How much risk lies unaccounted for in the supply chain?

Utilities are well versed in managing primary risks, but a survey reveals that many of them are overexposed should problems emerge with their suppliers, says Tom Grand.

Utilities must feel at times like they are walking a tightrope. Mounting scrutiny and intrusion from regulators, government and media mean they can fall one way if they slip up in their service to customers and tumble on the other side if they succeed in making eye-catching profits – when they get accused of being ruthless and greedy.

It is a balancing act that requires first-class risk management through the whole supply chain. So it is perhaps surprising that many utilities are not putting in place basic safeguards to protect themselves adequately for the supplier-related risks they face.

Independent research consultancy IFF recently interviewed senior supply chain professionals from 80 large utilities across the globe. A large number of them admitted they were unprepared for these eventualities.

One-third of respondents said they felt unprepared for exposure to legislative issues, and almost one in five (17 per cent) said they felt exposed to a block in the flow of critical products.

This is compounded by the fact that a substantial proportion of the utility sector had already experienced financial and health and safety problems arising from suppliers’ shortcomings.

A quarter of utilities surveyed have experienced problems following the business failure of one of their suppliers, and close to one in five have felt the impact of suppliers’ health and safety shortcomings. So, facing a plethora of challenges and risks, why might utilities overlook some areas of risk management among their suppliers?

James Palmer is the sales director at risk management specialist Achilles, involved with its pre-qualification system for utilities – Utility Vendors’ Database (UVDB) .

He believes that worldwide, utilities are largely ill-equipped in the skills and resources to carry out the extensive financial risk analysis required to be fully assured of their suppliers’ financial durability beyond their top-tier suppliers. “What it comes down to is you need visibility of the real capacity of a supplier compared to the work it has taken on. That is extremely difficult to achieve.”

Palmer also says that growing demand for skilled labour globally, coupled with a shrinking pool of suitably trained people, has put constraints on utility sub-contractors’ capacity to sustain levels of health and safety compliance. He highlights utility operations – where there are highly skilled, engineering tasks to be done – and the exceptional level of skill needed to perform those tasks safely.

He holds up as an illustration a European power company that laid off many of its oldest power engineers in a cost-cutting exercise. In giving those staff early retirement the company lost all its expertise in the significant legacy systems in play on its network. Ultimately, the company had to go through a “very expensive reversal”.

While conceding that there need be no further justification for zeal in health and safety beyond the protection of lives and livelihoods, Palmer says assiduous attention to health and safety makes commercial sense. “The impact of on a business of a health and safety incident is often more costly than its prevention,” he says.

Palmer says UK utilities have in place “pretty good” financial risk mitigation which “stands up to scrutiny”. But he counsels that utilities should make continuous efforts to improve their preparedness by averting financial difficulties at their suppliers.

“In our experience, this works well when firms use an independent body to augment their own efforts. For example, we see many firms use further analysis largely based on the standard financial services bankruptcy prediction tool, the Altman Z score.”

As big buyers, utilities are capable – and occasionally guilty – of squeezing their suppliers to the point where they precipitate the collapse of a contractor. Palmer flags up a need for utilities to behave more strategically in the event of a supplier’s financial distress or bankruptcy and seek to keep the distressed supplier in business.

“Administration is not a mechanism for winding down. It’s intended to give an organisation a future. It shouldn’t be seen as a process for dismembering and running for the hills. Utilities should work with the administrator in a responsible way and look at the strategic rather than tactical considerations,” says Palmer.

On health and safety, he says UK utilities show sound instincts: “There is a strong emphasis on continuing improvement, innovation and pride [in health and safety] in the UK utility sector… But there is never any room for complacency.”

Utilities in the UK and elsewhere exist amid shifting legislative, regulatory and commercial landscapes. Growing liberalisation is often being accompanied by greater political intervention as the public responds to the exposure of a truer cost of supply. This is creating complicated challenges along with greater operational risks. Meanwhile, investors continue to look for safe returns .

The need for utilities to shield themselves from financial collapse or health and safety shortfalls in their supply chain is growing. While the UK utility sector’s track record is stronger than its overseas counterparts’, risks remain and the means or methods to address them are not fully in place.

Tom Grand, regional director for Achilles in the UK and Ireland, with responsibility for UVDB