Supply Chain Risk: Survival in a Volatile World

[00:00:00.000] If you’re at home today.

[00:00:01.270] I am. Nice. In my office with my library. Not a fake backdrop, real books.

[00:00:08.000] No, it’s a good background. I’m in our podcast studio in our Montreal office. Yeah, nice. I see that. A little better background this time. Yeah, let’s get into it. So this is our third recording. We’re back for more. It’s been an interesting start to the year with regards to global supply chains, trade, and tariffs. We’ve been lucky enough to do some work together on this. We wanted to get back together and talk about how really risk is impacting global supply chains and maybe think through some or provide some details on projects that we’ve worked on and how we’ve gone through that process. Good to have you back. Looking forward to it. What I wanted to start with today is just to ground everyone, the topic of risk. When you think about that or when you define that to a prospect, at a macro level, what does that mean to you?

[00:01:07.600] Yeah, no, good question. Risk, to me, at a macro level is what are the threats to a company’s business, to its financial and its operational stability, especially if they’re operating across borders. Where do these threats come from? Is it because of political tensions or conflict or even war? Is it affecting the markets? How How do these things affect a company’s ability to operate consistently and have a supply of products into their end customers? Some examples could be, the biggest one which we see happening right now is a trade war, where a nation or nations decide to put tariffs on other countries’ products that will impede the flow of products across borders. Now, if the tariff policy is rolled out in a scattered way or a very egregious way with extremely high tariffs, as we’ve seen, it’s very, very disruptive to trade, and that’s happening right now. That’s one big example. Companies need to be aware of what’s going on, and then they can take specific mitigating strategies to reduce the risk.

[00:02:13.050] Yeah, that makes sense. How do we bucket risk? Are there categories? If we think about it, first principles, we just said, what is a risk? Now, going a level deeper, what are the categories that we characterize them in or what buckets How do we put them in?

[00:02:31.500] I think we have to put them in three buckets because it’s all about to what degree is risk controllable by individual companies and to what degree is risk somewhat predictable and foreseen? Because there are Blacksworn events that nobody predicts, but maybe there are actions that you could take to mitigate it if you had some advanced planning. So broadly, the three big categories are what we call systemic risk, and then geopolitical risk, and then operational risk. So what is systemic risk? Systemic risk is non-controllable by humans. It’s something that no human actor, whether it’s an individual, a company, or a government, can control. An example of that would be climate change. Nobody can control climate change. No matter how powerful the government or the company is, they can’t control it. But if you see the patterns and trends for that, you can take actions to shift your supply chain, shift your manufacturing base, get in front of it to try to derisk. Another big systemic risk is pandemics. And there’s been a history of pandemics throughout human history, as long as it’s been around. But the biggest one was that we remember in most recent memory was COVID.

[00:03:46.430] And COVID disrupted global supply chains and global business. There are shortage of products around the world, and everyone had to adapt to that. And some companies and countries adapted well, others were not able to. And so there could be another pandemic around the corner, and it could be more severe. So that’s another example of a systemic risk. A third systemic risk is global financial markets. Yes, financial markets are controlled by individual actors, individual companies and governments to a degree, but the network effect of financial markets can be devastating. We’ve seen financial crisis with global stock market crashes in the early 1900s that affected global markets and global business and global companies. And it took a It’s a long time to get out of that. There was Asian currency crisis in the late 1990s, and we could be on the cusp of a US dollar crisis now. It’s hard to tell. But the financial market crisis and crisis relating to currencies are also something that is a little bit hard to predict and need to be aware of. Another type of systemic risk is nature and biologics, which is maybe a subset of climate change, but things can happen all of a sudden in nature and we’re not prepared for it.

[00:05:04.660] So being aware of those as well is important depending on the nature of the industry. So if you’re in the steel industry, maybe nature and biologics is less important. But if you’re in the food business or restaurant business or anything having to do with food production, whether it’s crops or protein-type foods, then it’s important to be aware of that. The second big type of risk, which is It’s human caused and human controllable, but more at a governmental level. It’s less controllable at a company level because most companies can’t decide. Companies don’t decide when to go to war. Companies don’t decide to invade another nation, but countries do. We’ve seen recently the Russian invasion of Ukraine, part one and part two. We’ve seen military actions against Israel and Israel’s response in the Middle East. There’s a lot of things going on from a military standpoint that can disrupt supply chains and the Red Sea, the Houthis attacking the ships going through the Red Sea, things of that nature. So geopolitical risks generally can be put into governmental actions. We can say US government is one of the drivers. Then there’s foreign government responses to that. Then another category of geopolitical could be regulatory changes.

