.of.the.required.data.
collection.. Supplier. infractions. can. occur. or. be. discovered. at. different.
points. along. a. supply. chain.. Inconsistency. in. collecting. and. allocating.
supplier.charges.will.quickly.undermine.the.validity.of.this.model.

Supplier A Supplier B Supplier C

1st quarter deliveries 10 12 10

Total value of
deliveries

$10,500 $18,000 $35,000

Average delivery
value

($10,500/10) = $1,050 ($18,000/12) = $1,500 ($35,000/10) = $3,500

Non-conformance
charges assigned to
each supplier

$1,000 $1,400 $2,500

1st quarter SPI ($10,500+$1,000)/$10,500
= 1.10

($18,000+$1,400)/$18,000
= 1.08

($35,000+$2,500)/$35,000
1.07

Average shipment
from all suppliers*

$2,500 $2,500 $2,500

Q adjustment factor $1,050/$2,500 = .42 $1,500/$2,500 = .60 $3,500/$2,500 = 1.4

Adjusted SPI 1.04 1.05 1.10

Adjusted SPI for Supplier A = $10,500 + ($1,000 × .42)/$10,500 = 1.04
Adjusted SPI for Supplier B = $18,000 + ($1,400 × .60)/$18,000 = 1.05
Adjusted SPI for Supplier C = $35,000 + ($2,500 × 1.4)/$35,000 = 1.10
* Average shipment from all suppliers equals (total value of shipments/total shipments) for all suppliers
within a commodity, not just those listed in this table. �is is a provided piece of data in this example.

figuRe 13.1
Supplier.performance.index.with.Q.adjustment.

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Risk Measurement • 257

Life- Cycle Cost Models. Life-.cycle.cost.models.may.be.what.comes.most.
to.mind.when.thinking.about.total.costs.analysis..This.type.of.model.is.
most.often.used.when.evaluating.capital.decisions.that.cover.an.extended.
time.period,.such.as.equipment.and.facilities..Life-.cycle.models.are.very.
similar.to.net.present.value.models.used.in.finance..Life-.cycle.cost.models.
are.used.when.evaluating.capital.decisions,.such.as.plant.and.equipment,.
rather.than.the.purchase.of.everyday.components.and.services..The.other.
cost.models.described.here.are.more.applicable.for.repetitively.purchased.
goods. or. services.. Life-.cycle. costs. apply. whether. equipment. is. sourced.
domestically.or.internationally.

Developers.of. life-.cycle. cost.models.often.allocate. their. cost. elements.
across.four.broad.categories.that.reflect.usage.over.time..The.life-.cycle.is.
essentially. one. of. buying,. shipping,. installing,. using,. maintaining,. and.
disposing:

•. Unit.Price—Includes.the.price.paid.along.with.purchase.terms
•. Acquisition.Costs—Includes.all.costs.associated.with.delivering.equip-

ment,.such.as.buying,.ordering,.and.freight.charges.to.the.customer
•. Usage.Costs—Includes.all.the.costs.to.operate.the.equipment,.includ-

ing.installation,.energy.consumption,.maintenance,.reliability,.spare.
parts,.and.yield.and.efficiency.during.production

•. End-.of-.Life. Costs—Includes. all. costs. incurred. when. removing.
equipment.from.service,.less.any.proceeds.received.for.resale,.scrap,.
or.salvage

Companies. should. compare. the. assumptions. made. during. the. devel-
opment.of.life-.cycle.estimates.with.actual.data.as.they.become.available,.
particularly.since.life-.cycle.models.often.look.years.into.the.future..This.
will.provide.insights.regarding.how.to.improve.the.life-.cycle.models.

A.popular.misconception. is. that.having.a. total.cost.model. inherently.
provides.better.information.than.not.having.a.total.cost.model..We.like.
to. think. this. is. true,. but. the. reality. is. that. total. cost. models,. like. fore-
casting. models,. almost. always. have. some. degree. of. inaccuracy.. This. is.
especially.true.if.a.model.is.populated.with.data.that.are.based.largely.on.
estimates.or.averages.rather.than.actual.data..Or,.the.model.may.fail. to.
take. into.account. some. important.cost.elements..Do.not.underestimate.
the.value,.however,.of.a.well-.specified. total. cost.model.when.managing.
supply.chain.risk..Total.cost.measurement.is.one.of.the.best.risk.manage-
ment.approaches.that.we.can.put.in.place.today.

