7 Basic Types of Supply Chain Risks

With new products constantly entering the markets and increased availability of international trading, supply chains are now more complex than ever before. A supply chain is a logistical system consisting of the buying company and its partners, such as suppliers, delivery agents, and distributors, that encompasses the process of turning raw materials or goods into the final product and distributing them to customers.

Functional supply chains are essential for businesses to succeed, so stakeholders prioritize ensuring their stability. As with any complex system, supply chains are exposed to various risks that might disrupt a company's operations and impact profitability.

In this article, we cover the 7 main categories of supply chain risks that companies should be aware of and strategies to mitigate them.

What Are Supply Chain Risks?

Supply disruption is defined as any unforeseen event that disturbs a supply chain's normal flow of goods and materials. Such disruptions can result in production disruptions, hampered productivity, and major negative consequences for business operations.

In the short term, supply chain disruptions can cause a company to be unable to fulfill customers' demands. In the long run, supply disruptions can also negatively affect the company's financial performance, liquidity, and share price.

Supply disruptions can be caused by various factors, some of them internal and others external. Internal supply chain risks are related to the company's own operations, for example, inefficient purchase order approval workflow or inaccurate budget estimates. External supply chain risks, however, relate to conditions outside the company's influence, such as market tendencies, political climate, or regulatory environment.

Importance of Supply Chain Risk Management

Risk management is an important component of a general supply chain management strategy. Businesses that know how to recognize risks in time can prevent unfavorable situations from happening or mitigate negative impacts. As a result, they can ensure stable supply chain operations and competitive advantage due to financial and reputational durability of the business.

Supply chain risk management is the process of identifying and assessing risks pertaining to the supply chain, reducing or eliminating the possibility of their occurrence, and dealing with their eventual consequences. It is a comprehensive task that requires hands-on knowledge of the company’s internal processes, clear understanding of its weaknesses and strengths, as well as extensive insights into the market trends. Supply chain risk management is one of the top priorities of procurement professionals.

Identify and Mitigate the Most Common Risks

Identifying specific risks is the first step in any risk management process. Let's look at the most common risks that can affect supply chains.

1. Financial risk

Financial risks are caused by unfavorable economic factors that involved parties can control to a greater or lesser extent. For instance, these risks include unexpected or adverse fluctuation in exchange rates, sudden cost increases, credit issues, or bankruptcy of the involved company.

Financial risks can affect both buyers and suppliers and impose significant financial restraints on the entire supply chain. For instance, a sudden depreciation of the buyer's currency can cause a sudden price shift and increase the cost of imported goods. Budget overruns might tie the buyer's hands while placing the following orders. If the purchasing company has credit issues and cannot request additional funding, it might not be able to secure the required goods at all.

Some examples of financial risks include missing out on early-bird pricing or facing late-payment penalties due to missing order milestones. Other risk factors, such as changes in the scope of work, might force the deal review.

Mitigation strategies

Conduct a thorough assessment of the partner. Taking due diligence seriously is the first risk mitigation strategy that both buying and selling companies should adopt. By evaluating the counterparty's financial stability and credit health, both the supplier and the client can minimize the risk of insolvency.

Hedge against currency fluctuations. By using financial instruments like derivatives, companies can protect the price of future purchases against adverse exchange rate movements.

Negotiate long-term contracts. By fixing a price and signing a long-term contract, both sides of the deal can prevent cost volatility and ensure budget predictability.

Diversify the sources of financing. Ensuring access to multiple finance sources can help avoid liquidity issues. Securing plan B or even C to get the cash to pay obligations is always a good idea.

2. Geopolitical risk

This type of supply chain risk encompasses disruptions arising from political instability, regulatory changes, or trade restrictions. Political upheavals, changes in government policies, or trade wars can often surprise companies and drastically impact their budgets, P&L, and even prospects of staying on the market.

Many existing companies—suppliers or buyers—can experience difficulties adapting to the new market situation. Sourcing efforts, especially those in cheaper but less stable countries, must consider the potential for geopolitical disruptions.

Mitigation strategies

Stay informed about the geopolitical situation. By regularly monitoring the political and economic situation in the region of supply chain agents, the business can ensure it won't be surprised by regulatory or political shifts.

Diversify the supply chain geographically. Spreading the supply chain across different regions is one way to minimize the impact of geopolitical instability. With globalization, it's become easier to spread your eggs across different baskets, so to speak, by finding alternative sourcing options across various regions.

Involve trade and legal experts. By engaging with experts specializing in international trade regulations and law, companies can minimize the risk of facing the reputational or financial consequences of the supplier's instability. Instead of trying to catch up with the latest social and legal developments in the affected regions, company stakeholders can outsource this task to the experts mentioned above and rely on their feedback when deciding on the next steps.