[00:06:26.560] Within government actions, I think the big example is with trade and trade policy. But there are knock-on subsets to trade policy that we’ll talk about later when we look at the specific case study. And then foreign governments naturally will react if the major trading partner US is creating actions against them. We put 145% tariffs on China. China reacted with 125% tariffs. And effectively, trade between US and China right now is really, really slowing down. The number of ships sailing between China and the US is down by something like 60%. We’re going to see stockouts of goods in the US economy probably in 3-6 months because we’ve stocked up. But if a deal isn’t negotiated, the stuff that we buy from China and the US is going to start slowing down and they’ll have to be alternative supplies or not. We can’t have eight dolls. We can only have two dolls. We just to live with it. The last category I think, is operational risk. And these are, if identified early enough by individual companies, they can be mitigated. But companies can’t be head in the sand and say, Things have always been a certain way, so they’re going to continue that way.

[00:07:45.750] And so companies need to be very clear-eyed about supplier risks in terms of where they’re sourcing their product from and how are those suppliers being impacted by governmental and geopolitical factors. And transport and logistics risks, depending on how the transport lanes are being affected, as we just said, in the import supply chains, the number of ships sailing between China and US ports is drastically down. So even if you can source product and bring it in competitively, there may not be the amount of capacity of transport that you need to bring it in. So transport logistics is an operational risk that one needs to really look at and come up with. There’s a constantly changing compliance compliance and regulatory regime where safety standards are set by various nations for various products that are bringing in their country, and those can be used as a trade war tool, or they can be changed at any time. So one needs to really be aware of those when importing products. So safety standards and regulatory rules around bringing products in cross-border can also impact business. But within operational risks, these are all controllable if you have the radar out in front knowing what will affect your business and how to stay abreast of any potential changes in those areas so you can de-risk.

[00:09:06.380] Yeah, great summary. I appreciate it, Steve. I think we’re going to get to this in a little bit, but as a precursor to that, We have these categories, and then you gave some good examples within those categories. But this came to the forefront on some work that we did recently around really assessing supply chain risk for the inbound supply chain of a company that’s making a consumer packaged goods in the US. But 100% of the product that is the raw material is being imported from abroad, and it’s also a fresh product. Pretty much everything that you listed is pertinent to that situation. I think in that example, these risks apply. But maybe you could talk a little bit about how do we frame that or how does that deliverable look to an end customer so that it’s digestible and they can understand first what it looks like, and then maybe afterwards we can talk about, well, what are the mitigative actions? What’s the punchline here? What can I actually do about it?

[00:10:15.020] Sure. This project, this actual project that we worked on for a PE firm that was considering purchasing this fresh consumer product in the US, had a very unique supply The supply chain is such that it was a highly perishable product with a shelf life of about 7-10 days. From the time it was produced in the source country to the time it had to hit the processing plant of the US producer in the Midwest, there was only 7-10 days. And so very, very just-in-time supply chain with lots of dancing with air freight and immediate customs clearance upon entry into the US. Everything had to go smoothly. And then speed trucking refrigerated speed trucking to the processing plant. And this food processing company in the Midwest, only effectively 100%, 99% of their product was coming from one country in South America. And so Very fragile supply chain in that sense. It worked well when it worked well. But the private equity firm that wanted us to look at this, wanted us to look at all the different risks to the supply chain. What potentially could… If something went wrong, first of all, how would it affect the business?

[00:11:29.700] Would they run out of supply? Number two, what would the potential areas of risk that we look at? Before we went into coming up with the different areas of risk using systemic risk, geopolitical risk, and operational risk as our guide, we came up with a way to measure it around what would be the impact to occurrence. If that risk occurred, how badly would it hurt the business? Would it be catastrophic and they would have no product to supply light and they don’t have any alternative sources. So that would be very high impact occurrence. We looked at what would the likelihood of it occurring? So climate change is constantly happening, but what if there was a spike and all of a sudden all the product being produced in that area died? This is a fresh live product. That would be pretty catastrophic as well if they didn’t have any alternatives. But it’s hard to place likelihood of aircraft not being available from a given point. It It could, but it could not. It’s hard to know. So likelihood of occurrences is another fact we looked at. Then we looked at, is it controllable or not? Using our same, is it in the systemic category, the geopolitical category, or the operational category?

[00:12:43.140] If it’s controllable, then most definitely take action, take recommendations to remove that risk, and that will help you solve your problem. Then what’s the likely time frame that the risk may occur? Now, this is very subjective, but you can look at trend lines and you can see across different risk categories Is how frequently have been happening in the past. Is the risk matrix vibrating more where it seems like there’s more likelihood of this? We’re going in that trend line. Economists all the time in the Wall Street Journal say, The likelihood of a recession in the US is increased from 25% to 45% or whatever it is. There are trends that you can look at to come up with likely time frame. Then based on that combination, we came with a risk rating, which then will help prioritize how urgent it is to take action. That was the framework that we applied for this specific highly perishable, inbound, time-sensitive food supply chain. But this same framework could easily apply to any other consumer product supply chain. It could be applied to industrial machinery. It could be applied to pharmaceutical or life sciences product. It can apply to many different frameworks.

[00:13:51.880] We put that together.