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258 • Supply Chain Risk Management: An Emerging Discipline

SupplieR CapaCity eStiMate MeaSuReS

Most.of.us.have.heard.stories.about.a.buyer.placing.an.order.with.a.sup-
plier.only. to.find. that. the. supplier’s. assurances.about.available.capacity.
simply.are.not.true..Or,.how.about.when.total.demand.in.a.marketplace.
increases.and.a.buying.company.finds.it.has.been.placed.on.the.short.end.
of.a.supplier’s.allocation.schedule..Either.of.these.conditions.creates.oper-
ational.risk.as.supply.is.not.readily.available.to.satisfy.demand.

A.risk.management.approach.that.will.provide.some.clues.into.available.
capacity.is.something.we.call.rough cut supplier capacity analysis..It.is.called.
rough cut.because.it.is.not.meant.to.be.a.precise.estimate.of.available.supplier.
capacity..We.are.simply.trying.to.get.a.feel.regarding.what.might.be.avail-
able.and.comparing.that.to.a.specific.requirement..And.when.we.get.a.better.
feel.for.the.amount.of.available.capacity,.we.can.engage.in.some.worthwhile.
discussions.with.suppliers..Let’s.illustrate.how.this.technique.works.

Table 13.2.presents.data.for.the.three.suppliers.that.appeared.in.Chapter 6.
when.calculating.Z–.Scores..We.are.now.introducing.two.new.additional.
pieces.of.data—the.estimate.of.the.average.capacity.utilization.rate.at.each.
supplier. and. a. quoted. price. per. unit. for. the. item. of. interest.. This. table.
presents.a.methodology.for.estimating.the.capacity.available.at.each.sup-
plier..This.analysis.reveals.that.only.one.supplier.appears.to.have.adequate.
capacity.available..According.to.these.numbers.the.buying.company.could.
face.major.operational.risk.if.it.decided.on.a.single-.source.contract.with.
FASE.Chemicals..The.risk.could.be.so.severe.that.it.affects.the.success.of.
a.product,.which.then.leads.to.strategic.risk..And.placing.a.single-.source.
contract.with.DMS.will.require.some.serious.discussions.to.verify.these.
estimates.and,.if.verified,.to.work.out.a.plan.to.meet.demand.requirements.

The.point.of.this.exercise.is.to.provide.a.broad.understanding.of.where.a.
supplier.stands.in.terms.of.capacity..One.risk.here.is.that.a.supplier.could.
also.be.speaking.to.other.buyers.that.are.interested.in.the.available.capac-
ity..It. is.also.possible.some.contracts.at.the.supplier.are.expiring,.which.
could. make. additional. capacity. available.. One. thing. we. are. confident.
about.is.these.suppliers.are.not.likely.to.drop.existing.customers.simply.
to.fulfill.a.new.contract,.at. least. in.the.short. term,.making.the.capacity.
discussion.a.key.part.of.the.risk.assessment.process.

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Risk Measurement • 259

taBle 13.2

Rough.Cut.Supplier.Capacity.Analysis

A.pharmaceutical.company.has.forecasted.that.it.requires.20.million.pounds.of.a.
chemical.compound.to.support.the.launch.of.a.new.product.next.year..The.following.
data.are.collected.to.help.in.the.estimate.

Ninaka
Materials

FASE
Chemicals DMS NV

Quoted.price.per.pound $4.75 $5.75 $5.20
Current.installed.capacity.utilization 98% 95% 94%
Sales.2014.generated.from.the.chemical.

compound
$6,500,000,000 $550,000,000 $1,355,000,000

Rough.cut.estimate.of.available.capacity 27,926,960.lbs. 5,034,325.lbs. 16,632,570

Current.installed.capacity.utilization.indicates.that.portion.of.the.supplier’s.production.
capacity.that.is.currently.utilized.for.the.production.of.chemicals..For.example,.if.
current.installed.capacity.is.98%,.then.this.supplier.is.utilizing.98%.of.its.production.
capacity.and.therefore.has.2%.of.its.capacity.available.for.new.business..This.does.not.
indicate.how.many.available.pounds.this.represents.

