The Risk Intelligent Supply Chain for Retail

The Risk Intelligent Supply Chain for Retail Stuart Winn Senior Vice President – Marsh Inc. www.csasupplychainsummit.com Retail’s New Operating Realities  The retail industry is in the midst of perpetual change (and change = volatility) – Superstores and giant discounters are everywhere, malls are lagging, and "power towns" are surging – Savvy firms are combining bricks, clicks, and catalogs to create multi-channel retail powerhouses • Internet sales alone rose 18% in 2006 to US$104 billion – Retail productivity has increased greatly since 1995 with the development of new or remodeled stores with the latest in checkout and inventory management systems – Other technologies, such as RFID, while in somewhat limited use (relative to the opportunity) can contribute over 2% cost savings (as a % of revenue) in a retail setting – Globalization and outsourcing have become the norm Sources: Plunket Research, National Retail Federation, Retail Compliance Council 2 Retail’s New Operating Realities  The sheer number of business partners and the complexity of the industry are becoming increasingly challenging issues for retailers – When a retailer has virtually thousands of suppliers it is difficult, yet critical, to ensure performance levels are met and one’s own business is preserved  Stakeholder demands and the impacts from regulations, such as Sarbanes-Oxley, continue to present heightened business pressures – Demands greater accountability and accuracy in the reporting of financial results, increased levels of transparency and governance (board and C-suite level), and a greater need for end-to-end risk management practices Sources: Plunket Research, National Retail Federation, Retail Compliance Council 3 Retail Industry Challenges 1) 2) 3) 4) 5) 6) 7) 8) 9) 10) 11) 12) 13) 14) 15) 16) 17) 18) 19) 20) 21) 22) 23) 24) 25) Attracting and retaining employees Workforce productivity Data security Network interruption Reducing retained GL and WC loss costs Cost allocation High consumer debt Globalization Foreign sourcing/outsourcing Vendor indemnification management Product recall Creating a “customer experience” Consolidation Innovation Training at store level Business continuity “Shrink” and other product losses Workplace violence High cost of employee benefits Employment practices Logistics and transportation issues Brand integrity Quality assurance Supply chain disruptions Product/brand mix complexity High 25 Relative Cost Manage 12 7 4 19 9 22 6 13 14 24 8 21 11 16 3 17 23 18 1 2 15 20 10 5 Low Business Impact High Note: Issue placement represents a general industry perspective. Individual retail segments, as well as individual retailers, may have a very different perspective on their risk profile. 4 The Marsh Perspective • The industry has experienced significant changes over the last several decades: – – – – enhanced technological capabilities increased focus on efficiency significant reliance on outsourcing/offshoring customers with more options for what, where, when, and how to buy than ever imagined • In concert with this industry evolution has been the increased significance and materiality of risks facing the retail industry—managing the risks associated with natural hazards, terrorism, data security, biological threats, and political instability, for example, while also dealing with fierce competition and margin compression can be extremely complex and seemingly impossible at times Traditional risk transfer mechanisms, such as insurance, have become, in some cases, cost prohibitive or unavailable to cover a retailer’s full spectrum of risk • • Retailers should identify and prioritize what’s most critical and then consider the end-to-end supply chain associated with delivering those vital few aspects of their business, so they can focus their risk management capital, time, management attention, and other resources on ensuring supply chain resiliency 5 “Supply Chain” Versus “Risk Intelligent Supply Chain”  Over time, organizations have narrowed the definition such that supply chain refers more specifically to the act of managing their primary suppliers responsible for the key inputs into their product or service and less about the strategic process of creating value for the customer In the special instances when risk management was a major factor in the supply chain equation, it was always from a point-in-time perspective and not dynamic—failing to address the continuously changing business landscape Marsh focuses on the original definition of supply chain, which represents the end-to-end process, from raw material source through to the ultimate consumer, comprised of internal and external interdependent parts, that are used to generate value for an organization Marsh advocates with retailers the concept of the Risk Intelligent Supply Chain, helping them understand that this area of risk management:       is an everyday part of doing business must be done dynamically in order to address the volatility of the business environment encompasses the totality of steps in a process required to deliver something of value to the consumer Source: Ganeshan & Harrison - Introduction to Supply Chain Management, Marsh 6 First, Understand the Retail Supply Chain Design Source Produce Distribute Sell Consume Information Flows Logistics Logistics Logistics Logistics Cash Flows • Filling Unmet Customer Needs • Inventions • Innovations • Conceptualization • Specifications • Material Sourcing • Services Sourcing • Vendor Selection • Pre-Fabrication • Assembly • Manufacturing • Overseas Transport • Intermodal • Owned Stores • Third-party Stores • Outlets • Wholesaler • Liquidator • Customer (buyer) • Consumer (user) • Re-seller • Warehousing • Local Delivery • Internet/Wireless • Catalogue • Television/Radio Retailers have successfully created well-integrated supply chains, achieving significant efficiency and effectiveness 7 Logistics Next, Understand a Lot Can Go Wrong Across the Supply Chain Design Source Produce Distribute Sell Consume Information Flows Logistics Logistics Logistics Logistics Risk Risk Risk Risk Risk Logistics Risk Cash Flows • Poorly designed products can result in future recalls • Product complexity can create downstream execution issues • Failure to capture customer demands/needs can result in poor sales • Globalization and sourcing from emerging markets leaves retailers vulnerable to product safety and quality issues • Lack of ongoing monitoring of suppliers can result in degradation of product quality and service levels • Supply disruptions can bring production to a halt and impact customer perceptions • Single/sole-sourcing creates failure points • Realigning and consolidating facilities creates concentration risk • Labor disputes or stoppages could create significant disruptions • Outsourcing arrangements, although cost effective, create vulnerabilities that extend beyond the immediate business • ―Lack of product harmonization‖ (1000s of SKUs) introduces product complexity risk and additional cost • Concentration of distribution and fulfillment in few locations creates risks • The risk of significant product theft is high at this stage, possibly disrupting supply • Labor shortages or stoppages could create a disruption • Less resilient local hauling lanes create significant exposures within the last few miles of the delivery process • Concentration (measured as a % of revenue or # of stores) creates exposure • Product recall and quality issues at this stage can have significant brand implications • Rapid growth could dilute the brand if service and quality levels are not met • High turnover coupled with poor training can result in serious customer service issues • Demand volatility can complicate planning in the upstream processes • Customer perceptions (real or imagined) can play havoc on brand value and reputation • Operational failures resulting from an unplanned increase in demand can impact brand and customer loyalty • Poor handling of returns or other service issues can influence future buying behaviors 8 Retailers Must Prepare for a Disruption’s Impact on Their Supply Chain Design Source Produce Distribute Sell Consume Information Flows Logistics Logistics Logistics Cash Flows • In everything that you do, what is most critical to protect? • What would be the impact to your company if a disruption were to occur at any of these points? • Are you insured for this kind of disruption? • How would you respond and how long would it take? • What would the financial and social implications be? • How would your customers respond? • How would your competitors respond? • Could your company and your brand recover? 9 Logistics Logistics Current Solutions Fall Short of Addressing Today’s Retail Industry Complexities • Business Challenge – Demonstrate to critical stakeholders that material business risks are effectively and efficiently managed based upon the reality that there is not unlimited capital, management attention, time, or resources to manage risk Traditional Response – Attempt to manage risk across the entire organization by establishing at least a basic risk management capability to protect the broad risks faced by the organization Traditional Result – Inefficient and ineffective risk management strategy that provides superficial coverage for the organization based largely on the threat rather than the materiality of the impact • • Retailers are coming to this realization, either as a result of trying to manage the impacts of their own catastrophic business failures or through an internalization of lessons learned by peers 10 The Rationale for Transforming the Focus of Supply Chain Risk Management • • Most companies (not just in retail) underestimate the range of potential risks/impacts across their organizations Any adverse event, such as a hurricane, act of terrorism, pandemic, or something more mundane like a surge in raw material costs, could touch every part of a retailer’s business—its suppliers (and its suppliers’ suppliers), customers, shareholders, and communities in ways that many retailers have not previously (or thoroughly) considered ―Economic responsibility‖ to investors, business partners, and customers has been the traditional driver of preparedness activities to date in retail ―Social responsibility‖ is also an important concept for high profile, big-brand companies… how they choose to treat their customers, employees, and suppliers during a crisis could have a lasting impact—for better or for worse—on their reputation and public standing Despite the looming risk challenges, no organization has unlimited capital, resources, staff, time, and/or management attention to tackle all threats and vulnerabilities Retailers must challenge themselves to consider and address the broader risk issues they face • • • • 11 Why Focus on Retail Supply Chain Resilience? The traditional approach to managing a company’s operational risk has been focused almost exclusively on the transfer of risk associated with the results of a disruption based upon the history of adverse events Insurable Risks • • • • • Catastrophic