With the collapse of Hanjin, logistics managers across the world are striving to minimize supply chain disruptions. But the horse has bolted for some shippers that depended too heavily upon a vulnerable carrier. This post examines how “the stable door” should have been bolted in the first place because the prevention of such an over-exposure is far more effective that ex-post damage limitation.
Presently, some shippers are facing inventory shortages and revenue losses that could far exceed any transportation savings that may have accrued from selecting Hanjin during the sourcing process. They may be scrambling to get capacity from other carriers that can act opportunistically. Logistics procurement teams are being asked, often unreasonably in light of over-emphasis on cost savings, how this was allowed to happen in the first place.
We describe in brief how pre-emptive risk management scenarios mitigate such dangers and allow BCO’s to avoid over-dependence upon vulnerable carriers in a manner that lets senior management have input and accountability when it comes to future problems. Whilst there are always risks, having effective business rules that spread risk is central to how high performing logistics procurement teams avoid unmanageable disruptions is the key objective. But secondary goals that include defensibility of decisions later on should disaster strike are also important in order to uphold the integrity of the decisions and re-frame how the awards were made.
Risk Management for ocean freight transport sourcing can be challenging. The bid processes may involve thousands of lanes and tens/hundreds of thousands of TEU’s so macro-level risk management needs a sourcing tool that is much more powerful than Excel. Lane by lane decisions are not an effective mechanism for distributing risk in a quantifiable manner.
1 Clean and Structured Data
Any sourcing process that relies purely upon Excel is doomed to fail. Best practice strategic sourcing for ocean freight transportation involves the collection of bid data in structured databases because it is necessary to apply optimization-backed techniques that behind the scenes transpose the bid data into a mathematical model and let procurement teams apply business rules to mitigate risks and assess trade-offs.
2 Capture Key Risk Factors
For Ocean freight procurement, typical risk factors include the following:
1. currency volatility,
2. underlying financial vulnerability of carriers,
3. the cross-contamination of carrier bankruptcy risk within Alliances,
4. port strikes and canal closures,
5. oil price shocks,
6. vessel sinking or groundings,
7. environmental disasters,
8. piracy, weather, theft…
We focus on the bankruptcy risks here; but note that other risks can also be addressed if logistics procurement teams have an optimization backed tool that can apply business rules and re-optimize outcomes across all offers and lanes.
To mitigate risks associated with carrier bankruptcy; the obvious measure is to cap award volumes to vulnerable shippers so that if bankruptcy did ensue; then your supply chain would not reach an unmanageable or critical state. The key is deciding which lanes should be awarded and this requires optimization. Some lanes are time sensitive or contain more valuable inventory. The key is to be able to set up scenarios that capture progressively more risk averse award scenarios and then decide with stakeholders what an appropriate trade-off is.
These type of rich scenarios cannot be computed in Excel because they require combinatorial optimization. The specific combination of lanes to award to shippers, especially when you have numerous constraints is a computationally very challenging task that necessitates Artificial Intelligence techniques to determine the winning outcome. But when scenario analysis is reduced to just a few button-clicks it becomes all the difference between risk management becoming a reality versus a mere aspiration.
3. Assess Trade-Offs with Internal Stakeholders
Good risk management relies on informed stakeholders. Research analysts such as Drewry and others can give objective data regarding the stability or otherwise of carriers. It is important to consult with analysts when making award decisions and using this information to create scenarios that address identified risks. By then applying appropriate constraints around an award scenario so that upfront costs are increased but risk and potential future hidden costs are mitigated is the essence of prudent logistics procurement practice.
It is also important that all key stakeholders have input into scenario creation so that there are clear insights into the costs of various trade-offs. It may well be sensible for some shippers to contract with lower cost but higher risk carriers if you form a view that the shipper has high inventory levels; low seasonality of demand and low average value of inventory per container.
The primary business rules for addressing carrier bankruptcy risks are to limit award volumes to those carriers. But it is important to know that alliances of carriers end up subcontracting transport contracts to one another so there is cross contamination of risk. Best practice techniques involve limitations on Alliance volumes, so grouping carriers and then establishing boundaries across those in aggregate also forms an additional layer of risk management. The precise boundaries should examine the capacity for stronger alliance members to absorb the collapse of the weakest carrier.
4. Reporting for Current and Retrospective Analysis
When disaster strikes, senior management may want to know how supply chain exposure were allowed to happen. Unravelling the decision making process can be difficult unless you performed those actions in a tool that stored the scenarios that were created; how risk management constraints were iteratively added and how that increased costs. Furthermore, audit trails allow logistics teams clearly identify cases where excessive cost saving goals were allowed to trump prudent advice from seasoned logistics teams.
Best practice logistics procurement teams will have identified the risk factors; applied prudent business rules and chosen the sensible trade-off against cost and then provided an audit trail for the entire award scenario and decision making process. And all of this relies on an optimization backed sourcing tool that makes it easy and intuitive to manage the balance between risk and reward.