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Have your business risks gone global?

In the pharmaceutical sector, part of the art of commercial success is to calculate risk--the likelihood, the need to take it, the consequences if the risk becomes the reality--and to plan your business moves accordingly, almost certainly incorporating a healthy dose of risk prevention. That's the theory at least, and, operating in a globalized economy that has increased the potential for risk at just about every step, it should also be the practice.

For all the organizational sophistication and slick operational performance underpinning successful globalization, the need for any commercial enterprise--including a major pharmaceutical company--to identify and consider at each stage the possibility of what could go wrong has not reduced. If anything, it has increased; for every benefit globalization offers, there are potential pitfalls that a company ignores at its peril.

There have been several high profile examples of the risks to reputation pharmaceutical companies run in the daily task of bringing new products to market. Newspapers screaming 'drug test disaster' mean those unfortunate stories are not easily forgotten. But commercial risks--events and occurrences that can severely damage a corporation if not properly managed--need not be of the headline-making variety.

Research

Research in the US and Europe with executives from the world's leading companies demonstrates that, in a global business, disruption to the supply chain comes second only to 'competition' as a threat to a company's wellbeing. In other words, the principle risk to the existence of a global business is largely defined by the way the company is configured. Overall, according to "Managing Business Risk Through 2009 and Beyond," the report based on the aforementioned research, most businesses expected the severity of their most prevalent business risks to remain constant or intensify, and foresee a range of emerging risks on the horizon. It all adds up to a clear need for companies to develop strong, consistent enterprise-wide--which increasingly means global--risk management programmes. Future-gazing on the supply chain specifically, nearly one-quarter of the executives questioned expected the risks to increase, while just one in 12 believed they would lessen.

The price of preventing a major business disruption can be dwarfed by the clear-up cost if a risk is realized. Effective risk management involves taking that message on board and acting on it in good time, on the basis that, while many sources of risk--changes in competition, government and regulatory developments, pricing volatility, variable client demand and political threats--are not within a corporation's control, what is in its own hands is preparedness to respond to events occurring.

Supply Chain Risks

Although risks to global pharmaceutical supply chains are arguably higher than ever, the good news is that most threats--many of which still come from 'traditional' events such as fire, flood, wind and explosion--can be mitigated through a sound risk management strategy designed to 'prevent,' 'control' or ultimately 'recover.' It is a process that considers far more than mere cost.

Good risk management can provide competitive advantage. It is also a key aspect of corporate governance. Modern approaches use information, technology, science, engineering, experience and even imagination to prevent loss. This has never been more important; practices such as outsourcing, lean manufacturing and just-in-time inventory bring obvious benefits, but they can push reliance on the supply chain to the limit, and the chain itself to breaking point. When the break occurs, the disruption can reduce your company's revenue, cut into your market share, inflate your costs, send you over budget, and threaten your production and distribution. Effects on revenue can be severe, but that may be just the start, with disasters having the potential to damage long-term business prospects, as well as a company's credibility with investors and other stakeholders. It can easily take 2 years for a company to recover from a supply chain failure--assuming recovery is possible at all.

Many corporations that have developed global supply chains seem to be unaware of how new business paradigms have changed their risk profile, taking on greater exposure to natural disasters, lower safety standards and less reliable legal systems, without planning for when things go wrong. But, the mightiest corporations can be vulnerable to situations that may never even have occurred to them; low costs and convenience can come at a high price. Headline-grabbing risks include 'freak' weather events, appalling acts of terrorism, supplier collapse, political upheaval or accounting fraud. Yet, for some reason, it's human nature to think that these global occurrences won't happen to you. But the job of those responsible for the performance and value of a business, and for its very survival, is to recognize that such events will almost certainly happen, and someone's business, somewhere, will almost certainly suffer the consequences. It could be yours.

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Fortunately, pharmaceutical businesses have tremendous opportunities to reduce their supply chain exposure, and there are many good reasons to do so--not least the increasingly stringent corporate governance environment. The key question, of course, is how?

Reducing Supply Chain Exposure

The first step is to identify the possible weak links--the "pinch points"--where problems could cause disruption. You may look at key products, revenue drivers, core business processes and locations--from procurement of raw materials to delivery of finished goods. Once any 'weak links' have been identified, you can apply proven techniques to reduce the potential for them to harm your business.

In the pharmaceutical business specifically, where production techniques and equipment can be complex though often common across the industry, there are numerous proven measures that can be identified and implemented throughout the production and distribution process to reduce the likelihood of damaging events taking place and the consequences if they do. A programme with this aim will draw on the expertise of the company's risk management team, and all its functional arms including sales, marketing, purchasing, operations and finance.