disaster Property damage/loss Product liability Business interruption Others Uninsurable Risks • • • • • • Supplier non-performance Customer demand volatility Partner work stoppages Product defects/recalls Emerging risks (pandemic) Others 12 Failures, Many of Which Are Uninsurable, Can Have Major Impacts on Retailers • Based on a sample of 885 disruptions announced by publicly traded firms, companies on average experience a 107% drop in their operating income, 114% drop in return on sales, and 93% drop in return on assets Firms that experience disruptions face on average 6.92% lower sales growth, 10.66% growth in cost, and 13.88% growth in inventories More importantly, firms do not quickly recover from the negative economic and reputational consequences of disruptions Another study of 1,000 companies’ supply chain glitches determined their subsequent impacts to be an average of over 10% reductions in shareholder value Other research on the ―CPG retail tug of war‖ indicated likewise, that firms would be ―fired‖ by their customers for poor supply chain performance Average Changes to Profit and Returns Associated with Supply Chain Disruptions Sources: Hendrick and Singhal - The Effect of Supply Chain Disruptions on Long-term Shareholder Value, Profitability, and Share Price Volatility; ChainLink Research • • • • 13 Our Approach to the Risk Intelligent Supply Chain for Retail In our experience, the most rational way to begin to manage risk is to focus laser-like on those business units, products, services, and/or geographies that create the greatest value and represent the greatest potential impact to the organization. Often the best way is to bring in external expertise that is capable of helping retailers in new and powerful ways: • Better understand critical failure points along the supply chain continuum by helping them to prioritize specific and unique value drivers that are critical to the success of their business • Assess the risks of a critical brand, product, or service; then maps resources to critical processes that will enable retailers to uncover the dependencies and skills required to maintain their operations (and presumably, optimize the built-in efficiency of their supply chain in times of ―normalcy‖—not just disruption) We recommend selecting a partner with the breadth of industry expertise, and relevant capabilities to enhance and optimize resilience throughout the supply chain, so that it is truly adaptive to the dynamic retail environment 14 Supply Chain Performance Has Greatly Improved Over the Past Several Decades • Retailers have been successfully optimizing their supply chains based on cost and service for years • Globalization, outsourcing, offshoring, the Internet, ―just-in-time‖, site consolidation, and other productivity efforts have greatly benefited the industry Better Better • More products/services • Higher service levels • Order cycle times • Cash to cash • Active assets • Reduced operating costs • Greater throughput • Greater efficiencies • Fewer assets High Cost Current Performance Faster Faster Cheaper But Is Optimized Optimum? High Acceptable Low Unacceptable Service 15 Balancing “Better, Faster, and Cheaper” With a Heightened Risk Awareness • Progressive companies are including ―risk‖ as a key input in their strategic and tactical supply chain decisions • Many of our clients are realizing that as they have reduced supply chain costs, they have unintentionally increased their risk Risk Management Strategy Risk Management Strategy Risk Profile Risk Profile Cost Cost ―Better, faster and cheaper‖ Efficiency Efficiency 16 Balancing cost/risk trade-offs All Resource Interdependencies Along the Supply Chain Are Typically Unknown Resource Dependencies People Technology & Processing Physical Relationships This knowledge gap is compounded by the fact that the responsibility for managing risk is typically fragmented across business units, brands, product lines, and geographies 17 Prioritize the Specific Aspects of the Business That Are Critical to Success All Retailer X’s brands, products, services, and geographies Retailer X’s Business Priorities (contribution to overall value of the organization) Value Filter Retailer X’s critical brands, products, services, and geographies i.e. Brand XYZ All business lines contributing value to the organization (and all associated internal & external support resources) Valuation (factors to consider) Quantitative factors: Revenue value Asset value Cash flow value Qualitative factors: Brand Compliance Strategy Based on the value assessment, management establishes priorities based upon which to allocate time, management attention, resources, and capital 18 Retailers Must Consider and Map the Entire End-to-End Supply Chain Brand XYZ BUSINESS VALUE DRIVER Brand XYZ External Source Source Source Suppliers Design Sourcing PROCESSES (Supply/supply chain) Production Distribution Sales External Source Source Source Customers People Process Tech & Physical Relationships Process Process Processing RESOURCES People Process Technology and Processing Process Physical Process Relationships 19 Map Resources to Critical Processes and Skills Required to Maintain Operations Resources People Process Technology and Processing Process Physical Process Relationships General public Store Employees Electronic data Equipment Contingent work force Electronic applications Nonphysical infrastructure Facility External suppliers Corporate Functions Raw materials Internal suppliers Cash and currency Investors Customers/Consumers Identify the dependencies