Why Supplier Risk Assessments Are Critical to Supply Chain Resilience

Article Highlights:

• A supplier risk assessment is a process organizations administer to identify and evaluate the risks associated with a specific supplier. Supplier risk assessments are a crucial aspect of many supply chain risk management (SCRM) programs, frameworks that often also include capabilities like supply chain visibility, transparency and traceability across supplier tiers, and sourcing resilience strategies.
• Depending on their size, industry, and operations, suppliers can pose a raft of different risks to the businesses that source from them. These risks run the gamut from financial issues to regulatory violations to concerns about data transparency. 
• In a supply chain landscape in which large corporations regularly surrender as much as 10% of their total revenue to costs associated with supply chain disruptions, identifying, assessing, and mitigating risks can yield substantial financial rewards. 

Major news headlines often reverberate through global supply chains. A destructive hurricane can shut down factories and cripple local infrastructure; a violent border skirmish may trigger the closure of specific transportation routes. But while newsworthy events like these may be the most high-profile risks for businesses that source from complex manufacturing networks, they are not the most clear and present danger. Rather, the greatest risks to organizations come from the most important variable in their supply chain: the suppliers themselves. 

Suppliers are a vital aspect of operations for almost all businesses that manufacture goods. In an era defined by globalization and specialization, they are more critical than ever. According to research by McKinsey, automotive manufacturers have as many as 18,000 suppliers across their full supply chain, with aerospace and defense firms not far behind with an average of 12,000. Even small and medium-sized enterprises (SME) have become highly dependent on the global supply chain: according to a recent report by Spendesk, these firms have as many as nine times more suppliers than they do employees. 

Because suppliers play such a prominent role in today’s global manufacturing, they have also emerged as perhaps the most consequential vessels for supply chain risk. But for original equipment manufacturers (OEMs) to defend themselves against these threats and cultivate the resilience to withstand them effectively, they first need to identify them. 

What Is a Supplier Risk Assessment?

A supplier risk assessment is a process organizations administer to identify and evaluate the risks associated with a specific supplier. Supplier risk assessments are a crucial aspect of many supply chain risk management (SCRM) programs, frameworks that often also include capabilities like supply chain visibility, transparency and traceability across supplier tiers, and sourcing resilience strategies.

According to Iowa State Business School, supplier risk assessments typically consist of four distinct elements:

• Risk identification
• Risk assessment
• Risk management decisions and implementation
• Risk monitoring 

In risk identification, the organization uses current and historical data to identify the risks associated with a specific supplier. This may entail collecting financial records, regulatory filings, manufacturing site documentation, and other evidence that can be used to gauge risk. In the second step, risk assessment, organizations often rely on a risk matrix. These tools measure the likelihood of a given risk against the severity of the impact if it were to happen, and can be essential instruments in classifying and prioritizing supply chain risk. 

In the third step, risk management decisions and implementation, the organization needs to determine what risks they want to address, and how. This entails developing and implementing mitigation programs, including strategies like multisourcing, supply chain diversification, contractual protections, and new supplier requirements. Finally, risk monitoring is the continuous process of observing risk—and the risk management programs that were implemented—to measure their effects over time. 

What Kinds of Risks Do Suppliers Pose?

Depending on their size, industry, and operations, suppliers can pose a raft of different risks to the businesses that source from them. These risks run the gamut from financial issues to regulatory violations to concerns about data transparency. Supply chain risk management (SCRM) tools can help businesses understand the level of risk their suppliers pose in these myriad categories.

Financial Health

Manufacturers and other businesses run into financial woes all the time. In fact, as many as 20,000 businesses file for bankruptcy in the U.S. every year, according to court data. While public companies operating in the supply chain often have some level of financial stability, private firms are more likely to work under more precarious fiscal circumstances. Small, private manufacturers operating deep within a company’s subtier often represent a particularly high financial risk for OEMs that rely on the goods they produce.

SCRM platform Z2 evaluates companies using a mixture of financial statements and its own proprietary risk-sensing algorithm. For public companies, Z2 evaluates key metrics like liquidity, solvency, profitability, and growth. For private firms, the tool analyzes indicators of financial health such as company size, industry benchmarks, and year-over-year growth.

Geopolitical Risk

Admittedly a broad category, geopolitical risk refers to any political hazards stemming from a company’s geographical base of operations. This could include armed conflict, government instability, or the geopolitical dynamics between nations. Taiwan, for example, may be a wealthy, highly industrious island nation, but its tenuous relationship with China—and how that relationship could evolve over the remainder of the decade—puts companies headquartered there at high geopolitical risk. 

Z2 uses factors like political instability, regulatory volatility, and proximity to conflict zones to evaluate the geopolitical risk posed by suppliers and other businesses. The tool also pays special attention to how adverse geopolitical developments could impact operations at different manufacturing sites.