Corporations that fail to take risk seriously are liable to suffer the consequences. Of more than 800 companies that suffered a supply chain disruption between 1989 and 2000, during a 3-year span--regardless of industry, cause or time period--affected companies experienced on average 33-40% lower stock returns relative to their unaffected competitors. Similarly, share price volatility in the year after the disruption was 13.5% higher than in the year before the disruption. Sales were down, costs and inventories were up, and dramatic drops in operating income, return on sales and return on assets were all reported. And the problems aren't short term. Professor Vinod Singhal of the Georgia Institute of Technology has said: "Like a heart attack that cuts off the flow of blood, a supply chain glitch cuts off the flow of information and supplies. And, similar to a heart attack, has lasting effects on a company's health."

The globalized company is in a good position to use data and analysis to minimize dangers. Loss analysis and engineering data, for example, have pointed the way to effective fire prevention policies. One of the challenges today is to extend that effort to a business operation that can span the globe, and could include many independent suppliers and intermediaries over whom the company has no direct control, each adding a new layer of 'risk' to your supply chain.

Good risk management need not mean a blanket policy of avoiding low-developed high-exposure territories, but rather one in which the attendant risks are factored into the decision-making process, and weighed against the potential rewards. Just as globalization has increased risk, so it provides opportunities to manage it. Companies can opt to site facilities in safer locations, tap into educated overseas workforces and set up production centres closer to sources of raw materials. In addition, globalization often increases, exponentially, the number of vendors and suppliers that companies can tap--the classic preventative measure of not "putting all your eggs in one basket."

Alternative suppliers should be truly divorced from the risks borne by their preferred counterparts. If two suppliers are located near each other, or have common suppliers themselves, the same power failure, political upheaval or natural disaster could knock both out at the same time, as evidenced by the simultaneous loss of multiple shipping companies in Hurricane Katrina. To prepare for such eventualities, selection criteria for alternative suppliers should take into consideration a wide variety of factors. Do they get their electrical power from the same grid? Do they rely on the same transport systems? Do they buy their raw materials from the same place? Fewer answers in the affirmative will suggest a more reliable back-up source when managing a disruption.

The nature of most risk in a pharmaceutical business is fairly straightforward to predict or categorize. Taking an overview of pharmaceutical risk for the 15 years during 1985-1999, FM Global found the most significant losses were associated with fire and explosion (31%). The next most likely cause of damage to a company's operations and balance sheet was natural hazards (20%)--particularly wind and flood, a category that looks likely to increase as the world's climate appears to be becoming more volatile. Contamination accounted for another 18%.

In the environment of the pharmaceutical plant, both risk and risk prevention opportunities are numerous. Between them, primary and secondary pharmaceutical plants use numerous chemical, biological and mechanical processes, and every stage of the operation on the way to arrival at the finished product comes with associated risks, which are usually identifiable, virtually always preventable. The possibility of engineering perils such as equipment breakdown or service interruption, fires of the electrical or non-electrical (as in 60% of cases) variety, can usually be prepared for.

In both Europe and the US, risk planning needs to look beyond mere physical restoration of production facilities. If a whole production process needs to be rebuilt because of a physical property loss, regaining validation alone can be very time intensive. A new site, a new process, a product or process change at an existing site, even the in-kind replacement of a piece of equipment--all are likely events at some stage and the time they occupy will be major factors in recovering from a disruption to business.

Rapid Response

With the best will in the world, of course, accidents do happen. When they do, the organization's goal must be to limit the business impact. If a major disruption occurs, a rapid response is essential. The two prerequisites to make that possible are a business continuity plan and an adequate insurance programme. Business continuity experts can help companies better understand the risks they face, and be better prepared to prevent, control and mitigate them, however unlikely they seem. A plan should cover numerous contingencies: disaster recovery, the safety of employees, the retrieval of backup business data, emergency communications, the possible relocation of business operations to an alternative location and the sourcing of goods from alternative suppliers among them.

Recent catastrophes have demonstrated the ability of businesses to routinely underestimate the degree to which disasters can disrupt them. The Deloitte risk management study, 'Disarming the Value Killers,' found many of the greatest market capitalization losses in the world were attributable to 'extremely unlikely' events for which companies seemingly failed to plan.

Insurance will form one part of an effective approach to risk, but it can never replace the loss of customers, employees, management time or reputation. Conversely, the costs of a risk management programme that places an emphasis on prevention and control can be offset by lower insurance premiums and better insurance coverage, because effective risk management reduces the chance a company will suffer damaging business disruption. As this demonstrates, while it's true that managing risk can add significant up-front costs, it can also pay back the investment made many times over, and can ultimately be instrumental in securing the very existence of a corporation when things go awry.

For further information

Tom Roche

Engineering Manager

FM Global (UK)

www.fmglobal.com
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Title Annotation:RISK MANAGEMENT
Author:Roche, Tom
Publication:Pharma
Geographic Code:4EUUK
Date:May 1, 2010
Words:1956
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