and skills required to maintain operation of the supply chain and ensure they are appropriately protected in order to provide greater supply chain resilience Inventory Work in progress Liquidators Vital records Regulators Supplies Other tangible assets (i.e. Public Infrastructure) Industry consortiums Third-party service providers Auditors Insurers 20 Identify and Implement Reality-Based Solutions for “At Risk” Resources ―At Risk‖ Resources People • The retailer’s warehouse supervisor is the only person who knows how to reboot the product tracking application if it fails Potential Solutions • Identify potential candidates for cross-training and train at least 3 people (3 levels of succession) to eliminate this dependency Technology & Processing • Inventory balances must be updated and reconciled daily in order to ensure proper financial and compliance reporting • Incorporate the inventory system into the IT disaster recovery plan with a recovery time objective of less than 1 day and develop a business recovery plan with manual workarounds for inventory balance updates and reconciliations in case of a total IT failure • Perform a regional risk assessment, develop appropriate emergency response and contingency plans, identify opportunities to improve security and other mitigation activities, and also take into account the current concentration of stores when evaluating future locations Physical • 48% of all corporate-owned stores are within 15 miles of Los Angeles, which represents a significant concentration risk exposure should a regional event occur Relationships • A retailer’s best selling product is solesourced though a supplier with one manufacturing location • Review and enhance service level agreements with the existing supplier, determine if the supplier has a business recovery plan, and identify alternate suppliers who could produce the product in the event of a supplier disruption 21 Create a Roadmap Outlining the Implementation Process 22 Then Make the Supply Chain Risk Intelligent and Responsive • Take the static view of the newly mitigated supply chain • Layer the supply chain over an intelligent source of data that enables the dynamic monitoring of risk along each critical resource of the supply chain • Create alerts by threat, severity, or geography that provide 24x7 monitoring of the supply chain and enable business leaders to be aware of issues on a real-time basis Respond to material and relevant supply chain risks on an ongoing basis using a global dashboard and stay abreast of the changing business landscape by tracking risk profile changes over time 23 • Act Watch FYI Easy Jean Co. Example Disclaimer: This example is based on a fictional client though the scenarios, risks, and solutions are based upon our actual experience in the retail industry • • Easy Jean Co. is a U.S.-based retailer of teen apparel 200 stores in the U.S. and is slowly expanding into Europe with 4 current stores and 6 more planned for 2008 Flagship store is based in New York City Clothing design has 20 employees and is based entirely in New York City, though 5 former designers are based in Hong Kong to work with suppliers in the region Material sourcing and production are performed entirely in Malaysia, with the exception of Easy Jean’s underperforming premium brand, Elite Jeans, which is sourced from Mexico and manufactured in California Jeans represent 80% of the company’s total revenues, 25% of which are generated through the NY flagship store Accessories are a high-margin and growing source of revenue for Easy Jean Co. Other products include knits, wovens, and a variety of seasonal products • • • • • • 24 Easy Jean Co.’s Priority—Its Jean Product-Line All Easy Jean Products Easy Jean’s Business Priorities (contribution to overall value of the organization) Value Filter Easy Jean’s Critical Products Accessories Jeans Jeans Accessories All business lines contributing value to the organization (and all associated internal & external support resources) Valuation (factors to consider) Quantitative factors: Revenue value Asset value Cash flow value Qualitative factors: Brand Compliance Strategy Based on the value assessment, management establishes priorities based upon which to allocate time, management attention, resources, and capital 25 The Jean Product-Line’s Critical Supply Chain and Key Risk Issues Conceptual Design Technical Specifications Prototype Fulfillment Production and Delivery Sourcing Point of Sale Direct & Indirect:  Manufacturer  Fabric/Thread  Buttons  Artwork  Colors/Dying  Inner Lining  Labels/Hang Tags  Hangers/Packaging  Shippers • Design flaws • Missed trends • Costly design • Lagging trends • Low or no demand • Design cycle time • Supplier issues • Material quality and safety • Tariffs and quotas • Production failure • Late delivery • Late/under • Product quality delivery and safety • Sales/market issues • Product quality • Transport expenses • Shrink • Retail disruptions • Late/under delivery • Product recall • Shrink • Retail disruptions 26 Mapping the Jean Process to Critical Resources Is Vital to Managing Risk Conceptual Design Technical Specifications Sourcing Prototype Fulfillment Production and Delivery Point of Sale Direct & Indirect:  Manufacturer  Fabric/Thread  Buttons  Artwork  Colors/Dying  Inner Lining  Labels/Hang Tags  Hangers/Packaging  Shippers Resource Dependencies People Technology & Processing Physical Relationships 27 Analysis Uncovered Several Exposures for the Jean Product-Line ―At Risk‖ Resources People • Designer concentration within the flagship