Regulatory Compliance

A critical risk for almost all industries, the regulatory adherence of suppliers can have major ramifications for their customers. Manufacturers that fall out of compliance with environmental or trade regulations could be forced to shut down facilities, suspend production, or pay large sums to regulatory bodies. All these consequences can reverberate across the supply chain and ultimately impact OEMs, leaving them exposed to production shortages, reputational damage, and other adverse outcomes. 

Z2’s internal database of supply chain relationships allows the tool to not only identify  compliance issues for direct suppliers, but also potential regulatory concerns deeper within a business’s subtier. Through gleaning subtier relationship data, Z2 is capable of uncovering compliance risks at tier two, tier three, and beyond, giving organizations an effective compliance risk-sensing mechanism.

Manufacturers that fall out of compliance with environmental or trade regulations could be forced to shut down facilities, suspend production, or pay large sums to regulatory bodies.

Tariffs and Other Trade Measures

Since the second Trump administration took power, tariffs have been leveraged in the U.S. to a degree not seen in nearly a century. The consequences for American businesses is a supply chain landscape tripwired with new costs and trade risks. Any supplier risk assessments conducted today should take into consideration where the supplier is headquartered, where its manufacturing facilities are based, and the stability of its trade relationship with the U.S. 

Z2 uses key indicators like COO, COD, and HTS codes to determine the tariff impact for specific parts and manufacturers. Because Z2 offers part-to-site mapping, customers are able to go beyond direct suppliers, shedding light on the actual manufacturing sites where their orders are originating—a critical capability in today’s high-tariff environment. 

Sourcing Dependency

Whether you’re an OEM, EMS provider, or subtier manufacturer, multisourcing is an essential strategy for fostering resilience across your supply chain. Any comprehensive supplier risk assessment should include detailed questions around sourcing strategies, diversification, and any single-source dependencies lurking in your supply chain. Businesses should press suppliers on whether their orders are manufactured at multiple sites, where those sites are located, and how much geographical diversity they have in their manufacturing operations more broadly.

Sourcing dependency is a critical risk factor for Z2, and the SCRM tool uses a multifaceted coding system to determine the vulnerability of electronic parts. All components in Z2’s database are coded in one of five different ways, based on sourcing diversity/dependency. In addition, the software automatically flags parts that are overly reliant on a single supplier, site, or country.

Businesses should press suppliers on whether their orders are manufactured at multiple sites, where those sites are located, and how much geographical diversity they have in their manufacturing operations more broadly.

The Full Spectrum of Supplier Risks

These are just some of the most prevalent risks that suppliers pose to their customers. Other hazards include cybersecurity threats, ESG performance and corresponding risk, data transparency, and disruptions to manufacturing operations. In a supply chain landscape in which large corporations regularly surrender as much as 10% of their total revenue to costs associated with supply chain disruptions, identifying, assessing, and mitigating risks can yield substantial financial rewards. 

Risk Analysis and Risk Appetite

After supplier risk has been identified and assessed, businesses need to make consequential decisions about just how much risk they are willing to take on. This is known as risk appetite. Risk appetite can be defined as the amount and severity of risk an organization is willing to assume in pursuit of its goals. The Institute of Risk Management defines the term as the “the amount and type of risk that an organisation is willing to take in order to meet their strategic objectives.”

Importantly, some sources define risk appetite as the magnitude of risk a business is willing to take on before it implements mitigation measures to reduce the probability or severity of that risk. In the context of supplier risk assessments, then, risk appetite can be understood as the amount of risk an organization deems acceptable without the need for specific corrective actions. As valuable as supply chain risk management (SCRM) is, it also requires resources, expertise, and funding to execute successfully. If a threat posed by a specific supplier is determined to not be severe or likely enough, it may not justify extensive SCRM measures. 

Equip Your Company With the Right Risk Intelligence 

In theory, a supplier risk assessment sounds like a single, finite task—a one-and-done action sourcing and procurement professionals can take to evaluate the risks posed by the different actors in their supply chain. In reality, however, today’s supply chains and the manufacturers that operate as key cogs within them are continuously evolving, as regulations, trade dynamics, and sourcing relationships fluctuate from one year to the next. 

Because of this, it’s no longer enough to carry out a single supplier risk assessment. Organizations that want the visibility and discernment required to see the evolution of risks over time need an effective SCRM solution. Z2 offers comprehensive supplier risk assessments for over 700,000 global suppliers, evaluations that look at 12 different risk factors to arrive at a single holistic score companies can reference when making crucial supply chain decisions. 

To learn more about Z2 and its risk assessment capabilities, schedule a free trial with one of our product experts.