Time for a Supplier Health Check

Make sure your suppliers are up to the challenge of increased responsibilities.

As original equipment manufacturers ramp up production to meet increased demand, there is a new problem that a recovering economy presents -- the need for OEMs to evaluate the health and capabilities of their vendors. Manufacturers that proactively work with their suppliers and adopt some new approaches for working with suppliers should be better-positioned to identify and mitigate risks.

The Consequences of Distressed Decision-Making

The latest Institute for Supply Management (ISM) Report on Business found that manufacturing is continuing to grow. The ISM's New Orders Index also increased 4.3 percentage points compared with the previous month, marking the 18th consecutive month of growth in the index.

Rising demand means that suppliers need cash to bring dormant production lines back up and make investments in working capital -- but that's not always easy. With the economic downturn coming so hard and fast, some suppliers went to extreme measures as a means of survival, making cutbacks from both a cash and human-capital perspective that have left gaping holes in operations. For example, decisions to defer strategic investments in new capabilities or to maintain existing manufacturing capabilities have left many suppliers not only behind the times, but in many cases in real risk of losing continued manufacturing capability.

These reduced capabilities and resources can pose significant risks to OEMs as they begin to reinvest in new products and reinvigorate their go-to-market strategies. With a significant number of new-product launches on the horizon, OEMs have moved significant modular production responsibility to the Tier 1s (i.e., a supplier that supplies parts directly to the OEM). As a result, the Tier 1 suppliers may need to expand globally in the high-growth markets more quickly than they had originally anticipated, and manufacturers need to know if their Tier 1s are up to this challenge.

Assess the Situation

Before conferring the same levels of trust in their suppliers as they did prior to the recession, manufacturers should perform a supply chain assessment. At the heart of these considerations is the question: "What supplier process upgrades need to be in place to enhance customer satisfaction, increase capital efficiency, increase profitability and improve long-term shareholder value?"

First and foremost, OEMs should intensely monitor supply chain risk to decide which organizations need to be eliminated out of the chain and which ones may be capable of handling new volume demands but may need financial or operational restructuring assistance.

One "stress test" is to take a look at the increase in new product demand and juxtapose it with a forecast in incremental new business to be placed with each supplier. This will enable OEMs to take a big step in stratifying the supply base and understanding which "links" are strong, which are weak and which ones may need to be helped or replaced.

It's also more important today for the supply chain to be able to support new-product launches. While it used to be common that the OEM manufactured and designed almost every component, now much of the design and parts manufacturing is being pushed down to the suppliers. This is creating a situation in which these supplier organizations may have to reinvent, retool or fold.

Another important consideration when taking stock of the supplier's condition is to conduct a comprehensive business assessment that includes, but is not limited to, a detailed operational and financial assessment. Answers to several questions should serve as the foundation of this assessment, such as:

  • Does the company have access to capital to retool and meet an increase in demand?
  • Has a new organizational structure gained traction, and can this be verified?
  • Has the management team been significantly reduced by a spate of layoffs, and, if so, what ripple effect has this had on the entire organization?
  • For the perceived weaker links, is there a recovery roadmap or is the organization banking on hope when OEMs come calling with an increase in demand?
  • Does the supplier have a viable business plan and the liquidity to execute against that plan?

Often overlooked in the assessment process is a bird's-eye view into the smaller specialty companies that sit in the supply chain. In some situations, "specialty shops" lack up-to-date IT and financial controls systems because those components were weakened during the recession. Now, these companies may be asked to transform into a full-blown middle-market company as the economy improves and OEMs ramp up.

For example, a well-known home appliance manufacturer with nearly $20 billion in revenue had a relatively small but reliable specialty supplier with $6 million in total sales. Given their impressive track record together, the manufacturer wanted to help grow the supplier's business but had concerns as to whether the organization would be able to meet the challenge of increased demands for new product launches.

The manufacturer enlisted the help of a third party to conduct a comprehensive business assessment of the supplier and develop a roadmap that detailed the short- and long-term actions the supplier needed to take to complete a successful transformation. The result was that the manufacturer received more cooperation and more detailed information from the supplier, which, in turn, painted a clearer financial and operational picture.

A third-party business assessment such as this is often a "win-win" for both the supplier and the manufacturer. The supplier can gain help in developing a roadmap to adapt to a new marketplace, while the OEM can gain a level of comfort that the supplier will grow with the manufacturer and manage the business effectively.

Act Proactively

Strong supply chains can be a tremendous asset to OEMs and their vendors. However, when a supplier sends out distress signals, it's important for manufacturers to take preemptive action. Waiting for a supply-chain issue to reach a head may lead to dire consequences and irreparable damage. For suppliers, the window to ramp back up may be closing rapidly, as the current global economic environment does not allow for a gradual "gear-up."

Comprehensive business assessments of each weak link throughout the supply chain should be completed by OEMs prior to implementing new go-to-market strategies and new product launches. Implementing monitoring systems that provide management with transparency and early alerts to risks are critical. Manufacturers also should consider working with advisers who can provide the industry depth, knowledge and capabilities that can help predict potential supplier distress.

Rapidly responding to weaknesses and distress signals can help OEMs protect their brand, minimize disruptions, increase the company's value and get new products to market ahead of the competition -- many of the keys to growth in this environment.

Tim Dumond is a principal in the supply chain advisory group at KPMG LLP.

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