As 2019 begins, there are signs that the growth trajectory of the past few years may be flattening and that the new year may be more uncertain. This means that it is prudent to shift from a singular focus on supply and begin to evaluate your supply chain based on risk. More specifically, small and medium size suppliers that have become accustomed to year over year growth may find themselves in a bind if the threat of a slow-down becomes a reality. This could be especially problematic with unique suppliers that are involved in providing critical technology. In one of our recent engagements, we evaluated the financial stress that would occur with different types of downturn scenarios and learned that several critical suppliers would face serious financial issues.
So what you should you, as a supplier management professional, do in order to understand and mitigate the risk associated with your suppliers? How do you get visibility into your supplier’s ability to survive a downturn when there are no signs of trouble in your relationship? And most importantly, how do you get ahead of the curve and deploy mitigation strategies that act as shock absorbers in the event of a downturn? While this topic is too broad to cover exhaustively in a short newsletter, experience tells us that most of the risk comes in three important areas. This is where you should explore first with your key suppliers:
- Are they financially strong enough to weather a storm?
The issue of financial strength is more of a risk with smaller, specialty suppliers of high-tech or fabricated components. Due to their niche, these small suppliers tend to become very dependent on a few customers in a certain industry and as such, are much more exposed than those who serve a wider base of customers. It is not uncommon to see one or two customers represent 50% or more of these suppliers’ revenues. As such, it’s important to gain a better understanding of your supplier’s financial health through an assessment. For instance, ask them to share with you how their business is split among various customers and industries. Although this may be sensitive information, most suppliers will share this if they understand the intent and are covered by a non-disclosure agreement. What is their Altman-Z score and how has it evolved during the past few quarters? What trends do you observe in their key financial ratios? How much are they investing in their business and in supporting your business specifically? The key is to look for patterns that may point to stability or spell trouble for you in the long-term.
- How effectively do they manage your inventory exposure?
As some supply chain professionals may recall from the past two downturns, just because you do not have inventory in your factory and on your books, it does not mean you are without inventory risks. You may have inventory exposure due to contractual commitments you have with first and second tier suppliers. As companies outsource more work, these suppliers and contract manufacturers are making inventory commitments on their behalf further upstream in the supply chain. With typical reporting practices, you do not know about all of this inventory exposure until there is a shift in the market and it suddenly becomes excess. In fact, during good times, suppliers get into the dangerous habit of building inventory and overdriving the supply chain with cushioned forecasts that expose their customers to unexpected risk.
It is important for you to know your inventory exposure on an on-going basis for two reasons. First, your knowledge of this information will force dialogue with your suppliers and give you a chance to modify their behavior should that be needed. This is a great opportunity for you to clearly understand how your forecasts are used – or misused – in pipelining the supply chain. Second, your inventory exposure can be a critical data point when your product marketing organization decides the timing for product obsolescence. Typically, companies decide to obsolete a product based on market information alone and absent any information from the supply chain. If you have inventory piling up in the supply chain, it may be to your benefit to delay a product obsolescence until some of this inventory has been consumed.
- Are they at risk of losing key talent or the “secret sauce”?
If you have a highly specialized small and medium supplier, it is likely that their success is dependent on a few key players. Departure of key personnel from small and medium size suppliers can be impactful especially if they are actively working with your product development and engineering organization on new product introductions. The extreme version of this scenario is when the supplier is highly dependent on your business or that of another customer, and simply cannot continue to operate when there is a significant downturn. In order to address this risk, you may want to take some proactive measures such as requiring that certain information be stored in an escrow account, that specific plans are in place for key personnel, and that you have pre-negotiated intellectual property rights to ensure a smooth transition should something catastrophic occur with the supplier.
As the saying goes, “growth hides all sins” and the growth curve of the past few years has put some companies in the mode of chasing demand and foregoing the normal due diligence in managing their suppliers: supplier discussions are normally focused on near term supply; inventory exposure is an after-thought; and, there is limited visibility to how suppliers will weather a storm. As you begin a new year with signs of uncertainty on the horizon, gaining some peace of mind about your suppliers’ stability may be warranted.
Assessing and mitigating supplier risk is an area in which Symphony has substantial experience, utilizing a variety of homegrown tools. If you think we can be of assistance, please feel free to contact us at info@symphonyconsult.com.