Conducting a Country Risk Assessment for your key suppliers

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Author: Paul Curwell

Introduction

Choosing a supplier is an important decision for any business, no matter the size or time in operation. We all know that picking the wrong supplier can have disastrous consequences for your brand, reputation and customer satisfaction. Globalisation has driven manufacturing to low cost destinations, typically in less developed parts of the world. Whilst this meant the ability to purchase a product for a cheaper price, it also came with risks relating to reliability, quality, supply chain disruptions, integrity and ESG (Environmental Social Governance) risks such as indentured labour.

Stories of bad procurement experiences abound in relation to sourcing Personal Protective Equipment like gloves and masks for health workers during the COVID-19 outbreak. For example, some customers purchased counterfeit product whilst others purchased products which did not conform to stated specifications and had to be destroyed. However, in other cases the government where the manufacturer or distributor (e.g. warehouse) was located stepped in to compulsorily acquire the products for their own citizens, at the customer’s expense.

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As highlighted by these examples, three main risks need to be considered as part of any supply chain decision:

  1. How well do you Know Your Supplier (KYS)
    • Are they legitimate?
    • Do they have a good track record in the market?
    • Are they financially solvent?
    • What do existing customers think of them (do they have any customers)?
    • Will associating with them damage your reputation?
  2. Does the product quality and pricing meet expectations?
    • Are their products legitimate?
    • Do they use substandard or counterfeit components?
    • Do their products conform to expected / agreed standards and specifications?
    • Are they competitively priced?
  3. Is the supplier located in a high risk country?
    • What factors external to the supplier might impact their ability to service your needs?
    • How dependent are they on other parties, such as trucking companies and electricity utilities, to delivery on supply agreements?
    • Are there any other considerations which might result in supply chain disruptions or non-delivery?

This concept of a ‘high risk country’ and the concept of country risk is examined in more detail below.

So what is country risk anyway?

The importance of understanding country risk is often overlooked, or given only a cursory glance by many businesses. As Australians we are truly privileged in terms of our advanced society, laws and infrastructure, and it is easy to forget that this is not the case for other countries (especially those manufacturing low cost products for import). When used by economists and the investment community, country risk refers to the “losses that could arise as a result of the interruption of repayments or the operations of entities engaged in cross-border investments caused by country events as opposed to commercial, technical or management problems specific to the transaction” (Toksoz).

The term political risk may also be used interchangably with country risk in some situations, however it is typically used to refer to those sources of risk with a political dimension whereas country risk as used here is much broader. According to Moosa (2002), country risk analysis is used in three scenarios:

  • Multinational companies use it as a screening tool to select preferred countries for investment and / or market entry based on risk factors;
  • Country risk metrics can be used as part of a continuous monitoring program for in-flight projects or investments (see below); and,
  • It can help identify, assess and manage country-related risks pertaining to projects or other initiatives in a foreign country.

For the purposes of this article, the selection of suppliers falls into the latter category.

You don’t need to consider country risk as part of every supplier decision

Not every product is created equal – some products may be more highly commoditised (and therefore readily availble from multiple suppliers) than others. Typically, it is not necessary to follow the practices outlined in this post for products which can be easily purchased from many suppliers in many different countries (and indeed regions of the world).

Situations where a business should to conduct a proper country risk study of its supply chain include:

  • Companies that are sourcing a contract manufacturer to build their products to specification
  • Products that require rare or hard to obtain ingredients / materials / components
  • Products that require specialist skills, equipment or manufacturing conditions (e.g. clean rooms)
  • Products that require components which are made under license by a fourth party

Where does country risk fit into the overall decision process for a supplier?

The process of choosing a supplier generally involves at least five core steps:

  • Identify and document your business requirements
  • Identify source countries for the product
  • Identify potential suppliers (i.e. individual businesses)
  • Negotiate and award the contract
  • Monitor the supplier for the life of the contract

Often, the identification of a potential supplier is conducted in tandem with the country risk assessment, however the order really depends on how many supplier choices exist. For example, in the case of contract manufacturers there may be suitable suppliers across multiple countries. Assuming these contract manufacturers are broadly comparable on other attributes such as price / quality and KYS outcomes, the inherent country risks may become a determining factor in the ultimate decision.

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What does the country risk assessment process involve for suppliers?

