Community of Inquiry article series
2016.01.18 • published on LinkedIn
Logistics industry from the institutional investor's perspective
Article 2: Landlord involvement in risk mitigation
1. With respect to this article series
This is the second of five articles in a Logistics Community of Inquiry series in the following four linkedIn groups:
||Global Logistics & Supply
Chain Professional Group
For a more comprehensive explanation of the purpose and objectives of this CoI (Community of Inquiry), please see the first article in this series.
2. Market dynamics and competitive influencing factors
In the first article, we explored some of the goals and deliberations an institutional investor may have when starting to invest in a logistics portfolio, especially regarding
macro-economic factors and internal performance for shareholders. On a micro-level, we also assessed the building specifications and the specific market and site conditions,
with a final short look at legal and fiscal due diligence issues at the end.
One could argue that these are the main factors an investor needs to consider to ensure a stable Return on Investment (ROI). However, this approach is often considered too
one-sided. evaluating the investment. Though the first year of the investment will almost assuredly cover initial ROI assumptions, ever-changing market dynamics and the
turbulent competitive environment for the tenant (i.e. logistics service provider), can play an important role in how your investment performs for the rest of its lifecycle.
Let us assume your logistics investment has a 10-year duration, which is already taking a considerably long view. Although it would be nice to believe nothing will happen
in that time, to do so would be to bury your head in the sand. One cannot invest in logistics without considering the volatility of the logistics environment. In order
to ensure you are going into your investment with both eyes open, you should always assess a property from both the perspective of the investor/landlord and that of the tenant.
Once the risk factors has been assessed from all sides, one can create a more comprehensive risk mitigation plan spanning investor/landlord and tenant concerns.
3. Risks in the supply chain network
First, we will examine supply chain challenges from the service provider's perspective. In former days, many supply chains functioned almost on autopilot, but today
many dangers lurk in both the domestic and global markets. Although it is difficult to speak of a "standard" supply chain, especially when comparing supply
chains in different markets, a typical supply chain structure with the various links is shown in figure 1.
Figure 1: Supply chain network structure with types of intercompany business process links (source: Lambert & Cooper, 2005)
Complex supply chain networks harbour many hidden and/or unforeseen risks. One of the main risks is the interdependency between supply chain partners. Even within a
competitive field or industry cooperation between trading partners will generally emerge. At a threshold level, this interaction is bidirectional: exchanging
essential information and engaging partners, be it suppliers or customers, in longer-term contracts. According to van Halderen & van der Meer (2015),
confidentiality between companies in the supply chain, regardless of whether supported by non-disclosure agreements or not, is still missing.
It will take a long time and many more attempts to make many of the traditional linkages between and among trading parties seamless.
Figure 2: Key transition from open-market negotiations to collaboration (source: Spekman, Kamauff Jr. & Myhr, 1998)
The risks for logistics providers in the total supply chain occur in key business processes, such as:
- Failure to create long-lasting relationships with the customer
- Dependency within the whole supply chain
- Service management errors
- Faltering order fulfilment
- Incorrect estimation of consumer demand
- Unexpected or more product returns
- Lacking product development and commercialisation
- Mediocre procurement processes
- Flow management running behind
- Non-synchronised IT systems and software packages
- Inaccurate or non-existent forecasts for the demand of products and services.
Another problem often arising within supply chains is the so-called non-member process links (see figure 1), i.e. parallel supply not within a logistics manager's
scope of control.
4. Risks in the day-to-day supply chain
Supply chain disruptions can be detrimental to a company's financial health. A study by Hendricks & Singhal (2005) highlights these negative consequences by analyzing
over 800 supply chain disruptions that took place between 1989 and 2000. Firms that experienced major supply chain disruptions saw the following consequences:
- Sales were down 93 percent, and shareholder returns were 33-40 percent lower over a three-year period
- Share price volatility was 13.5 percent higher
- Operating income declined by 107 percent, and Return On Assets (ROA) declined by 114 percent.
Logically enough, many of these day-to-day risks mirror those of the global supply chain, as the global supply chain is essentially an extension of the local one.
In their 2014 survey of over 150 supply chain executives, the University of Tennessee|Knoxville Global Supply Chain Institute unearthed some alarming figures regarding
supply chain risk management and mitigation.
(sources for all figures: University of Tennessee|Knoxville Global Supply Chain Institute, 2014)
Looking at these results, it would be difficult to conclude that logistics companies are "highly effective" at supply chain risk management. In a recent study done
by Risk and Insurance Magazine the typical supply chain manager estimates that just 25 percent of his company's end-to-end supply chain is being assessed for risk in any way.
