Risk Management in Construction Supply Process
Krishnan Sampath, PhD, MBA, MA, MPhil, SMP from IIMC, PGDMM
Veteran (Airforce), Business Leader, Mentor & CxO of CE and Construction Industry
INTRODUCTION
?
There is an old adage in Tamil – When a poor salt vendor sets out to sell his salt, rain comes, when he tries to sell cotton, storm is his unexpected guest, goes the saying. But he still venture out to carry on his business, unmindful of the risks he encounters day in and day out in his small enterprising struggle.
?
Risks in supply process are enormous. With modern day supply networks connecting various stake holders each trying to maximize their own supply profits, risks as common to all need to be addressed, particularly in short gestation project environments.
?
There are many uncertain moments in a supply process. A fire accident few years ago in Hanil Lear, the only vendor then to supply car seats, near Chennai put Hyundai motors operations on hold for three good days. So was the recent case of Tata Motors short in production targets with Mico, the fuel injection pump vendor, caught under the clouds of recent Jaipur Oil inferno. Labour unrests in auto components hub of India- Gurgaon pushed many automobile manufacturers in hardship. Indian government early in the year imposing unexpected import restrictions in tubular products in the form of advance license has made many a companies in the offshore oil and gas business incur additional opportunity costs and loose precious weather window available to them.??
?
These incidents are not isolated. Many uncertain actions subject the supply process into tremendous stress leading to losses. Can one control uncertain actions – the answer is a big NO. So what next, can a business enterprise sham away the uncertain future, certainly not. Then what happens is what is interesting study and is the focus manipulated by the authors. Risks are ‘Danger’ on the one side and ‘Opportunity’ on the other, describes Aswath Damodaran. He also recommends that risks are to be challenged and risks are to be seen as opportunities waiting to happen and explored.
?
RISK – AN UNDERSTANDING THROUGH LITERATURE
?
Australian and New Zealand standards define risk management as the culture, processes, and structures that are directed towards?effective management of potential opportunities and adverse effects (AS/NZS 4360:1999).
?
Aswath Damodaran describes Risk as “combination of Danger and Opportunity – representing both downside and upside of Risk”. He opines that minimizing risk exposure would also reduce the potential for opportunity. Interestingly, he links rewards to risk exposure, in his book Strategic Risk Taking.
?
A McKinsey Global survey in 2006 brings out that ‘Risks in supply chain are growing’.
Aberdeen group in 2008 finds out in a study that growing global operations and volatile global economy are two primary reasons for enterprises to focus on Supply chain risk management practices. The primary risks as identified by Aberdeen survey are supplier risk profile and logistics congestion.
?
Risks lurk along the entire length of supply chains, and are as diverse as political instability, exchange rates, carriage capacity, shelf life, and customer demand, describes David Stauffer (HBS WKS, 2003). He emphasize that while larger risks were carefully looked into, smaller and mundane risks receives less attention.?It is appropriate to note that demand fluctuations itself is seen as a risk, supply abundance is also seen as a risk, explains Prof Ananthraman of HBS.
?
It is argued by Marsh consulting that financial performance is closely linked to supply risks which say “In today’s increasingly complex environment, risk-adjusted supply chain management can translate to improved financial performance and competitive advantage”. Authors would like to draw inferences from the concept of supply chain profit advocated by Chopra and Meindll(2007)relative to financial performance in managing supply chain risks.
?
Supply chain disruptions ‘also can damage credibility with investors and other stakeholders thereby driving up cost of capital’ argues Russ Bosman of FMGlobal. In one industry after another, supply chains have stretched farther than they’ve ever stretched in the past and resultant fear is consequences of a more severe disruption – read risk, rues Russ. Globalization and lean inventory to free up resources have seen more intense debates over risks they posed and opportunities of potential bottom line improvements experienced by companies’ world over.
?
Prof. Yanni Papadakis of Drexel university clearly links strategic importance of risk management in his ‘event study of Operational risk and supply chain Design’. He argues that a risk management policy alleviate adverse impacts of disaster induced supply disruptions.
?
TYPES OF SUPPLY CHAIN RISKS
?
There are numerous types of supply risks. Some of the significant risks in a supply chain may be categorized as:
a)????Supplier risks
b)???Logistics risks
c)????Financial risks
d)???Demand and supply risks
e)????Political/policy change risks
f)????Environmental and non environmental risks
g)???Inhouse risks – Design changes
?
Operational level risks can be classified as process related and product related both requiring different strategies.?Process risks can be best described as:
a)????Design changes risk
b)???Certification issues/risk
c)????Safety risk
d)???Documentation in international logistics / International payouts risk
e)????Duties and regulations risk
f)????Absence of management support in risk management
?
Some of the product risks can be described as:
a)????Product failure
b)???Supplier capacity
c)????Quality issues
d)???Raw material shortfall / excess risk
e)????Cash flow risk
f)????Local resources availability
?
