Tag: risk management

Operational risk can have a crippling effect on a company if not managed properly. This is especially true in the financial services industry. Banks and investment firms must pay close attention to variables that have the potential to impact their operations, not only from the breakdown of technology and processes, but also from a personnel perspective. The responsibility of managing one’s money is great, and the inability to properly anticipate and manage potential risk factors can have a devastating effect, all the way up to the industry level. A case in point was the subprime mortgage crisis of the late 2000s, which led to a nationwide economic recession.

Mike Pinedo, the Julius Schlesinger Professor of Operations Management at New York University’s Stern School of Business, is an expert in risk management research, particularly in the context of the financial services industry. In his presentation at The Boeing Center’s 13th annual Meir Rosenblatt Memorial Lecture, he described the main types of primary risks in a financial services company: market risk, credit risk, and operational risk. Ops risk, which is the risk of a loss resulting from inadequate or failed internal processes, people, or external events, may be the most important factor, he claimed.

Pinedo goes on to describe various types of operational costs such as human resources, I.T. investments, and insurance costs, and how they impact corporate risk management. For example, rogue traders can pose a risk if they make inadvisable decisions, so some investment firms choose to take out insurance against that possibility. Other types of ops risk include transaction errors, loss of or damage to assets, theft, and fraud, all of which can pose a catastrophic risk at the industry level. Pinedo adeptly inserted anecdotes into his lecture to provide examples of these risk factors playing out in the real world.

The annual Meir J. Rosenblatt Memorial Lecture brings the “rock stars” of supply chain and operations to the Danforth Campus every fall. Each lecture gives prominent thinkers and practitioners alike the opportunity to hear an expert in the field highlight emerging trends.

This lecture series was established in 2003 to honor the memory of Meir J. Rosenblatt, who taught from 1987 to 2001 at Olin Business School as the Myron Northrop Distinguished Professor of Operations and Manufacturing Management. A leader among faculty, Rosenblatt often won the Teacher of the Year award at Olin and authored the book “Five Times and Still Kicking: A Life with Cancer,” having battled cancer multiple times throughout his life.

For more supply chain digital content and cutting-edge research, check us out on the socials [@theboeingcenter] and our website [olin.wustl.edu/bcsci]

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Supply Chain  //  Operational Excellence  //  Risk Management

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Video, above: Professor Panos Kouvelis, Emerson Distinguished Professor of Operations and Manufacturing Management and Director of The Boeing Center for Supply Chain Innovation at Washington University speaks about his research on managing commodity price volatility in the supply chain in the latest Boeing Center digital production.

When commodity prices are stable, firms usually agree upon fixed wholesale price contracts, quantity discounts, buybacks and even some revenue-sharing schemes. But in volatile commodity price environments, annual price volatility can be as high as 60%, resulting in the need for escalation clauses and adjustable contracts. High volatility may even create situations where vulnerable suppliers fail to meet contractual obligations.

The focus of the new research is to find ways to better manage risks for such environments through using the right contracts and when it is appropriate to use financial hedges. One example of contracts often advocated for in such cases is the pass-through, or index contract, which is used to describe how the supplier will pass some of the increased material costs down to the buyer. These contracts can be effective as long as the downstream buyer is “big” enough to absorb the risk or has financially hedged such risks appropriately.

Pass-through contracts have not been viewed favorably by the corporate finance community. For example, environments of perfect markets with no financial frictions can be dominated by the so-called “coordinating contracts,” such as revenue-sharing or two-part tariff contracts.  Coordinating contracts achieve “first best” (i.e., the same profit as a single firm owning and running the whole supply chain), and with appropriate setting of their parameters, can coordinate the commodity risks for short lead-time environments.

Long lead-time environments create the need for appropriate penalty structures on top of such contracts, a feature not mentioned in the current literature, but elucidated in Kouvelis’ research.  However, in an environment of financing frictions (e.g., firms have limited working capital and need to borrow to execute their supply chain transactions), the coordinating contracts might be ineffective in the handling of financing costs.

In many cases, a pass-through contract with a downstream buyer that hedges commodity risks can be more effective. These situations are common when under capitalized suppliers with good margins contract with larger buyers in high volatility price environments, such as the auto, appliance, and aerospace manufacturing settings.

To learn more, read the abstract from Prof. Kouvelis’ paper below, or download the paper HERE.

Paper title: “The Role of Pass-Through Contracts in Environments with Volatile Input Prices and Frictions”
Authors: Panos Kouvelis, Danko Turcic (Olin), Wenhui Zhao, Shanghai Jiao Tong University (SJTU) – Antai College of Economics and Management

We model a bilateral supply chain with stochastic demand, stochastic input costs, production lead times, and working capital constraints. The supply chain participants contract as follows: Either they use the pass-through contract under which the upstream supplier passes her entire commodity input cost onto the downstream assembler, or they use an appropriately adapted revenue sharing contract under which the firms split both the production costs and the operating revenues. In the absence of financing needs for either firm, the pass-through contract is dominated by the revenue sharing contract – even if downstream buyer hedges all input costs. However, when working capital limitations drive financing needs in the chain, the financial frictions break the coordinating nature of the revenue sharing contract, and the created double marginalization inefficiencies and financing costs for firms with differential working capital and financing needs weaken the profit performance of the contract. Pass-through contracts do dominate revenue sharing ones when there are low (or no) working capital suppliers. Hedging behavior can be justified even in the absence of financing frictions for pass-through contracts, and it only involves the buyer. Hedging behavior in revenue sharing contracts happens when financing is needed, and either firms both hedge, or neither hedges, all commodity purchases in the supply chain. Double marginalization inefficiencies versus financing costs are the main factors in determining the effectiveness of the contracts, with financing cost dominated environments favoring the pass-through contract.