Prepare contingency plans. Developing action plans for possible geopolitical instabilities is a way to mitigate this risk. This is especially critical for material-dependent productions and industries where switching to an alternative supplier can be challenging. Contingency plans might include, for instance, re-allocation of costs within the company to secure the order, changing the sourcing strategies to work with the available amount of goods or services available under budget, or passing certifications to comply with the newly established regulations. Numerous industry-related factors have to be considered while developing the contingency plan.

3. Environmental risk

In the sourcing process, environmental risks can be approached from two points of view.

Firstly, environmental risk is represented by events related to natural disasters or climate changes that can disrupt supply chain operations. Such events include, for example, earthquakes, floods, and hurricanes that disrupt delivery routes and schedules. At the same time, climate change can cause resource scarcity and disrupt the availability of goods.

A second aspect of environmental risk to the supply chain is that organizations can negatively impact water, air, and soil through discharges, emissions, and other forms of waste. Both suppliers and customers have to consider any associated environmental risk and environmental laws surrounding them. If one company finds out that the counterparty isn't compliant with their corporate environmental responsibility principles, the deal might be off the table.

Mitigation strategies

Identify and monitor potential environmental risks. By identifying potential risks and thoroughly assessing them, companies can evaluate the probability of unfortunate events and predict the possible character of the natural disaster.

Develop a response and recovery plan. By creating and regularly updating a robust response plan, companies can ensure they are prepared for a prompt response in the event of a natural disaster. Developing strategies to use alternative suppliers and delivery routes can also help the buyer to ensure business continuity and mitigate the impact of the unfortunate event on the supply chain.

Invest in sustainable practices. Prioritizing sustainable sourcing and production practices can help companies align with market trends arising from environmental concerns and, as a result, reduce the long-term impact of climate change on their operations.

Evaluate the corporate practices of potential supply chain partners. By conducting extensive due diligence on potential suppliers, delivery companies, and other supply chain stakeholders, the buying company can better evaluate the production and operational practices of the other parties. This way, they’ll only contract supply chain agencies that comply with their corporate environmental responsibility principles.

4. Supply risk

This risk arises when requested goods or services are unavailable or suddenly become scarce, insufficient, or delayed. Supply disruptions can happen for various reasons, including, but not limited to, supplier bankruptcy and capacity constraints, quality problems in a batch of goods or materials, geopolitical issues, or natural disasters. Goods from global supply chains are especially vulnerable when it comes to availability, as a change of circumstances in one country can cause disruptions in availability and delivery elsewhere in the world.

Healthy supply chains rely on suppliers. Poor supplier relationships and lack of accountability from the supplier's side can also threaten supply stability and lead to unexpected shortages.

Mitigation strategies

Adjust inventory levels. By maintaining an inventory buffer, also known as a safety stock of critically important goods and materials, companies can deal with the immediate supply shortage without jeopardizing operations.

Invest in supplier relationships. Developing strong collaborative relationships with suppliers—especially the key suppliers—is a way to secure priority for the company's order in terms of supply shortages. Trustful supplier relationships also facilitate open communication and cooperative problem-solving, which is critical in times of instability. When there is a trustful partnership between buyer and supplier, the latter will feel incentivized to come forward with their concerns and discuss how to tackle the anticipated problems.

Conduct regular supplier audits. By continuously evaluating the capability and reliability of their suppliers, a company can minimize the probability of being caught by surprise by a supply shortage or delay. And, by looking into a supplier's open-source financial statements, monitoring media reports, and following the feedback on the market, the buying company can notice any irregularities and suspicious trends in time. Such a head start allows for time to find an alternative source and prepare a contingency plan to mitigate the negative impact of the supply shortage or delay.

Diversify the supplier base. Contracting several suppliers across different regions ensures companies don't rely on a single source. If one supplier fails to deliver, another can fill the gap.

5. Demand risk

Demand risks occur when customers' demand suddenly fluctuates, leading to over- or understocking of the company's inventory. Shifts in customer demand can be caused by force majeure situations on the customer's side, changes in consumer preferences, new offers on the market, or seasonal variations.

Supply chain actors can also face a change in customer demand if the company's initial estimates are inaccurate or derived from poor data.

Mitigation strategies

Build strong relationships with key customers. Fostering strong communication channels with key customers and engaging with them directly is the easiest way to understand their needs and stay informed about any changes in time.

Implement the practices of flexible inventory management. By cooperating closely with suppliers, the company can implement a just-in-time inventory strategy. This strategy is based on having minimum inventory on hand and aligning supplier orders with the current demand. With this flexible inventory management strategy, goods and materials arrive when production is scheduled to begin according to the most recent demand estimates.

