No Supplier Is Too Big To Fail

During the Great Recession economic experts focused attention on banks that were deemed “too big to fail” - their role was judged too critical to the health of the overall US economy. The US government responded with bail-outs and the Dodd-Frank legislation, designed to bridge the economy towards a more sustainable position and reduce risks associated with a few important firms.

Today we know there is no such thing as a company “too big to fail.” Globalization, the European sovereign debt crisis, climate change and even pirates can disrupt your supply chain and threaten your ability to reliably meet the needs of your customers- and when this happens you won’t be able to count on the government to bail you out.

Although risk management has traditionally been considered a responsibility of the finance department, the nature of global supply chains and the attendant risks are causing this to change dramatically. Today procurement leaders balance cost and risk management in their sourcing and supply management strategies and they’re seeking a wide range of data points to validate their decisions.

Supplier Business Failure

The US Census Bureau Economic Census reports that there are 28 million US businesses. According to the US Small Business Administration approximately 600,000-800,000 business “deaths” occur each year, as a result 50% of all start ups fail before their fifth birthday.

The recession has caused a business credit crunch, forcing many businesses to operate on razor thin reserves. Supplier dependency can also be a factor, your relationship with your supplier could be the only thing keeping a supplier up and running. Gaining visibility into your supplier’s financial health is key to minimizing supplier risk.

Factors obscuring visibility to supplier’s financial health:

1. There is no requirement in the US for privately held firms to file financial statements – and nearly all US-based businesses as privately held.
2. Without proper training one can easily draw false conclusions by relying on financial ratios - few procurement professionals have extensive training in financial analysis.
3. Suppliers are reluctant to sharing financial statements, fearing that customers will use their financial position against them in negotiations, or recognize that the firm is struggling and go with another firm.

Supply risk management strategies must take into account the disruption that a supplier represents. A risk assessment would assert that a promotional products company represents limited risk as there are many sources of supply and the switching cost is low, while a specialized direct materials supplier warrants a deeper review.

Also it’s important to recognize that performing a supplier screen during the supplier qualification process is necessary but insufficient, ongoing monitoring is also important for suppliers which represent higher risk.

Assessing Supplier Failure Risk
A tiered approach accounts for the risk associated with the commodity or service being provided as well as the inherent risk of the supplier in question. A simple snapshot view is appropriate for determining whether further due diligence is required.

Firms which fall into higher risk segments should undergo a financial health assessment. As part of this process the procurement team can leverage technology to gather multiple years of audited financial statements from the supplier and have financial analysts review for the purpose of assessing failure risk and whether the firm has adequate capital.

CVM Solutions offers an initial risk assessment weighted against the client’s requirements, technology and financial analysis. This can be client-paid or supplier-paid model. In its role as an unbiased 3rd party CVM reports various financial metrics such as Altman-Z in an effort to determine whether the supplier meets the client’s risk threshold and also provides commentary to guide the client as to any unusual or one-time factors. CVM can also provide financial benchmarking, providing value to both suppliers and clients.

CVM customers experience several benefits:

1. The client can ensure that a consistent, risk-weighted process is being applied to all suppliers and that supplier-provided information is verified against public and proprietary sources of business information
2. Suppliers often prefer to provide financial statement detail to a 3rd party and CVM does not disclose financial statements to the client, only a final summary report
3. The client can leverage a proven solution without a capital or headcount investment

ChainLink Research reports that firms often under-invest in supply risk management and provides recommendations on identifying and mitigating supply risk. Click here to watch a tutorial from Bill McBeath, Senior Research Analyst with ChainLink Research as he reviews the importance of managing supplier risk and compliance as a critical competency for organizations.