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In part two of his BCTIM Operational Excellence seminar, Dana Hullinger, Director of Supply Chain Strategy, Architectures & Analytics at Boeing Defense, Space & Security, speaks about BDS Supplier Management’s role in supply chain strategy and using financial and operational risk reduction to affect a transformation from cost center to value creator.

Hullinger also explains how creating a strategic approach to supply chain management in the defense industry is instrumental to top-line growth and bottom-line profitability.  One strategy mentioned by Hullinger was the introduction of a third supplier for the landing gear on the Boeing 777X. This increased competition for Boeing’s business, he said, encouraged innovation, investment, and excitement in the company. Such strategies, Hullinger said, allow BDS to look further down the road and orchestrate supply chain solutions instead of simply negotiating in the existing supplier climate.

For part one of Hullinger’s presentation, click here.

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The Boeing Center was pleased to host Dana Hullinger, Director of Supply Chain Strategy, Architectures & Analytics at Boeing Defense, Space & Security for the second BCTIM Operational Excellence seminar of 2016. His presentation, titled “Transforming the Supply Chain Organization: Tackling the Biggest Supply Chain Risk of Them All,” focused on the challenges of supplier management in the aerospace and defense industry. Hullinger, responsible for supply chain architecture and investment, reduces operational and financial risk by analyzing the current supplier landscape and making strategic decisions about sourcing and procurement.

BCTIM-Hullinger2As one might expect, Boeing’s supply chain is amazingly complex. With over 5,000 suppliers in 30+ countries, handling more than 120,000 purchase contracts, efficient and organized supply chain management is essential.  Naturally, such complexity introduces risk when operating in a global market.  Some of the challenges highlighted by Hullinger regarding the globalization of Boeing’s supply chain are:

  • ensuring that suppliers do not use conflict minerals in their manufacturing processes
  • protecting against information theft by cyber criminals
  • managing obsolescence due to technological innovation

These challenges are particularly important for Boeing as it strives to reduce risk BCTIM-Hullinger3and increase visibility across its entire supply chain.  Effective risk management and communication with suppliers, Hullinger claimed, are vital to the company’s future growth. A collaborative process will enhance Boeing’s ability to manage supply chain risk and maintain its position as the preeminent company in defense and aerospace.

We thank Mr. Hullinger for sharing his expert knowledge with the supply chain and logistics community. Also, we congratulate Boeing on 100 years of innovation and excellence, and look forward to the next 100.

By Evan Dalton

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In a recent research seminar of The Boeing Center on Technology, Information and Manufacturing (BCTIM) at Olin Business School, interesting issues on capacity and risk management in a commodity industry, specifically palm production and distribution which are representative of many agricultural supply chain activities, were discussed.

Guest Blog by: Panos Kouvelis and Guang Xiao

Professor Onur Boyabatli, from our partner university Singapore Management University (SMU) presented his most recent paper “Capacity Management in Agricultural Commodity Processing and Application in the Palm Industry” in the first seminar of our Fall Lecture Series in operations and supply chain management. He illustrated the common operational challenges that palm producers face due to the uncertain production and market environments, e.g., production yield risk, input and output price risk, etc.

Professor Boyabatli proposed a multi-period model to capture a palm producer’s processing, storage, and selling decisions as well as the long-time capacity investment strategy. He provided several interesting managerial insights and suggestions regarding to the production activities in similar uncertain environments. First, storage capacity should be adjusted in response to a change in output price volatility. Second, byproduct volume and margin considerations are important for overall profitability, and focusing only on main product profits while ignoring byproducts may lead to lost opportunities in certain markets and significant overall profit loss. Finally, overlooking yield uncertainty also has significant negative impact on the processor’s profitability. These insights were supported through both analytical and computational results using actual palm processing data.

Professor Boyabatli’s talk not only provided useful background knowledge of the palm industry practices, but also stimulated many thought provoking discussions among the seminar participants. Hopefully, more research can be inspired by linking the integrated supply chain risk management with industry practices among the faculty members and doctoral students after this talk.

Some of our faculty are strongly interested in risk management commodity processing industries, and the work of Professor Panos Kouvelis, Ling Dong and Danko Turcic examines interesting risk management aspects of such industries. At the same time we hope that relevant business research, like the one highlighted above, will intrigue industry executives and managers in improved practices effectively guiding their actual capacity and production planning processes.

Some biographical details of the presenting author: Onur Boyabatli is an Assistant Professor of Operations Management at the Lee Kong Chian School of Business, Singapore Management University. He earned his PhD degree in Technology and Operations Management from INSEAD, France. His primary research interest is on the integrated risk management in supply chain with application in agricultural industries.