Risk management and readiness to change within international value chains

In the last three to four decades, advances in technology and an enabling policy environment have allowed businesses to internationalize their operations across multiple locations in order to increase efficiency, lower costs, speed up production, and provide new opportunities to millions of workers.

Through international supply chains, businesses today seek to add value in production where it makes most sense to do so. Indeed, this has become a key element of corporate competitiveness. For their part, some governments – though not all – recognize that participating in international supply chains will bring value and opportunities to their workers and economies; they have thus sought to foster friendly policy frameworks.

These production relationships embody the interdependence among nations that characterizes our world today. They also embody the interdependence among firms of different sizes, with different strengths and weaknesses and based in different locations. While there are many advantages to these international supply chains, they also bring with them new or intensified risks, endangering their sustainability. Those risks need to be properly managed by businesses themselves and national governments, as well as the international community as a whole.

Different types of risk can disrupt supply chains. Some of those risks are chain specific, like those linked to technological disruptions (innovation; changes in business model) or disruptions related to changes in consumer tastes or in product reputation. Other risks are rather location-specific in nature like social disruptions (strikes, armed conflict, terrorism) or natural disruptions (earthquake, ash cloud).

Disruptions related to policy changes (e.g. trade policy, regulation) can belong to either category. Macroeconomic disruptions – like financial crisis – can be systemic in nature and have global impacts that act across supply chains. Last but not least, there are risks that have the potential to trigger fundamental changes in the set-up of supply chains. This may be the case with the rise of 3D printing – that has the potential to fundamentally change the role of manufacturing and logistics within supply chains – or of long term trends in the global distribution of wealth that may affect where supply chains begin and where they end.

Any of these disruptions tends to affect all private sector players within a value chain. But the extent of the impact is likely to differ depending on the position of individual firms both literally (location) and figuratively (role within the supply chain). The extent of the impact will depend on how risk is managed in an anticipatory sense, as well as the availability of mitigation strategies within a given position in the chain. The availability of mitigation strategies will also very much depend on the nature and foreseeability of risks.

Location-specific disruptions can be highly disruptive for actors that are bound to the location. For international lead firms, instead, location-specific risks are often manageable as they tend to source inputs from several locations or can shift their sourcing strategy. Policymakers need to be aware of this. Political instability can have major consequences for the potential of local firms to connect to value chains. Even minor changes in the design or administration of policies can have major local economic effects if they affect sourcing decisions of lead firms. Countries that build up a reputation of instability and unpredictability will be avoided by major players in global supply chains and may find it hard to reverse such reputations.

Sometimes external factors change slowly, and the risk they entail for supply chains are in principle foreseeable. Yet such foreseeable risks do not always trigger reactions, maybe because they are not felt to represent an immediate threat. The rise of the middle class in Asia, for instance, has been changing the configuration and design of supply chains in a process that already started a number of years ago. More and more supply chains are ending with consumption in emerging economies. This is affecting where distribution and marketing takes place. With a significant part of R&D being dedicated to adapting products or services to consumer needs, R&D is also increasingly shifting towards emerging markets. Yet, university text books still tell us that R&D takes place in the ‘industrialized’ world.

Foreseeing and managing value-chain specific risks should really be part of daily business for any actor within a value chain. Product life cycles are becoming shorter, change has become more rapid and more ‘international’ in nature. Foreseeing and managing risk has therefore become more challenging, but it has also become more important than ever for being successful in business. Being ready to change and adjust to changes in the market should be enshrined in every entrepreneur’s DNA and, to the extent possible, the policy environment should make it easy for entrepreneurs to foresee and manage change.

SMEs depend more than their larger counterparts on the quality of the business environment in order to manage risk and change within supply chains. True, smaller-sized players are sometimes more agile, which is an advantage in a changing environment. Yet, the costs of risk management strategies also represent a higher burden for smaller firms.

SMEs therefore find it easier to survive and prosper within regional or global supply chains if they are operating within a stable and predictable policy environment and have ready access to high quality and up-to-date information about developments in the markets of relevance for them. Timely awareness of threats will make it possible to avert crisis and identify new opportunities instead.

This article is a part of ITC's SME Competitiveness Outlook 2015.