ninaka
$6,500,000,000.sales.generated.from.the.compound/98.capacity.points.used.to.generate.
the.sales.=.$66,326,530.in.sales.generated.by.each.point.of.used.capacity.×.2.capacity.
points.available.=.$132,653,060.potential.capacity.available.in.dollars/$4.75.quoted.
price.per.pound.=

27,926,960 estimated pounds available

faSe
$550,000,000.sales.generated.from.the.compound/95.capacity.points.used.to.generate.
the.sales.=.$5,789,474.in.sales.generated.by.each.point.of.used.capacity.×.5.capacity.
points.available.=.$28,947,368.potential.capacity.available.in.dollars/$5.75.quoted.price.
per.pound.=

5,034,325 estimated pounds available

dMS
$1,355,000,000.sales.generated.from.the.compound/94.capacity.points.used.to.generate.
the.sales.=.$14,414,894.in.sales.generated.by.each.point.of.used.capacity.×.6.capacity.
points.available.=.$86,489,362.potential.capacity.available.in.dollars/$5.20.quoted.price.
per.pound.=

16,632,570 estimated pounds available

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260 • Supply Chain Risk Management: An Emerging Discipline

eMeRging Supply Chain RiSk MetRiCS

We.are.witnessing.a.combination.of.existing.measures.as.well.as.the.devel-
opment.of.entirely.new.measures.being.applied.to.the.risk.management.
arena..The.following.describes.some.of.these.risk-.related.measures.

Value at Risk

A.metric.that.will.increasingly.have.corporate-.level.visibility.as.a.risk.met-
ric.is.value.at.risk.(VaR),.a.metric.that.is.used.extensively.by.the.financial.
community.to.evaluate.financial. investments..From.a.financial.perspec-
tive,. VaR. represents. the. largest. loss. likely. to. be. suffered. on. a. portfolio.
position. over. a. holding. period. (usually. 1–10 days). with. a. given. prob-
ability. (confidence. level)..VaR. is. a.measure.of.market. risk.and. includes.
three.components—a.time.period,.a.confidence.level.or.percentage,.and.a.
loss.amount.or.percentage.attached.to.a.risk.7.This.concept.is.now.being.
applied.to.supply.chain.scenarios..Chapter 5.provided.a.detailed.illustra-
tion.of.this.metric.and.its.use.in.supply.chain.risk.management.

time- to- Recovery

The.time-.to-.recovery.(T-.t-R).from.adverse.events,.a.risk.resiliency.mea-
sure.used.extensively.in.the.information.technology.arena,.is.generating.
significant.interest.as.an.evolving.supply.chain.risk.measure..An.example.
of.a.T-.t-R.measure. involves. the. time.to.recover. from.a.natural.disaster,.
such.as.a.flood..Virtually.any.supply.chain.disruption.can.have.a.T-.t-R.
measure.attached.to.it.

T-.t-R.measures,.like.most.measures,.have.an.objective.attached.to.them..
Some.sources.refer.to.this.objective.as.the.recovery.time.objective.(RTO),.
which. is. the. time. in. which. a. system,. a. facility,. or. equipment. must. be.
restored.after.a.disruption.to.avoid.an.unacceptable.break.in.business.con-
tinuity.and.the.incurrence.of.significant.losses..T-.t-R.measures.how.long.
it.takes.an.entity.in.a.supply.chain.to.reach.full.volume.or.full.operating.
status.after.a.major.disruption..This.does.not.have.to.mean.full.recovery.
at.a.specific.facility..If. the.full.volume.for.a.part.from.a.supplier.can.be.
provided.within.two.weeks.by.working.overtime.at.another.facility,.then.
two.weeks.is.the.T-.t-R,.even.if.the.affected.facility.takes.longer.to.recover.