Risk management as a strategy
?
Supply process risks are not unknown for the business community which gives night mares to operational folks. This is more than evident in construction projects. It can’t be a show stopper for a high risk, time starved and weather strained offshore oil and gas projects. More the risks, more the business success, if challenged properly and executed.
We’ll explore further in the following sessions.
?
The author recalls his strategy lessons from Strategic Management Program of IIM Calcutta, where Prof Biswatosh Saha, explains what a strategy is and how it should be developed. ‘Expecting the unexpected’ was what he has started his strategy classes to students. This essentially means that risk management is forward looking.
?
Prof. Yanni Papadakis of Drexel University too aligns a company’s financial performance to that of supply chain strategy with a particular reference to risk management. He further argues that the impact of supply disruptions may test if supply chain management affects company’s risk structure.?
?
Risk is a strategic management. Failure to forecast risk is strategic failure and cannot qualify for successful operational forecasts. The operational inefficiencies forced on the manufacturers due to risks create significant management challenges in the short term. It calls for prudent management strategies in supply management context.
?
Hence, it is worth investing in developing supply chain strategies with appropriate risk profiling done on possible disruptions and uncertain variables present not just with the supply network but across the business spectrum. This will help enterprises face all the three dimensions of risks such as risk pass through, risks to avoid and risks to seek out.
?
?
POSITIVE / UPSIDE EFFECTS OF RISK
?
RISK AND INNOVATION
Risk taking plays creating innovation, argues Aswath Damodaran. Contrary to traditional grouting system for sub sea pipe lines by grout bags filled with a particular type of cement, a new design was developed by Leighton in one of its projects in western coast of India. The new system was for creating a sub sea concrete mattresses pre cast in on shore location and transported on barges to actual installation locations in high seas. The design was not approved by the client initially; however, Leighton confidently went ahead with the new design and laid the sub sea rigid pipes with these mattresses. While the variation was challenged by the client, pass over of season one has proved that this system was far more convenient, superior and cost saving. The trade off though was split in use of grout bags and mattresses among different pipeline sizes, ultimately, it resulted in significant cost and time savings for both.
?
TRIGGERS FOR NEGATIVE / DOWNSIDE EFFECTS OF RISK
?
DESIGN CHANGES
领英推荐
A design change during the course of project execution is a significant risk altering the total material forecast. Material take off (MTO) is a critical input in planning the total supply process in a construction industry. Since material management / inventory planning is charged to project in total, replenishment strategies do not exist in construction environment. Therefore any change in design triggers a fresh sourcing process. Also, specialized materials in offshore oil and gas projects commands a significant lead time since the supply is under make-to-order process.?This context of operation is derailed resulting in time and cost overruns. Significantly, this is one of the core issues affecting the credibility of whole industry which may result in bad brand value.
?
Design changes are of two pronged. They could be due to site conditions either due to faulty survey/estimation or site conditions not suitable for choice of process. For instance, soil conditions would have changed after a rainfall or an earthquake in the region, or increased hydrostatic upward pressure which would need additional reinforcement to prevent seepage from ground.
?
Design changes also occur due to change in client preferences or technical compliances. In one of the electronic factory projects in India, Leighton has to change the flooring system immediately after construction due to increased static discharges being observed during factory operations.
?
These changes in design due to what so ever reasons affect the overall supply process there by resulting in time and cost overruns. The cost impact of such time overruns significantly alter the project completion timeline.
?
CHANGE IN PRIORITY
Client initiated and Site conditions
A change in design either at the drawing board or due to site conditions change the operation priority. Another big reason for change in execution priority is accessibility & feasibility issues at sites. A schedule MTO planned over a span of the project based on the execution plan. Electrical systems need to be installed after civil works are completed. Similarly, false roofing systems would come after electrical systems and HVAC are installed. The order does not change for things to fall in place. But many changes happen at site level. They invariably stretch the project completion timeline. In an offshore situation, the priorities change for various reasons such as client initiated, weather vagaries, conflict among various sub contractors, surprises in location-due to faulty surveys etc. However, such changes place exceptional pressure on supply process. As discussed previously, materials in this segment are of make-to-order quantity and quality. The supply spread is based on execution priority as agreed and approved by stakeholders. A supply manager cannot be expected to ensure supplies on sudden change of events and developments. However, things are different in construction and hence, sourcing efforts would continue albeit at premium and added priority freight costs.
?
Changes are variations. They are significant triggers of risk. They fire additional resources in order to meet the changes. Contractual obligations are strained, confidence level alters and brand image is weakened. However, changes cannot be avoided, but need to be forecasted in order to minimize the risk exposure.
?
TOO MUCH DEPENDENCE ON COST FACTOR – A RISK
?
