When Danny Boeykens, a partner at MÖBIUS, a European boutique consulting firm, read my posting on “Supplier Risk Management and the Automotive Supply Chain,” he pointed me to a Financial Times article by Richard Milne that provides a European perspective on this problem.   

As stated in the article, “When Edscha, a German manufacturer of sun roofs, door hinges and other car parts, filed for insolvency [in February], it presented BMW with a crisis. The luxury carmaker was about to introduce its new Z4 convertible—and Edscha supplied its roof.”  BMW did not want to go to another supplier, as that would have delayed the launch by six months.  And it is not just Edscha that fell into financial trouble—BMW, Audi and Mercedes are jointly helping out several other suppliers with money and other tools for the same reason.

Not surprisingly, BMW has increased the staff at its risk monitoring department.

So, what processes and policies should companies put in place surrounding supplier risk management?  The FT article highlights four steps proposed by The Swiss Federal Institute of Technology (ETH) in Zurich.  I recommend you read the article for more details, but here is a quick summary:

• Establish a rating system for a company’s main suppliers. “The ratings should be based on financial information, with cash flow more important in many cases than profitability.”  It’s also important to understand the ownership structure of your suppliers, if any hedge funds or private equity firms are invested, for example.
• Set up an early warning system with visibility to operational and financial issues, such as a decline in product quality or requests for changing payment terms.  The article highlights an online system Daimler has implemented, where suppliers need to provide supply chain information, such as capacity and inventory data, and if any problems arise, red or yellow lights flash on a dashboard.
• Identify your critical components and all the suppliers involved, including second- and third-tier suppliers.
• Examine interdependencies between suppliers.  ETH research suggests that if one supplier (say Michelin in France) goes bankrupt, the probability of another supplier in the same industry (say Goodyear in the U.S.) going bankrupt increases.

MÖBIUS’s interest in supplier risk management has led them to develop a solution that expresses risk (and mitigation) in terms of EBITDA. The idea is to model a corporate supply chain (a) without risk, (b) with risk, (c) and with risk and mitigation, and compare the differences in EBITDA between the different scenarios.

The engine of the solution is based on simulation technology. This graphical tool allows a company to analyze the impact upstream and downstream of the supply chain nodes where risk might occur. This way a company can get a more comprehensive and systematic overview of its supplier risks and mitigation costs across the entire supply chain.  The particular supply chain model is validated by feeding last year’s actual results into it, and then verifying whether the EBITDA (no risk situation) coming out of the model reflects last year’s results.