Are Your Suppliers Causing You Growing Pains?

May 23, 2012
Supply chain expert Rose Kelly-Falls offers tips on how to manage risk down the supply chain -- when business is up.

In a recent IndustryWeek article ("Crunch Time," March 2012), a statement worth highlighting struck my eye. In today's turbulent economic climate -- in which global companies intertwine more than ever before -- Josh Cable writes: "One supplier's risk is everyone's risk."

This is a subject I discuss with our clients regularly: Business may be booming, but do your suppliers have the cash to make the investments and buy the raw materials needed to increase production?

And there's the rub. Ramping up can take suppliers a significant amount of time and a significant amount of borrowed money, requiring a line of credit that's quite hard to come by in today's economy.

If your supplier can't get approved for credit, what can it do?

Shared Responsibility

Increased demand should benefit a company. The question becomes whether suppliers can keep up with the subsequent increased production.

Your suppliers are eager to accept your new volume of business, but it's inevitable that there will be hiccups.

They may lack sufficient talent or the necessary financial resources; you can't just hand off the growth to your suppliers and then balk when they can't meet demands. Their ability to scale is just as much your responsibility as theirs, because the outcome is certainly yours to share.

Many companies learn the importance of managing supply chain risk the hard way. One aircraft-engine manufacturer reported a few years ago that the failure of one minor supplier cost it $4.5 million.

Unfortunately, even among companies that understand the need to monitor the financial health of suppliers and customers, many only practice sporadic or inconsistent reviews.

It's critical for a company to systematically review financial assessments of its suppliers on a regular basis -- quarterly, if possible.

Companies also need to look beyond their first-tier suppliers.

It's tempting -- and common -- to assume suppliers are monitoring their suppliers. But a chief procurement officer must be just as aware of how second- and third-tier suppliers are performing.

A game-ending disruption in your supply chain could happen at any level.

Transparency = Survival

So how can you assess your suppliers -- and their suppliers -- to ensure that they're ready for a necessary increase in production?

The key is to find potential problems before they arise. An early warning actually can enhance the relationship between you and your supplier by promoting collaboration, according to a report produced by Gartner Research.

The research findings support an important take-home: When suppliers provide transparency into their businesses, they increase their likelihood of surviving as the manufacturer's partner, or even growing from the partnership.

A company needs a solid understanding of the financial and operational capabilities of its entire supply chain.

Understanding a supplier's financial status requires a deep dive into its financial statements to see how several factors have changed over time.

For example, a supplier's receivables may be growing, but that could mean its credit and collection standards are weak. So beyond the financials, CPOs should be checking on factors such as:

  • Revenue-performance efficiency
  • Debt-service-management efficiency
  • Leverage-management efficiency
  • Working-capital efficiency
  • Cost-structure efficiency
  • Operating-profit efficiency (upstream)
  • Net-profit efficiency (downstream)
  • Cash-flow-development efficiency
A portfolio view of all of your suppliers over time -- not just individual supplier risks, but the net of all your suppliers' financial stability -- is necessary to adequately assess the potential risks posed to your company.

Cascading your risk-management processes is an increasingly important practice.

Start a Dialogue

Once you develop a solid framework for your supply chain risk-management practices that is reasonably maintained and integrated into every level of your business, you should share that framework down your supply chain, so that your suppliers can implement similar dependable processes to manage their suppliers, and share those practices in turn.

That sharing of information can help you determine the most effective path to expanded production that is the least damaging to your suppliers and your business.

Companies need to embark on a journey with their suppliers, especially in the aftermath of the financial crisis. While too little business may be an obvious reason for financial distress, too much business can cause equal distress if your Tier 1 suppliers and down can't sustain the increased demand.

Ultimately, it comes down to communication and building strong relationships with your suppliers. Work with them so they are prepared to scale up, and don't be afraid of the tough conversations.

Starting a dialogue will encourage your suppliers to be forthcoming about their production or scalability issues, will hold them accountable, and will encourage mutual trust.

Rose Kelly-Falls is senior vice president, supply chain risk management, for Rapid Ratings an independent ratings, research and analytics firm that provides financial health ratings on more than 5,000 public and private companies in 31 industry sectors.

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