Importance of Risk Management in Procurement
Risk is probably one of the most pervasive topics today in sourcing and supply management. The reason for this is quite logical: the more dependent on its suppliers a company becomes, the more likely that a disruption in supply anywhere along its supply chain can result in the company’s failure to meet its commitments.
The Nature of Risk
Spend management experts consider risk as a measure of the inability to achieve program objectives within defined cost, schedule, and performance constraints. In simple words, the risk is the chance of something happening that will have an adverse impact on your objectives, the probability of an unwanted outcome happening.
Why Is Understanding Risk Important?
Risk affects many aspects of the sourcing process — it is a guiding consideration when selecting suppliers. We select those suppliers that are most likely to meet our stated requirements: suppliers with low risk.
We recognize that uncertainty in the statement of work we issue with our contracts can add to the price of a service by a supplier through hold backs or contingency accounts due to vague or complex requirements. Furthermore, we base many of our key business decisions on the level of risk involved in an action or activity, or in the choice of a design solution or a technology.
We consider risk as an evaluation factor in choosing between alternative courses of action, often seeking the alternative with the least amount of risk. Thus, we typically see risk as a critical aspect of business operations that must be properly managed in order to remain in a tolerable range.
Risk management helps companies ensure the smooth and successful running of purchasing and supply operations. It also contributes to the resilience of a supply chain as a whole and to business continuity. Successful prevention and mitigation of supply chain risks can help ensure good financial performance and shareholder wealth.
Risk Management Principles
Clearly, effectively monitoring and managing risk is costly when the risk is high and consumes large amounts of critical resources, yet the customer is often blind to the value this produces. That's why risk management process must be well-understood so that they can be implemented with minimum cost. With an effective process in place, risk can be managed so that the impact of a potentially catastrophic event can be minimized or avoided altogether. In order to help you establish this process, there are several fundamental principles that you should recognize and understand first.
When a formal risk management process is first put in place, there is a cultural shift from putting out fires and crisis management within the organization to a much more proactive decision-making method that seeks to avoid problems. Systematically anticipating what events might occur to thwart our objectives becomes a part of everyday business, and the management of risks becomes integral to sourcing as any other process.
Now you know what risk is and why its understanding is crucial for effective business running. In our next article, we’ll examine in more detail basic risk principles and categorize them as related to financial, scope or schedule, legal, environmental, sociopolitical, project organization, and human behavior factors. We'll also tell you everything about supply chain disruptions.