building in NYC Potential Solutions • Evaluate opportunities to reduce the concentration, though should a failure occur, create a work-around so former designers can re-run an entire previous season’s line, with limited updates and changes, from the Hong Kong office location • Develop an IT disaster recovery plan with a a risk appropriate recovery time objective, invest in alternate recovery capabilities, and develop store-level manual work-arounds for sales transactions while the IT system is unavailable • Perform a local risk assessment, ensure appropriate insurance coverages are in place, develop emergency response and evacuation plans, identify opportunities to improve security and proactively identify alternate recovery locations in the city in case of the loss of the flagship • Review and enhance service level agreements with the existing supplier, determine if the supplier has a business recovery plan, and in the event of a disruption cease production of the Elite brand in California and use that capacity to produce the core jean product Technology & Processing • The data center for the 200 store network is located in the flagship store building and no alternate recovery capability exists Physical • Loss of the flagship would put 25% of the company’s revenue at risk Relationships • The core jean product is sole-sourced and entirely manufactured in Malaysia and the loss of the core-line represents 75% of the company’s revenue (Elite represents 5%) 28 Easy Jean Creates a Risk Intelligent Supply Chain and Response Protocols  Port worker labor strike breaks out in Malaysia resulting in closure of the port  Easy Jean VP of Operations is sent a notification on his BlackBerry from the supply chain risk management tool The VP of Operations calls the GM of the Malaysia manufacturing facility and determines the disruption will last at least 3 weeks The VP of Operations then convenes the crisis management team and activates the business continuity plan The plan shifts production resources to the California-based production facility where the core jean product line will be produced and the premium jean product line will be halted for the duration of the disruption Port closers due to labor strike     In addition, the crisis management team secures access capacity at a third-party manufacturer in Macedonia, days ahead of other competitors who are dealing with the same problem, enabling Easy Jean to maintain near normal operational capacity while its competitors have limited access to alternative manufacturing capabilities 29 The Upside of the Risk Intelligent Supply Chain   Positions retailers to focus on and protect (e.g. crisis, incident, and continuity management) the most critical aspects of their business Provides insight into critical risks and vulnerabilities while helping senior executives better understand processes and resources and how they enable success Prioritizes planning and risk management activities, efficiently and effectively allocating capital, management attention, time, and other finite resources Establishes a linkage and balance between risk mitigation, risk financing, and risk transfer strategies – Broader perspective on risk and an enhanced capability to monitor and respond to issues on a dynamic basis will result in a more robust and strategic risk management competency within the organization – New market capacity for risk transfer, that was previously unavailable, may surface based on insurers having a better understanding of the risk and more comfort in a retailer’s capability to manage that risk   30 The hypothetical case studies contained herein are for illustration purposes only and should not be relied upon as governing your specific facts and circumstances. All policy terms, conditions, limits, and exclusions are subject to individual underwriting review and are subject to change. The information contained herein is based on sources we believe reliable, but we do not guarantee its accuracy. It should be understood to be general risk management and insurance information only. Marsh makes no representations or warranties, expressed or implied, concerning the financial condition, solvency, or application of policy wordings of insurers or reinsurers. The information contained in this publication provides only a general overview of subjects covered, is not intended to be taken as advice regarding any individual situation, and should not be relied upon as such. Statements concerning tax and/or legal matters should be understood to be general observations based solely on our experience as risk consultants and insurance brokers and should not be relied upon as tax and/or legal advice, which we are not authorized to provide. Insureds should consult their own qualified insurance, tax and/or legal advisors regarding specific risk management and insurance coverage issues. This document or any portion of the information it contains may not be copied or reproduced in any form without the permission of Marsh Inc., except that clients of any of the companies of MMC need not obtain such permission when using this report for their internal purposes so long as this page is included with all such copies or reproductions. Marsh is part of the family of MMC companies, including Kroll, Guy Carpenter, Mercer Human Resource Consulting (including Mercer Health & Benefits, Mercer HR Services, and Mercer Global Investments), the Oliver Wyman Group (including Lippincott and NERA Economic Consulting), and Putnam Investments. Copyright 2007 Marsh Inc. All rights reserved. MA7-10264 31