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Risk Measurement • 261

Risk exposure index

An.extension.of.the.T-.t-R.index.is.the.Risk.Exposure.Index,.developed.by.
David.Simchi-.Levi.at.MIT..This.index.attempts.to.provide.a.better.way.for.
companies.to.quantify.their.supply.chain.risks.compared.with.the.tradi-
tional.2.×.2.matrix.that.places.the.likelihood.of.an.event.occurring.(high.
or. low). against. its. financial. impact. (low. or. high).. With. this. traditional.
approach,.potential.risk.events.are.plotted.into.one.of.four.quadrants.with.
those. with. the. highest. likelihood. of. occurring. and. the. largest. impact.
receiving.priority.for.attention..While.this.approach.serves.a.worthwhile.
purpose,.it.is.does.not.represent.cutting-.edge.risk.measurement.

The.Risk.Exposure.Index.assigns.a.cost.that.would.occur.from.a.poten-
tial.disruption.across.each.level.and.node.in.a.given.supply.chain,.based.
on.the.T-.t-R.for.each.level/.node.and.the.resulting.financial. impact.(FI),.
including.market.share.losses..Those.individual.risk.components.are.then.
totaled.to.produce.a.full.FI.for.the.entire.supply.chain.8

This. methodology. also. addresses. unpredictable. risks,. including. natu-
ral.disasters.and.fires.at.critical.suppliers..While.these.types.of.risks.are.
nearly.impossible.to.predict,.the.chances.that.such.a.disruption.will.occur.
over.a.period.of.time.is.quite.likely,.which.is.built.into.the.model..The.key.
to.this.analysis.is.the.calculation.of.the.financial.damage.that.such.a.dis-
ruption.would.likely.cause.

Supply Chain key performance indicators

We.expect.to.see.various.key.performance.indicators.(KPIs).emerge.that.
are.viewed.by.executive.management.as.supporting.a.company’s.risk.man-
agement.efforts..The.following.presents.six.measures,.some.of.which.have.
been.in.existence.for.a.while.but.not.necessarily.visible.at.higher.executive.
levels..These.are.not.predictive.measures—they.do.not.provide.warning.
about. pending. or. specific. risk. events.. Rather,. they. provide. insight. into.
how.well.some.important.business.processes.are.operating..We.will.prob-
ably.all.agree.that.when.important.processes.are.operating.well,.a.business.
faces.lower.risk.exposure.

Forecast Accuracy.. As. mentioned. in. Chapter 12,. best-.practice. com-
panies. track. and. assign. clear. accountability. for. forecasting. success. to.
an. executive. or. executive. steering. committee.. Best-.practice. companies.
also.regularly.measure.forecast.accuracy.across.their.different.products..

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262 • Supply Chain Risk Management: An Emerging Discipline

One.survey.revealed.that. fully. two-.thirds.of.respondents.reported.fore-
cast. accuracy. between. 50%. and. 80%,. a. range. that. indicates. room. for.
improvement..Forecast.accuracy.should.be.computed.regularly.and.com-
pared.against.preestablished.benchmarks..Many.techniques.are.available.
for.assessing.forecast.accuracy,.including.mean.forecast.error,.bias,.mean.
absolute.deviation,.mean.absolute.percent.error.and.tracking.signals..All.
of. these. techniques. compare,. in. some. manner,. actual. demand. against.
forecasted.demand.with.the.difference.between.these.two.figures.consid-
ered.error.

Concept- to- Customer Cycle Time.. Product. development. leaders. rely.
on.an.important.time-.based.metric.called.concept-.to-.customer.(C-.to-.C).
cycle.time..This.metric.reflects.the.importance.of.being.aware.of.the.time.
it.takes.to.develop.new.products.as.well.as.acting.as.a.target.that.no.sin-
gle.functional.group.can.unilaterally.attain..Surprisingly,. in.our.experi-
ence.most.companies.do.not.measure.an.overall.cycle.time,.making.the.
development.of.a.C-.to-.C.cycle.time.measure.especially.attractive..Holding.
functional.groups.mutually.accountable.for.this.measure.sends.a.powerful.
message.about.the.importance.of.collaborating.during.product.develop-
ment.efforts..And.as.Chapter 4.pointed.out,.the.linkage.between.strategic.
risk.exposure.and.new.product.development.success.(or.failure).is.strong.

