Supply Chain Risk Management Framework

1. Supply Chain Risk Management Framework Supply Chain Risk Leadership Council 4 Oct 2007

2. Overview Scope • Develop a Supply Chain Risk Mgmt Framework that will allow SCLRC members to work from common terms of reference and that will help guide future SCLRC activities Deliverables • This presentation • Adjustments as they become necessary

3. SCRLC Track Definition

4. Team Members and Sources Team Members • Ely Kahn and Andrew Cox, TSA • Tim Astley, Zurich • Brent Myers, FedEx • Craig Babcock, P&G • Ravi Anupindi, University of Michigan Sources • Committee of Sponsoring Organizations of the Treadway Commission (COSO), Enterprise Risk Management - Integrated Framework, 2004 • Supply Chain Risks and Risk Sharing Instruments, Robert Lindroth & Andreas Norrman, 2001

5. Definition of SCRM Supply Chain Risk Management (SCRM) is the practice of managing the risk of any factor or event that can materially disrupt a supply chain whether within a single company or spread across multiple companies. The ultimate purpose of supply chain risk management is to enable cost avoidance, customer service, and market position. Supply chain risks can be grouped into 3 broad categories: physical, process, and institutional risks

6. Types of risk are not mutually exclusive Types of risk INSTITUTIONAL PHYSICAL PROCESS Internal Environment Objective Setting Downstream Customer Risk Management is an iterative process Primary Customer Event Identification Your Company First-tier Supplier Risk Assessment Risk managementcomponents X-Tier Supplier Risk Response Control Activities Information & Communication Monitoring Includes links between supplier, your company, and customer Supply Chain Scope Supply Chain Risk Framework

7. Supply Chain Risk Management vs. Enterprise Risk Management Earnings/Sales Miss CEO/Leadership Succession Plans Major IT Outage Marketing Strategy Acquisition Integration Purpose Vision Principles Breach Company Tax Structure Concentration Risk/Supply Chain Resilience Product Quality/ Safety Phys. Security People/Assets

8. Key Risks Enterprise Supply Chain Stock market volatility Global terrorism Over-regulation Currency fluctuations Reputational risk Corporate governance issues Price deflation Emerging technologies Increased competition Loss of key talent Cost of capital General availability (cost, quality) of labor Regulatory concerns Reliability of suppliers (quality, warranty, yield,…) Commodity shortage/price fluctuations Fluctuations of foreign exchange rates Intellectual property theft Obsolescence of product inventory or technology War, terrorism, other geopolitical concerns Problems with supply chain infrastructure Plant breakdown, mechanical failures Natural disasters Others Source: PWC : 7th Annual Global CEO Survey – Managing Risk, 2004) Source: McKinsey quarterly global survey of business executives, Sept 2006

9. Risk Management Components

10. Risk Management Components Components of SCRM • Internal Environment • Objective Setting • Event Identification • Risk Assessment • Risk Response • Control Activities • Information & Communication • Monitoring Internal Environment Objective Setting Event Identification Risk Assessment Risk Response Control Activities Information & Communication Monitoring The components should be looked at as being interrelated.

11. Internal Environment • Encompasses the tone of an organization • Influences the consciousness and awareness of its people • Basis for all other components • Provides discipline, structure and organization • Establishes a philosophy regarding risk management, including its risk appetite • Oversight by board of directors • Integrity, ethical values, competence • Assigning of authority and responsibility Internal Environment Objective Setting Event Identification Risk Assessment Risk Response Control Activities Information & Communication Monitoring

12. Objective Setting • Set at the strategic level, establishing a basis for operations, reporting and compliance • Precondition for event identification, risk assessment and risk response • Aligned with the risk appetite (as defined in internal environment) • Risk tolerance Internal Environment Objective Setting Event Identification Risk Assessment Risk Response Control Activities Information & Communication Monitoring

13. Event Identification • Management identifies potential events • Differentiates risks and opportunities. • Events that may have a negative impact represent risks, which require management response • Events that may have a positive impact represent natural offsets (opportunities), which management channels back to strategy setting. • Involves identifying those incidents, occurring internally or externally, that could affect strategy and achievement of objectives. • Addresses how internal and external factors combine and interact to influence the risk profile. Internal Environment Objective Setting Event Identification Risk Assessment Risk Response Control Activities Information & Communication Monitoring

14. Event Identification Possible techniques • Event inventories • Scenario analysis • Internal analysis • Escalation or threshold triggers • Facilitated workshops and interviews • Process flow analysis • Leading event indicators • Loss event data methodologies • Interdependencies Internal Environment Objective Setting Event Identification Risk Assessment Risk Response Control Activities Information & Communication Monitoring

15. Event Identification Categorization of events (with reference to other framework axes), e.g. • External • Economic • Environment • Political • Social • Technological • Internal • Infrastructure • Personnel • Process • Technology Internal Environment Objective Setting Event Identification Risk Assessment Risk Response Control Activities Information & Communication Monitoring

16. Risk Assessment • Allows an entity to understand the extent to which potential events might impact objectives. • Assesses risks from two perspectives: • Likelihood • Impact • Employs a combination of both qualitative and quantitative risk assessment methodologies. • Relates time horizons to objective horizons. • Assesses risk on both an inherent and a residual basis. • Impact of events should be assessed individually or by category across the entity Internal Environment Objective Setting Event Identification Risk Assessment Risk Response Control Activities Information & Communication Monitoring

17. Risk Assessment Assessment Techniques • Benchmarking • Probabilistic models • Non-probabilistic models Internal Environment Objective Setting Event Identification Risk Assessment Risk Response Control Activities Information & Communication Monitoring

