The recession and credit crisis have significantly altered the financial relationships between customer and supplier as all wait for the next business turnaround.
Despite very high unemployment, there have been a few signs of stabilization in the manufacturing sector over the last few months, including an uptick in The Conference Board's leading economic indicators, real GDP, Purchasing Managers Index and capacity utilization. While these measures suggest that the recession may have bottomed out, analysts are divided on when the broader turnaround will begin. Until such time, OEMs and suppliers, some of whom have cut to the bone to survive, attempt to carry on. However, it is unclear if short term cuts were so severe that reaction to the inevitable turnaround in the manufacturing sector will hinder long term success.
What's more, given the market volatility and record number of business failures, monitoring the financial health of your supply base is now a requirement. Similar to quality, delivery and other operational metrics that companies have been using for years to monitor the performance of their supply base, keeping an eye on the financial health of your suppliers is critical to avoid supply disruptions and minimize financial exposure.
Current Environment
Since late 2007, manufacturers have reassessed their strategy to ensure survival. Over 130 lenders have failed in 2009, the highest level since 1992. Other lenders have exited certain sectors and reduced credit availability. Commercial and industrial loans outstanding from U.S. Commercial Banks declined 10% over the past 12 months. Business bankruptcies are up over 50% from 2008 year to date levels, and are at their highest level in over 10 years. Scores of others have gone out of business quietly. In reaction, manufacturers have curtailed discretionary spending, slashed payrolls and compensation, sold noncore assets, and stretched working capital to its limits, among other actions.
Reductions in the workforce have resulted in a U.S. unemployment rate of 10%, the highest rate in 26 years. Contrary to some improving economic indicators, unemployment is predicted to get worse before it gets better. While a large pool of candidates appears readily available when business picks up, employers will be challenged in hiring and retraining the workforce to coincide with the timing of the recovery.
The recovery will be hindered by deteriorating working capital. A Grant Thornton sampling of 25 large OEMs suggests their average days payables outstanding have increased from around 51 days as of September 2007 to about 58 days as of September 2009. Conversely, a review of the trend in average days sales outstanding of 261 public manufacturers with sales between $10 million and $750 million suggests their customers are paying slower as days sales outstanding have increased from 56 days in late 2007 to 62 days as of September 2009. The impact is being further pushed down the tiers. Based on the sample, the 261 public manufacturers are paying their vendors slower on average, up from 41 days as of September 2007 to 48 days as of September 2009.
Innovation may also be compromised as manufacturers are cutting research and development related expenditures. For those in the sample that reported having R&D costs, such costs on average as a percentage of sales have also declined steadily from almost 10% of sales in 2007 to 7% in late 2009. Since product development research spending cycles often precede related revenue by several years, the short term impact of such cuts will likely not impact suppliers until late 2010 and beyond. Capital spending on average remained flat over the same period, however, focus likely shifted from new acquisition to maintenance. Furthermore, since funding for capital projects is typically committed to months or years in advance, capital spending could very well trend downward over the next 12 months as the impact of recent cuts filter through.
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