Inventory Accuracy. Recall.from.Chapter 12.that.measuring.inventory.
accuracy. is. essential. for. managing. various. kinds. of. supply. chain. risk..
Inventory. accuracy. exists. when. the. physical. inventory. on. hand. for. an.
item.equals.the.computerized.or.electronic.record.on.hand.(POH.=.ROH),.
regardless. of. the. quantity. of. inventory.. Supply. chain. managers. should.
become. almost. evangelical. in. their. quest. for. perfect. record. integrity,.
including.the.integrity.of.records.and.data.at.suppliers.and.distributors.

Order- to- Cash Cycle Time. An.important.part.of.any.supply.chain.is.
the.customer.order.fulfillment.process..The.order-.to-.cash.cycle. involves.
the.steps.from.acquisition.of.a.customer’s.order.to.receiving.payment.from.
a.customer..When.viewed.narrowly,.order.fulfillment.focuses.mainly.on.
the.acts.of.distribution.and.logistics..When.viewed.broadly,.order.fulfill-
ment.includes.all.the.steps.and.activities.from.the.sales.inquiry.to.delivery,.
and.perhaps.even.the.return.of.the.final.product.or.service..This.involves.
order.preparation,. transmission,.entry,.order.filling.(which.may. include.
production.and.purchasing),.billing,.shipping,.tracking,.and.returns.

Companies. that. take.a.broader.view.of.order. fulfillment. extend. their.
perspective. to. include. the. management. of. accounts. receivable,. making.

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Risk Measurement • 263

order-.to-.cash. cycle. time. a. key. performance. indicator.. This. stresses. the.
financial.aspects.of.the.fulfillment.process.by.not.viewing.the.process.as.
complete.until.customer.payment.is.received..Ineffective.management.of.
the.order-.to-.cash.cycle.time.has.clear.financial.risk.implications.

Perfect Order Rate. The.perfect.order.metric.is.a.mathematic.composite.
of.multiple.factors..The.perfect.order.is.one.that.is.delivered.on.time,.com-
plete.(all.ordered.items.are.in.the.shipment),.damage.free,.accurate.(correct.
items.and.quantities),.with.proper umentation..Perfect.orders.not.only.
drive.customer.loyalty.for.the.product.and.producer,.but.they.also.lead.to.
greater.supply.chain.efficiency.and.reduced.investments.in.inventory.9

To. date. the. primary. users. of. the. perfect. order. metric. have. been. con-
sumer.packaged.goods.companies..Virtually.any.company,.however,.can.
use.a.perfect.order.measure.if.they.can.overcome.the.humbling.nature.of.
this.metric..As.variables.with.a.less-.than-.perfect.value.are.combined,.the.
resulting.metric.becomes.lower.and.lower..This.is.clear.from.Figure 13.2..To.
some,.it.simply.looks.better.to.report.each.line.item.separately.and.forego.
the.cumulative.measure..Let’s.not.mess.up.some.good.numbers.with.facts.

Return on Assets.. If. there. is. one. higher-.level. measure. that. tells. how.
well.a.supply.chain.is.performing,.return.on.assets.is.that.measure..While.
multiple.versions.of. this.metric. exist,. they.all. include.a.numerator. that.
includes.income.and.a.denominator.that.looks.at.assets..Regardless.of.the.
specific. formula.used,.one.thing.we.know.for.certain. is. that.any.supply.
chain.problems,.including.the.consequences.of.any.risk.events,.will.show.
up.in.the.numerator.and/.or.denominator.of.this.metric..Chapter 3.illus-
trated.how.a.company.uses.return.on.assets.as.its.primary.way.to.measure.
the.performance.of.its.business.units.

• “Perfect orders”:
• Orders delivered on time
• Orders delivered complete
• Orders delivered damage free
• Orders
lled accurately
• Orders billed accurately

97%
98%

96%
97%

99%

A perfect order is an order that is delivered complete, on time, in perfect
condition, and with accurate and complete documentation.

Perfect Order Rate = 0.97 × 0.98 × 0.99 × 0.96 × 0.97 = 87.6%

figuRe 13.2
Perfect.order.measure.

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264 • Supply Chain Risk Management: An Emerging Discipline

COnCluding thOughtS

Supply.chain.managers.must.take.an.unbiased.view.of.their.performance.
measurement.systems..The.objective.here.should.be.to.take.poor.measure-
ment. systems. and. make. them. better. while. transforming. good. systems.
into.excellent.ones..One.course.of.action.is.to.assemble.internally.a.team.to.
compare.the.current.state.of.supply.chain.risk.measurement.areas.against.
an.ideal.future.state..Any.gaps.that.exist.between.the.current.and.future.
state.require.a.clear.plan.to.get.to.a.preferred.state.