Monitor market trends and consumer behavior. Staying informed about market developments and trends is helpful for accurately predicting demand fluctuations. For example, a shift towards sustainable consumption can drastically affect customer demand. By recognizing and acknowledging this trend in time, the company can consider it when forecasting customer demand.

Invest in complex demand forecasting. A software solution can streamline demand forecasting. Tools that use real-life data and leverage predictive analytics can provide more accurate demand forecasts. By experimenting with the data input and including various external factors in the analysis, the company can prepare several possible scenarios and utilize the tool to evaluate their probability.

6. Cybersecurity risk

Cybersecurity risk is a newer threat to supply chain stability. With rapidly evolving technologies and supply chain digitization, buying companies and suppliers face the risks of attacks on supply chain networks, like data leaks or security protocol breaches. Such attacks can result in compromised classified information and operational disruptions, leading to financial and reputational losses.

Digitalization has become an inherent part of the evolution of the global supply chain. While digital solutions have undoubtedly streamlined supply chain operations and enhanced data handling, data security has become one of the relevant concerns.

Mitigation strategies

Implement robust security measures. By conducting regular security audits, a company can discover vulnerable links in the supply chain software stack and establish how to minimize cybersecurity threats. The first step is to invest in security protocols, firewalls, and data encryption.

Invest in regular system updates. To mitigate cybersecurity risks, companies ought to stay on top of software updates and invest in keeping all systems up-to-date with the latest security upgrades. Software developers constantly trace potential threats and work on improving the security of their products to protect their customers against potential vulnerabilities.

Train employees continuously. Educating employees on how to recognize a cyber threat, such as a phishing attempt, and react appropriately is an important step toward mitigating this risk. Regular security training should be conducted for current employees and anyone who joins the company.

Prepare a breach response plan. By developing detailed action plans for situations when cyber attacks do happen, the company can significantly increase the chances of a quick and effective response to data breaches and operational disruptions. This will help minimize the negative impact of the attack and return systems to their original state.

7. Operational risk

Operational risks is the most comprehensive group. They are associated with internal processes and can be caused by inefficient workflows, human errors, and system failures. When we talk about internal processes, there are many aspects to consider.

Poor project definition and incorrect estimation of the scope of work can prevent supply chain agents from efficiently responding to the company's needs. Misunderstandings about the scope of work can threaten the availability of materials and goods, delivery, and production timeline, and as a result, have cost and reputational implications.

Operational risks to the supply chain cycle can also stem from not having the right professionals, equipment, tools, or established procedures for the job. Poorly designed workflows, manual processes, and inadequate knowledge or training can cause delays and errors in processing orders, shipping, payments, etc., disrupting the supply chain.

Legal and contract-related risks are also important to consider as a threat to supply-chain operations. Different interpretations of obligations and incompliance with terms and conditions can lead to deal failure. Misuse of intellectual property or any other law violation can also pose a significant risk to the supply chain.

Mitigation strategies

Conduct regular internal audits of operational processes. By continuously assessing current internal processes, every company within the supply chain can identify operational inefficiencies and eliminate them. By finding ways to optimize internal processes, companies can prevent operational mistakes and avoid consequences such as financial losses or disrupted deals.

Develop knowledge base for employees and external partners. By preparing clear and comprehensive manuals, companies can ensure all employees are on the same page regarding established workflows and know what's expected of them. It's also a good idea to share relevant information about the company processes with the partners — such as suppliers or delivery agencies — so they know what to expect from cooperation.

Develop human potential. Training employees and supporting their professional development is one of the best ways to ensure that operational processes are maintained at the highest level. By supporting employees in developing their hard and soft skills necessary to do their jobs, the company can minimize human errors, support creative problem-solving, and increase team efficiency.

Use designated software solutions. Automation tools are the most efficient way to streamline operational processes, ensure workflow transparency and employee accountability, and centralize data. The right softweare also helps establish trusted channels for immediate communication with supply chain partners and decreases order processing time by eliminating repeated manual tasks.

Software like Precoro can help you optimize supply chain operations and boost efficiency. See how with Precoro’s free demo:

Frequently Asked Questions

Managing Risks to Achieve Success

To maintain supply chain resilience and ensure business continuity, it's vital to understand and simultaneously mitigate supply chain risks. There are seven main types of supply chain risks: financial, geopolitical, environmental, supply, demand, cybersecurity, and operational. By recognizing and proactively addressing these risks, companies can take practical actions to prevent them or minimize their negative impacts and successfully deliver to the end consumer.

Therefore, risk management should be an integral part of the company's procurement strategy. Investing in risk management helps not only protect the business against production disruptions and financial losses but also supports its competitive edge in the market.