Another study (Zurich, 2009) identifies five key supply chain risk factors and charts them on a map called the 'Risk Catcher'. The red line in the graph represents the
perceived current status and the blue line is where they want to be. Closing the gap between the two profiles is the subject of risk management improvement plans,
meant to yield strategic benefits across the business.
The Risk Catcher looks at the total risk management horizon of an enterprise. By taking this holistic approach, Zurich's survey could actually encourage risk
specialists to come out of their independent silos and into a collective problem-solving space. For example, 'management controls' is often the province of
the company's Chief Internal Auditor, 'handling the unexpected' the concern of the Risk Officer, and 'external dependencies' the focus of the Chief Procurement
Officer. These three do not often meet, but analyzing solutions with the purview of joint Risk Catching gives them the reason to do so.
The bottom line in the Zurich survey is that a shared risk analysis within the supply chain enables better risk management planning, thereby protecting profitability
when the chain breaks. In complex supply chain structures, as discussed above, companies rely on suppliers for information, yet essential information regarding
critical supplies and distribution nodes often remains hidden, obscuring interdependencies. Introducing standardised risk approaches and uncovering the weak
points will involve all critical levels of management.
Combining Zurich's (2009) holistic view of risk assessment and the risk ratings from the University of Tennessee|Knoxville Global Supply Chain Institute (2014)
survey (see figures 8 and 9) enables us to collect outcomes into a categorised table. This table can be extended to include landlord participation in risk
mitigation, thus tightening the relationship between landlord and logistics tenant.
Figure 8: Risk Catcher (source: Zurich, 2009)
Figure 9: Supply chain risks (source: University Of Tennessee|Knoxville Global Supply Chain Institute, 2014)
5. Landlord participation in risk mitigation
A supply chain could work effectively in a stable environment, but unfortunately, the volatility of economic cycles along with natural and man-made disasters
make stability little more than wishful thinking, see figures 8 and 9 and Tang (2006). Tang (2006) reported that a supply chain disruption can have significant impact
on a firm's short-term performance. For example, in 2000 Ericsson lost 400 million Euros after a plant belonging to one of their suppliers caught fire, and Apple
lost many customer orders after an earthquake hit Taiwan in 1999 (Tang, 2006).
In order to better identify supply chain risks, we have created a table based on Abdellaue's (2010) analysis. Abdellaue identifies three risk categories:
environmental, organisational and network-related. This paper will also include a fourth category: unexpected.
You can find the table outlining these Logistics Service Provider (LSP) risks and possible landlord countermeasures in appendix 1 of this paper.
Of the 53 determined LSP risk elements, there are at least 10 cases where the landlord could mitigate these risks through:
- Financial reimbursements
- Flexibility in utilisation of housing
- Making internal research resources available to the LSP
- Seeking cooperation on mutual issues, such as cost control, safety and security.
Admittedly, landlord involvement in the LSPs internal affairs could lead to contract renegotiations in the landlord's favor, but this is beyond the scope of this paper.
Of course, the logistics service provider can also help himself a lot by prioritising the risks in his business based on three factors:
1. Seriousness of consequences
2. The likelihood of the problem ever occurring and in what frequency
3. The possibility of early problem detection.
This approach is a fine way of identifying high priority risks to the supply chain. The logistics provider can determine which risks require a mitigation approach
and which are too low-impact or unlikely to warrant the effort.
The University of Tennessee|Knoxville Global Supply Chain Institute also made an interesting enquiry into the preferred methods of risk mitigation among supply chain specialists.
Figure 10: Supply Chain risk mitigation preferences (source: University of Tennessee|Knoxville Global Supply Chain Institute, 2014)
One striking result was that these specialists ranked insurance last amongst mitigation tools. In the following statement, the scholars at the University of
Tennessee (2014) assert that this is clearly a mistake:
"By doing so, they miss a great opportunity to selectively use insurance to mitigate key risks. Insurance provides the financial backstop when a loss occurs,
but a company can also leverage the broker's and insurance company's expertise and experience in preventing losses before they occur, especially the day-to-day
challenges previously mentioned. As stated earlier, not one of those surveyed uses outside expertise in assessing risk for their supply chain.
One simple approach supply chain professionals could employ is calculating an "expected loss" for each major supply chain risk as follows:
Expected loss = (cost of loss) x (subjective probability of loss)
Once calculated, expected losses can be compared with the cost of insurance to cover that loss. The expected loss includes the product value, the customer and
lost sales impacts, and the expediting costs to recover."