While.measuring.various.dimensions.of.supply.chain.risk.is.a.worthy.
pursuit,.the.reality.is.that.risk.measurement.is.simply.an.activity..Activity.
means.nothing.unless.it.leads.to.lower.supply.chain.risk.compared.with.
what. would. likely. occur. without. the. measurement. system. in. place..
Measurement.activity.must.lead.to.accomplishment.

Summary of key points

•. A.central.question.when.thinking.about.supply.chain.risk.measure-
ment.is.whether.a.measure,.model,.or.index.is.valid.and.reliable.

•. Most. firms. have. some. sort. of. supplier. performance. measurement.
system.in.place..Fortunately,.a.set.of.best-.practice.guidelines.exists.
for.assessing.whether.a.supplier.performance.measurement.system.is.
likely.to.satisfy.its.intended.use.

•. One. type. of. measure. scores. risk. events. or. suppliers. using. derived.
algorithms.that.model.risk..Risk.indexes.are.quantitative.models.that.
consider.multiple.factors.to.arrive.at.a.single.risk.indicator.or.score.

•. A.body.of.research.is.emerging.that.counters.the.notion.that.complex.
algorithms.and.models.are.automatically.more.effective.than.simple.
rules.of.thumb.or.guidelines.when.making.organizational.decisions.

•. At.the.ERM.level,.country.risk.index.ratings.are.particularly.valu-
able.when.thinking.about.making.foreign.direct.investments..At.the.
SCRM.level,.this.information.can.influence.logistics,.sourcing,.and.
selling.behavior.

•. Total.cost.of.ownership.is.a.topic.companies.cannot.ignore.as.they.
search. for. new. and. better. ways. to. manage. supply. chain. risk.. We.
expect. to.see.at. least. three.major.supply.chain.cost.models. in.use:.
total.landed.cost.models,.supplier.performance.cost.models,.and.life-.
cycle.cost.models.

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Risk Measurement • 265

•. A.variety.of.existing.and.new.measures.are.emerging.to.help.manage.
supply.chain.risk,.including.value-.at-.risk,.time-.to-.recovery,.and.risk.
exposure.indexes.

•. Various.KPIs.will.emerge.that.support.a.company’s.risk.management.
efforts,.including.forecast.accuracy,.inventory.accuracy,.the.perfect.
order,.concept-.to-.customer.cycle.time,.order-.to-.cash.cycle.time,.and.
return. on. assets.. An. underlying. commonality. linking. these. mea-
sures.is.that.they.are.superordinate,.which.means.they.are.higher.in.
class,.rank,.or.status.compared.with.other.measures.

endnOteS

. 1.. Bialik,.Carl..“Will.This.Bridge.Fall?.It’s.Hard.to.Say.”.The Wall Street Journal,.June 1–2,.
2013:.A2.

. 2.. Sull,.D.,.and.K..Eisenhardt..“Simple.Rules.for.a.Complex.World.”.Harvard Business
Review,.90,.9.(2012):.69–74.

. 3.. Adapted.from.Dittmann,.J..Paul..“Managing.Risks.in.the.Global.Supply.Chain.”.www.
scmr.com/article/managing_risks_in_the_global_supply_chain

. 4.. Accessed.from.http://www.prsgroup.com/.ICRG_Methodology.aspx.

. 5.. For.a.PowerPoint.presentation.of.total.cost.system,.send.a.request.to.rjt2@lehigh.edu..

. 6.. Cowman,. K.. “Material. Costs.”. Materials Management and Distribution,. 49,. 7.
(September.2004):.73.

. 7.. Accessed. from. http://www.businessdictionary.com/.definition/.value-.at-.risk-.VAR.html.

. 8.. Accessed.from.http://www.prweb.com/.releases/2012/3/prweb9259939.htm,.
March 8,.2012.

. 9.. Shaw,. Tim.. “In. Search. of. the. Perfect. Order.”. Accessed. from. https://www.teradata.
com/.article.aspx?id=1646.

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