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Supply chain risk management in the water industry
New and innovative insurance products are now available which provide financial protection on a global basis against non-damage scenarios such as strikes, political risks, and an influenza pandemic advises William Bruce, a Senior Vice President in the Risk Consulting Practice at Marsh
All companies dependent on external suppliers are exposed to the risks of disruption in their supply chain and water utilities are no exception. Indeed, regulatory and media scrutiny of water companies adds an extra dimension to the exposure and underlines the need for effective management of the risks.
UK water companies have adopted various strategies to help them achieve their regulatory targets, ranging from those whose business ethos is to manage most business functions in-house to others that outsource virtually all their critical activities to third parties. Generally, the trend in the industry over the last dozen years has been to seek financial and operational efficiencies through the use of third-party suppliers. Inevitably, as this trend has matured, the adoption of effective sourcing strategies has been recognised as being critical to the delivery of capital and operational obligations.
For example, Southern Water has established key partnerships with external providers on core services like major capital schemes, mechanical and electrical solutions, sewers and water networks renewal. However, the firm has gone one step further by implementing framework agreements with suppliers of non-core support services such as IT infrastructure management, engineering solutions and design, correspondence handling, finance and accounting and human resources. In presenting Southern Water's 2008 operational and financial results recently, the Chief Executive Officer, Les Dawson, acknowledged the key role played by the utility's key partners when he stated: "These results weren't delivered by Southern Water, they were delivered by a supply chain".
Good risk management is central to achieving such success. Water utility supply chain risk management should involve a broad based, detailed analysis of the supply chain; identifying and then measuring the impact of disruptions regarding supplies, suppliers or services. The approach taken by Marsh is based on classic risk management methodology, specifically risk identification, risk evaluation and risk treatment.
For the water industry, some of the key risks in the supply chain include:
- Single source suppliers, for example, for chemicals
- Geo-political risks including natural catastrophe, terrorism and strikes
- Suppliers of suppliers
- Insolvency
- Mergers and acquisitions
- Performance and compliance
- Quality of risk management at suppliers
- Contractual and procurement
- TUPE issues
Step 1 – Risk Identification
This step seeks to identify the critical suppliers/supplies. This entails understanding the value added in each stage of the supply chain and assessing the risk to delivery of this value. A risk-return perspective, based on profit, revenue or reputational considerations, supports prioritisation and delivers the greatest return on investment. A thorough view of the supply chain, from sourcing of raw materials to customer fulfilment, provides a clearer view of key vulnerabilities and risk concentrations.
Step 2 – Risk Evaluation
The next stage is to articulate exposures both quantitatively and qualitatively by employing various tools and techniques including impact modelling, forensic accounting and gap analysis. A comprehensive assessment and quantification of the risk in the supply chain facilitates evaluation and prioritisation of proposed risk transfer, financing and mitigation strategies.
Step 3 – Risk Treatment
This step enables informed decision making by management on the most effective risk mitigation strategies. It may be possible to reduce identified risks through increasing stock levels, arranging alternative or back-up suppliers, or working with suppliers to improve their own business continuity and resilience planning. Alternatively, an organisation may seek to transfer risk through contractual terms or by purchasing specialist supply chain insurance. Whichever option is chosen, it is influenced by understanding the risk return of different options, and the corporate strategy and risk appetite of the business.
In many cases a combination of rigorous procurement and contractual processes, together with robust business continuity plans may be sufficient to adequately manage the majority of the risks identified, though inevitably there will always remain certain exposures which go beyond the ability of the water utility to control.
Until now, insurance solutions have been limited to instances of physical damage, such as fire, flood or explosion impacting the immediate supplier. However, new and innovative insurance products are now available which provide financial protection on a global basis against non-damage scenarios such as strikes, service interruption, change of control, political risks, influenza pandemic, extreme weather, regulatory action or other significant delay in supply and which extend the protection to multi-tiered supply chains.
Regardless of the strategy adopted, it is critical for today's water utilities to conduct a detailed assessment of all aspects of their supply chain exposures so that executive management can make balanced and informed decisions on risk mitigation measures, including insurance where appropriate.
Andrew Ainscough is a Client Executive in the Construction, Power and Utilities Practice and William Bruce is a Senior Vice President in the Risk Consulting Practice at Marsh, one of the world's leading insurance brokers and risk advisers. To contact Andrew or William, please email: andrew.ainscough@marsh.com or william.bruce@marsh.com