In my career, I have seen many country risk assessments which really miss the mark. They might be a great piece of research that consumes copious numbers of pages and tells you everything you might ever want to know about a country, but so what? We’re in business, not writing a doctoral thesis or encyclopedia. Many country risk assessments are actually what are referred to as ‘country studies’, effectively research documents that catalogue many facts about a given country but are not linked to risks per se. I use a three-step process to produce a country risk assessment for a supplier, as follows:

  1. Map the supplier’s value chain – use Michael Porter’s value chain analysis to gain at least a basic understanding of what is required by the supplier to make your product. For example, if your supplier runs an iron foundry, you care about electricity and water as inputs. The reliability of your supplier’s phone network is important for delivery and payment, but without power and water there is no product. If your supplier depends on third parties for components, you need to understand this as well.
  2. Identify country risks – there are numerous methods for this, with two common ones being PESTLE and PMESII. If you already have a country study, this should be used as an input to this risk identification stage. Use desktop research and interviews to identify the required information, and then categorise your findings using the PESTLE and PMESII taxonomies:
    • PESTLE – stands for Political, Economic, Social, Technological, Legal and Environmental and is commonly used in government and business. Each of the PESTLE categories has a multitude of sub-factors, such as types of contract law (as a Legal example) which should be researched, discounted, or included where relevant
    • PMESII – stands for Political, Military (or law enforcement / organised crime), Economic, Social, Information (as in the reliability of information such as public records and the media) and Infrastructure. PMESII is a methodology used by the intelligence community.
    • Either method, or any variation thereof, should be developed based on your scope of work and objectives.
  3. Write up the country risk assessment and risk mitigation plan – the last step in my method for preparing a country risk assessment for suppliers involves overlaying the country risks against the value chain. Where possible, market forecasts and internal metrics (e.g. revenue, production) should also be referenced to ensure identification of country risks that actually impact the value chain. Once you have identified risks relevant to the value chain, these risks can be assessed and potential mitigation options identified for consideration.

Why should I bother? What is the cost-benefit here?

In her latest book on Political Risk, former US Secretary of State turned Stanford University professor refers to political risk in the context of her “five hards of political risk management” (p82):

  • Hard to reward
  • Hard to understand
  • Hard to measure
  • Hard to update
  • Hard to communicate

I have encountered situations where well-intentioned businesses sought to manage country risk, such as when selecting a single contract manufacturers for all their production, only to find executives balk at the thought of spending a thousands of dollars to identify and assess risks which in many cases would protect from losses of millions in future revenue. Whilst it might be hard to quantify the return on investment that justifies spending on country risk, the benefits are clear, as illustrated by this example from MIT Professor Yossi Sheffi’s excellent book ‘the resilient enterprise’:

On 17 March 2000, lightning resulted in a fire at the Philips NV semi-conductor plant in New Mexico, USA which damaged manufacturing clean-rooms and destroyed inventory under production. Two of the plant’s most important customers were Ericsson and Nokia, then leaders in the mobile phone market.

In Finland, Nokia received a call from the plant informing them of an anticipated one-week delay. However, on further investigation Nokia determined the downstream effects would impact millions of its handsets, jeopardising sales and market share. Nokia began to enact its contingency plan, including buying excess capacity in the global market.

Nokia’s primary competitor, the Swedish company Ericsson, also received the same call but was reportedly less concerned. By the time they realised the materiality of the situation it was too late. This event ultimately triggered billon-kronor losses for Ericsson, resulting in its exiting the mobile phone market entirely.

This example highlights the importance of understanding all aspects of risk in the supply chain – making early, informed actions are critical to managing supply chain risk.

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The country risk assessment process isn’t just a once-off

Most relationships in life start out well but deteriorate over time. Like any business relationship, suppliers need to be continuously monitored and the relationship nurtured to ensure long-term benefits to all parties. The concept of ongoing or continuous monitoring in due diligence and risk management generally has been around for many years, but has only recently started to take hold. Two elements need to be continuously monitored so as to properly manage supply chain risk:

  • Ongoing monitoring / continuous monitoring of the supplier themselves for factors such as financial solvency, quality, changes in ownership; and,
  • Ongoing monitoring of those external ‘country risk’ factors which the supplier may not even be aware of but which could disrupt ongoing supply.

One way to conduct ongoing (continuous) monitoring is through a strategic ‘early warning’, ‘situational awareness’ or ‘risk sensing’ capability which monitors the operating environment for tripwires, or leading indicators of an emerging risk which allows for closer monitoring and timely response. I will discuss how to build one of these capabilities in a future post.

Further Reading

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