18. Risk Assessment • Identifies and evaluates possible responses to risk. • Possible Responses: • Avoidance • Reduction • Sharing • Acceptance • Evaluates options in relation to risk appetite, cost vs. benefit of potential risk responses, and degree to which a response will reduce impact and/or likelihood. • Selects and executes response based on evaluation of the portfolio of risks and responses. • Examines, whether residual risk is within risk tolerance Internal Environment Objective Setting Event Identification Risk Assessment Risk Response Control Activities Information & Communication Monitoring

19. Control Activities • Policies and procedures that help ensure that the risk responses, as well as other entity directives, are carried out. • Occur throughout the organization, at all levels and in all functions. • Include approvals, authorizations, verifications, reconciliations, review of operating performance, security of assets and segregation of duties. Internal Environment Objective Setting Event Identification Risk Assessment Risk Response Control Activities Information & Communication Monitoring

20. Information & Communication • Management identifies, captures, and communicates pertinent information in a form and timeframe that enables people to carry out their responsibilities. • Communication occurs in a broader sense, flowing down, across, and up the organization. • Personnel receive a clear message from top management • Means for communicating upstream • Communication with external parties Internal Environment Objective Setting Event Identification Risk Assessment Risk Response Control Activities Information & Communication Monitoring

21. Monitoring • Monitoring shall assess presence and functioning of ERM over time • Effectiveness of the other ERM components is monitored through: • Ongoing monitoring activities. • Separate evaluations. • A combination of the two. • Serious matters reported to top management and the board Internal Environment Objective Setting Event Identification Risk Assessment Risk Response Control Activities Information & Communication Monitoring

22. Issues to be aware of • Risk Management is an iterative discipline---Risks must be revisited on a regular basis • Need to balance the audit approach (avoid or mitigate risk) vs. proactive approach (deal actively with risks) • Need to recognise role of risk management in realizing strategic objectives • Risk should be seen as a necessary component and factor in strategic opportunity. • There might be an economic benefit in accepting a particular risk, the focus should be on the risk-return tradeoff • Risk quantification needs to be included as well as the focus on risk mitigation. • Need to adequately reflected the external environment even though some risk-factors are beyond management’s control • Need to recognise correlation of risks – often difficult • Risk management is a coordinating function • Risk management is a dynamic process, not a check list approach • Need to recognise risk to reputation

23. Where do exposures remain after risk responses (mitigations/ controls) which are still beyond the company’s tolerance level? • Develop plans to respond to these residual exposures should they occur: • Business Continuity Plans • Incident Response Plans • Disaster Recovery Plans • Crisis Management Plans etc. Control Activities Information & Communication Risk Management Components Internal Environment Objective Setting Event Identification Risk Assessment Risk Response Monitoring

24. Risk Map After Response / Controls Limit OfRisk Tolerance Limit OfRisk Tolerance 1 2 1 Likelihood Likelihood 3 3 5 2 4 7 7 6 6 5 4 8 8 Impact Impact Risk Mitigation Effects Risk Map Before Response / Controls Develop Recovery Plans

25. Incident Management “Planning P” http://www.dfg.ca.gov/ospr/organizational/msb/readiness/2006%20IMH.pdf

26. Types of Risk

27. PHYSICAL PROCESS INSTITUTIONAL Types of Risk • Physical Disruptions: Destruction of critical infrastructure in the supply chain • Critical Infrastructure includes the material components or assets necessary for the continuous operation of the transportation system including equipment and personnel • Process Disruptions: Events that involve day-to-day operations of supply chain processes • Processes include the rules, actions, decisions, and information flows that give life to the physical level and are necessary for efficient and effective operation of the transportation system. Processes are what allow material components to work together—physically or virtually—as a system or supply chain • Institutional Disruptions: Events that involve changes in company or supply-network governance and strategy. • Institutional considerations include the policies, guidance, and organizations that empower and constrain the operation of the supply chain to meet large-scale company goals. Public sector examples of institutional disruptions include federal legislation, national policies, and state regulations. Private sector examples include company reorganizations, mergers, market shifts, and technology breakthroughs.

28. PHYSICAL PROCESS INSTITUTIONAL (Supplier Reliability) Risk Category Examples • Physical Disruptions • Natural Disasters • Terrorist Attacks • Accidents • Process Disruptions • Cyber Attacks • Demand Forecasting Errors (Bullwhip effect) • Missing or late shipments • Institutional Disruptions • New / Increased Regulations • Geopolitical Issues / War • Technology Step-Change

29. Supply Chain Scope

30. Scope includes links between supplier, your company, and customer Downstream Customer Primary Customer Your Company First-tier Supplier X-Tier Supplier Supply Chain Scope As a company looks beyond its own suppliers and customers, the scope of what is Included in supply chain expands… • Your company: Your company is the center of your supply network. The scope here refers only to in-house supply chain issues • First-tier supplier: Any supplier that directly supplies your company. This scope does not include companies that are 2nd tier or beyond • X-tier supplier: Companies that supply your first-tier suppliers. • Primary customer: Any direct customer of your company • Downstream customer: Any customer of your customers.

31. Deliver Source Return Return Physical Movement Information Flow Information Flow Financial Flow Supply Chain Framework Interdependencies Plan Plan Plan Plan Plan Source Make Deliver Source Make Deliver Source Make Deliver Return Return Return Return Return Return Supplier Internal or External Customer Internal or External Supplier’sSupplier Customer’sCustomer Your Company

32. Next Steps • Discussion • Close out track? • How do we use this framework?