Modern day supply management techniques focus too much on cost factor. Lean supply chains, limited vendor base, dependency on just in time and make-to-order are good as long as they work. Absence of Plan ‘B’ in failure of these concepts proves very catastrophic to enterprises. Examples are aplenty – Hanil Lear and Hyundai for seats, Mico and Tata for fuel injection pumps are a few to name.
?
Cost is a primary factor in any business enterprise. Making money is the process of business. However, this concept has to be prudently applied in risk management. Too much dependency would derail the risk mapping of a project. Adequate contingencies to meet any risk and uncertain situations shall have to be committed in project plans. Compromise in quality of products for cost considerations would result in greater risk to loss of life and materials. Projects in high risk industry such as offshore oil and gas and construction would need adequate protection from risk arising out of cost cutting.
?
Other potential triggers for risks could be Outsourcing risks, too much dependency on particular supply source and customer himself being a risk on many a situation.
?
Customer – A risk in himself? Some times many disruptions affect due to change in market conditions, choices by clients or client representatives. This is very much relative to construction industry. Also, priority of requirement affects the schedules there by disrupting the supply flow. Projects are put into a limbo for a particular choice of material. Customer suggestions and improvements during mid project reviews create a situation where in the schedules changed to accommodate the variations.
?
Outsourcing risks Engineering and procurement contracts generally outsource major packages to keep the project moving on fast track. Careful selection of sub contractors becomes very important criteria for successful completion of projects. Sub contractor financial capacity, operational efficiencies, design & engineering strengths and quality standards shall have to be very carefully evaluated prior to award of sub contracts to them. Similarly, the primary contractor shall have to ensure that sufficient provisions have been made to meet any uncertain events or under performance by the sub contractors. Plan ‘B’ – in corporate terms, could well augment risk mitigation strategy in the event of such uncertain moments.
?
Dependency as a risk : Companies build relationship over a period of time. Managers tend to trust in past performance while awarding new contracts. This system has known to be effective in most occasions. A dependency based on past performance has set to creep in the ordering system. However, it would be prudent on the part of supply / contract managers to evaluate the capacities of the vendor every time requirements come up. This would basically help supply managers to get best deals based on prevailing market prices and also will assure them of uninterrupted supplies.
?
?
Looking forward
Aswath Damodaran clearly sets out classification risks in to the following:
?
-??????Risks to pass through
-??????Risks to seek out
-??????Risks to avoid or hedge
?
A careful analysis of risks in hand would help supply managers to decide whether to seek that risk or to hedge or to pass through to other stakeholders in the chain. When a risk is clearly expected during the supply process, if the returns are expected to be high, hedging would be the best mitigation strategy. Similarly, supply managers would also have to consider when to avoid a risk if the resultant returns are expected to be in the negative.
?
Some of the characteristics of risk mitigation strategy could be a clear visibility of supply process amongst all stakeholders of the chain, control procedures in place, continuous monitoring of the process and confidence in the process itself. Ensuring continuity and adequate protection mechanism in the form of hedging also helps in facing the disruptions. Logical payoffs and tradeoffs would go a long way in ensuring converting the dangers into opportunities and liquidating the risks.
?
Another important factor in risk liquidity would be adequate frame work and organizational support spread across enterprise. Enterprise level risk management strategy would add strength and convey the confidence to executives in handling and liquidating disruptions during a supply process. The key to success is not to avoid risks but to analyze the risks, weigh the pros and cons, calculate the loss and gains and hedge if necessary and drop out if loss outweighs gains.
?
???????????????????????
?
?
?
?
?
?
References:
?
1.????????Strategic Risk Taking, Aswath Damodaran, Professor of Finance and David Margolis Teaching Fellow at the Stern School of Business at New York University, Damodaran Online,
2.????????Supply chain risk management – Building a resilient global supply chain, Aberdeen Group, 2008
3.????????Supply Chain Management, Chopra & Meindl, Prentice Hall, 2007
4.????????Supply Chain Management in Saudi Construction Industry, Maged Al Mahabashi, 2007
5.????????Supply Chains at Risk, By Doug Bartholomew, 2006 – Resource from www.industryweek.com, assessed on 05 Nov 09.
6.????????Understanding supply chain risk – a McKinsey Global Survey,?The McKinsey Quarterly, 2006.
7.????????The new supply chain challenge : Risk Management in a Global Economy, Rudd Bosman, FM Global, 2006
8.????????Supply Chain Risk – Deal With It, David Stauffer, HBS Working Knowledge series, 2003
9.????????Operations Risk & Supply Chain Design: An Event Study, Yanni Papadakis, Drexel University, 2002
10.??????AS/NZS 4360: Risk Management is the Australian and New Zealand joint Risk Management Standard.It was published originally in November 1995 and substantially revised and republished in April 1999.
Web Resources accessed on 05 Nov 09 from :