Risk management: How to understand supply-chain risk

With infrastructure projects growing in size and complexity, managing supply chain risk has risen to the top of the priority list for contractors and project managers.

For some time, tier one contractors have tended to assume more risk; leaving those nearer the other end of the chain with little accountability. This top-down approach to risk management is unfair to those higher up the chain, who are forced to shoulder the greatest burden of risk and pay the highest price if things go wrong.

Understanding the need to rebalance risk v reward

Regardless of their position in the supply chain, many contractors are feeling the pressure of tight operating margins and dwindling cash reserves. Some are choosing to push back on contractual terms in order to reduce their liabilities. Despite realising this could make it more difficult for them to win work in the future, they are increasingly cautious about agreeing to terms that could leave them out of business. Simply pushing risk up or down the chain is not sustainable and a whole-supply-chain approach to risk management is needed.

Find a strategy that works for all

Regardless of the scale of a specific project or programme, partners require a strategy for managing supply-chain risk which will allow them to profit from their involvement. On specialist or highly-complex projects, a project managers’ experience can be responsible for ensuring projects stay on-budget and on-time. By using quantitative risk assessment at an early stage in the process, contractors will gain a better understanding of the extent of their risk exposure; allowing them to price their activities accordingly.

Be proactive

Often, it is expected that liability will sit with the main contractor. However, a clear distinction must be made between the party that is liable and that responsible for managing risk. Although a contractor may be primarily responsible for the management of risk, its customer may need to accept financial ownership. This can be achieved by ensuring that risk terms are drafted into contracts and attributed to a stakeholder at the outset. Taking time to fully understand the risks and consequences during tender and procurement processes will encourage suppliers at all levels to accept some degree of liability.

Be realistic

Contractors must be clear about their expectations of those lower down the chain. If the risk vs reward ratio needs to be rebalanced, they may need to confront suppliers or customers to address this. Naturally, businesses operating with minimal cash reserves will be averse to absorbing additional risk, so contractors may need to take this into account.

For a fairer distribution of risk and rewards and a shift in responsibility to be achieved, the supply chain needs to work in a joined-up way.

First Published at Supply Management magazine.