Editor's Note: This story is part of a spotlight series on supply chain risk management. To see all of the stories in this series, please click here.
Many supplier performance issues are related to finances.
Deliveries were late and shortages were piling up with no relief in sight. The primary supplier was actively blaming the secondary supplier for the bottleneck, claiming that their supplier was behind in their coating process. They began casting aspersions on the supplier’s lack of process control, communication and even hinted at ethical issues.
While the protocol was for the primary supplier to manage all downstream relationships, this problem had escalated high enough that it was time to call the supplier directly to get to the bottom of the issue and develop a get-well plan.
“It’s a simple problem to solve,” said Teddy, the general manager of the coating supplier. “When they pay their bill I will ship them the product. We haven’t seen a payment in 60 days. They say they don’t have the money to pay us.”
A supplier’s financial condition must be a front burner issue. The root cause of deteriorating supplier performance is often related to financial issues, something suppliers are often quite reticent in telling their customers. An experienced buyer may discover financial issues when increasingly late deliveries, coupled with a range of incongruous excuses, begin to impact overall supplier performance. Financial issues may also be located in lower tier suppliers and remain hidden behind late deliveries, poor quality, and late deliveries from top tier suppliers.
Identifying financial issues
Discovering financial issues before they become apparent is not easy. Many consider financial issues such as poor cash flow, credit line constraints, capital shortages or even bankruptcy plans are not often divulged to customers on a timely basis, if at all. By the time a buyer analyzes an annual report or financial documents, it may be too late to take appropriate action.
While public companies must release financial statements, private companies are under no obligation to do so. Most private companies are hesitant to share financial information, however ones with strong buyer/seller relationships might do so within certain parameters. Yet even with full disclosure, companies can make their financial reports look however they want, while telling inquiring buyers to mind their own business.
Supply chain risk comes from these struggling companies trying to maintain normal business operations.
Supply Chain Dive
There are many causes of financial strain on suppliers. Companies may have constrained cash flow as a result of slow payments from their customers, inefficient alignment of supply and demand causing unnecessary inventory and production, inaccurate forecasting, inadequate sources of funding, capacity constraints, poor bookkeeping and financial practices and even ethical breaches. Some companies struggle week to week to meet payroll and keep a minimal supply of material trickling in the door.
Bankruptcy: The ultimate supply chain risk
Supply chain risk comes from these struggling companies trying to maintain normal business operations. Slow payments to suppliers result in late deliveries from their suppliers, causing a delayed production schedule. Late payments often result in a COD approach by suppliers causing even larger cash flow constraint.
Some companies need to continually find new suppliers who will extend credit terms, jeopardizing product quality and destroying existing relationships of those suppliers no longer shipping to them. Ongoing financial strain also leads to employees leaving, causing knowledge gaps and spikes to the learning curve from new employees, triggering more financial strain and poor performance.
The end result of this supplier tailspin can be bankruptcy. There are two major areas of bankruptcy in the United States. Chapter 11 of the Bankruptcy Code allows the company to survive as they restructure their debts and recapitalize. Chapter 7 results in the immediate cessation of business activities. Both can have a devastating impact on continuity of supply.
Companies can make their financial reports look however they want.
Supply Chain Dive
Each method of bankruptcy provides a different level of risk. Larger companies undergoing Chapter 11 may maintain reasonable operations, however their suppliers will not be paid the full value of their obligations and that may cause disruptions and performance gaps throughout the supply chain. Buyers need to be careful in determining the long- and short-term issues. Suppliers unhappy with their settlement may let their performance lag, causing supply chain turmoil.
Those companies undergoing Chapter 7 cease operations. Obligations to customers and suppliers alike are suspended while the company is being liquidated. While there is some hope in a Chapter 11 reorganization, and time to make alternative arrangements, firms entering Chapter 7 often do so with little or no warning, causing an immediate break in the supply chain. Buyers need to keep in mind that these bankruptcies can happen with suppliers at any tier, and at any time.
Mergers and acquisitions can also create supply chain angst. While they may result in hoped for economies of scale for the principals, there is often impact of customers downstream with changes in product offerings, customer support, credit terms, pricing, and the dissolving of existing relationships. In some cases, product lines are divested and new sources of supply need to be discovered, often at higher costs. These M&A financial schemes often consider stockholders before stakeholders, causing confusion, or worse, in the supply chain.
What the buyer can do
Buyers have limited control of the financial condition of their suppliers. Yet there are some things they can do to identify and limit risk and damage:
Pay special attention to small business and early stage companies. They may be riskier suppliers due to smaller capitalization, limited customers and cash flow constraints.
Identify sole-source suppliers and review their financial condition. Sole-source suppliers who will not share financial information should rank high on the risk register. Invest in secondary sources where needed.
Subscribe to data services that will advise of potential financial issues with suppliers.
Stay current on business and economic issues and trends that may impact the supply chain and ultimately your business.
Have frank discussions with your suppliers on performance issues. Make their financial condition part of any business review.
Reduce dependence of high value suppliers. The traditional rule of thumb is never to be more than 30% of any one supplier’s business no matter how good their performance, as the risk exceeds the reward. Resist at all times entering into deals with ‘captive suppliers”…those fully dependent on your business.
Encourage tier one suppliers, and critical tier two suppliers, to report on potential extended tier financial issues.
Pay your own bills on time. Companies will automatically service well paying customers better than late paying customers. Set a good example and be a good customer.
Every company experiences financial bumps and bruises along the way. Frank and honest discussion may help in the short term, but creating a supply chain strategy where financial considerations are a large part of supplier qualification and performance measurement is critical in the long term.