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Over the next few weeks, we will be publishing a few blogs focusing on risk management in freight procurement. Today, we are defining what risk is and how to account for it in a total cost analysis. And we start with a simple question:
What are your criteria for evaluating a supplier bid when analyzing your freight tenders?
Shortest lead time?
Let’s dig in deeper into what these two criteria really entail. Should be simple, right? Cost is cost and lead time is lead time.
But consider this: what most suppliers offer is a cost and a lead time for a flawlessly executed shipment.
Are all your shipments flawlessly executed?
If yes – congratulations!
If no – welcome to the club.
Nobody’s perfect and issues will always arise. The question is, who has a viable contingency plan in place to take care of disruptions in such a way that delivery disruptions and associated costs are kept to a minimum?
In other words – which supplier offers the best AVERAGE cost and lead time over the course of the contract validity?
To get an answer to this question, it’s imperative to add a new aspect to the tender process. Simply asking for price and lead time isn’t enough. A third aspect needs to be taken into account – risk.
So, what is risk?
Most easily, it’s defined as [probability] multiplied by [consequence].
If you’re delivering parts to a plant that would likely have to shut down production in absence of delivery, for example, the consequence is huge in monetary terms. So, you better focus on minimizing the probability as much as possible.
In short, if you run high consequence trade lanes, a total cost analysis should not be as simple as the number you receive in your price matrix multiplied by the number of shipments.
In reality, you’d come closer to the actual total cost if you used something like this:
Freight cost + (probability of delivery failure) * (alternative cost of delivery failure).
But how do you do that in practice? Stick around for the next post, which will go into more detail on how you can manage a freight tender with an eye to risk mitigation.
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