[00:13:56.110] I think The interesting conclusion in all of this was the mitigative actions across risks that really are not alike at all are very similar. The things that you do to try to mitigate the risks, whether it’s climate change or supplier concentration or pandemic or tariffs or similar, which was an interesting concept that I’ve subsequently been applying across other things I think about. But Maybe you can talk a little bit about what were the themes that came out of that that other people or people listening could start thinking about even now.

[00:14:40.070] Yeah, definitely. So the issue was because it was convenient, because it worked well, because this US raw material food importer was a relatively small player in the overall market of supply for their specific category, very easy to sole source from one country in South America. What we did is we did research on the global market for their specific product, and we found that there were ample supply of the same perishable product, fresh product, in multiple other countries around the world. The first part was we suggested geographical diversification. We looked at relative prices of their product, and we found that they could source the same exact quality of their product down to the exact specs of what they needed for their quality control to bring into their plant product at relatively comparable prices. Some of them were in Europe, some of them were in North America, and we found alternative sources for them to say, There is a path for you to source from other suppliers. That diversification itself will spread your risk. It’s just like why you have a diversified portfolio in your stocks and your retirement. Yeah, right. We also found that the main suppliers of this product, because it’s a natural product that’s grown in nature, that some of the key industry players that were the main players in the country they were sourcing from also are the main industry players in North American market and European market.

[00:16:16.970] They already had established relationships with these players. It was a relatively easy transition. We looked at those different factors. But what was really interesting is beyond the typical things of, Oh, Trade and Tariffs, long supply chains, transport, we found that there was additional country-level risk with the country in South America they’re sourcing from. That country has a free trade agreement with the United States. The product from that country is tariff-free, it’s duty-free, until the 10% base tariff went in for all countries. Even though they had a free trade agreement, even though the base tariff was only increased by 10%, we And we found that because there are things called secondary sanctions, that the US government has said, any country that trades with Venezuela petroleum products, they will be hit by 100% tariff. So this is US foreign policy impacting trade policy. So if this South American country that was producing this product happened to buy Venezuelan oil or petroleum products, everything coming from that country would be hit by 100% tariff. So it would have completely blown out their business model. So the private equity buyer and the US company wasn’t even aware the secondary tariffs could hit them because they were in this specialty food industry, fresh food industry.

[00:17:44.700] They weren’t thinking about what on a macro level, the South American government’s petroleum purchasing policies was going to be. So that was one area that we have to dig deeper. We have to look at secondary and tertiary impacts to how trade works to make sure that we can mitigate risks. If you can identify the risk, even those risks that you aren’t thinking about, then you can set up alternative plans around it.

[00:18:10.320] The other thing that we did in terms of these other scenarios that they consider or going from sourcing from one country to sourcing from two to sourcing from three or four was we could tell them at a high level what the impact to the cost of goods sold was How much is this going to be, which again allows the company to say, How much is solving for or mitigating this risk worth to me? We took the qualitative side and we were able to just do some math and tell them, Hey, this is going to have an impact of 5% or this is going to have an impact of 2% or 7%, depending on the scenario. That speaks to numbers people or private equity people because they want to assign a to everything. So although a lot of the upfront work was qualitative, it can then be made quantitative once we have a good understanding of it. Exactly.

[00:19:11.320] I mean, it’s like buying an insurance policy. So if you’re 99 % sourcing from that one South American country, and it’s a cheap landed cost, it’s based on the assumption that things will continue steady-state as they are, which in today’s world is a very risky assumption to make. Even if you stayed with that, You could switch 5% of your source to another country at a slightly higher price, but you’ve opened that channel, that supply chain source. If things do go catastrophic and that country decides to buy Venezuelan oil because it’s cheap, they don’t care about the implications, and all of a sudden the price from that South American country doubles because the tariff kicks in at 100%, then you have this alternative source that you can quickly turn on. And it’s more expensive, but it’s less expensive 100% tariff. And so helping with that modeling is really cool. And so it’s an insurance policy because it’s a little bit expensive to buy 5% of your supply from that other alternative country. But if you need to pull the trigger, then the insurance was well-welfared, that you established that relationship and those supply lines and those logistics and that import route.

[00:20:23.150] Then if you want to buy two or three different insurance policy, you could buy from Canada, you could buy from a couple of different countries in Europe. And spread your risk out. It’s a balance of risk. What is your risk appetite versus how much you try and chase the bottom line? We can help with that modulation based on all the different factors.

[00:20:41.760] This can be applied to really any industry sourcing from any set of countries. The principles that we have around what is risk, systemic risk, geopolitical risk, operational risk, can stretch very far. Anyone with an international supply chain should be conducting some exercise like this this year, I would say. We can definitely help with that. But I hope people learned from this podcast. If you have any questions, Steve and I would be willing to talk and would love to hear more about the challenges that different types of businesses in different countries are facing. Yeah, definitely. Thank you. Thanks, Steve. Appreciate it. Until next time.

[00:21:31.290] Yes. I’m sure there’ll be a lot more talk about coming up.

[00:21:34.180] Yeah. All right. Thanks a lot. Have a good one.