Immediately Improve Supply Chain Resilience by Prioritizing Supplier Financial Risk
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During the era of the COVID-19 pandemic and a global corporate debt bubble, supplier financial risk has become one of the most important categories for companies to monitor. It’s one thing to experience temporary disruptions over natural disasters, labor strikes, freight costs, or regulatory changes, but another to manage problems with several suppliers due to financial risk contagion.
Supplier financial risk is the source of many recurring, prolonged, and unanticipated supply chain issues that can otherwise be prevented or mitigated. To prioritize supplier financial risk, professionals should start by asking the following questions:
- Would you know if a critical supplier’s financial risk suddenly skyrocketed, and if so, how quickly?
- What supply chain issues can arise from your financially distressed suppliers?
- What percentage of your supply chain spend is allocated to public companies and their subsidiaries?
- How many of your public company suppliers and their subsidiaries are considered critical or strategic in nature?
- What’s the worst-case scenario and how do you prepare for it?
Focus on Public Company Suppliers
Corporate supply chains often segment public and private company vendors. According to our research, public companies and their subsidiaries represent about 53% of all purchasing budgetary spend with many being critical or strategic relationships. Public company vendors may be underrepresented in quantity, but overrepresented in spend within the supply chain. Moreover, private companies that are perceived to be independent brands are often owned and controlled by public entities through parent-subsidiary ownership structures.
When a parent company or operating subsidiary becomes financially distressed and slides towards failure, it can have major knock-on effects for one of your direct suppliers. Supply chain professionals therefore should monitor their own direct suppliers as well as entities that are interlinked from an economic and legal perspective. Public companies and their subsidiaries also control a massive proportion of product patents and intellectual property.
“One-in-two (1/2) vendors in the average corporate supply chain are linked to a public company. A financially distressed public company parent or even subsidiary can lead to a major ripple effect.”
-- Michael Flum, CreditRiskMonitor President & COO
Reliability Deteriorates Before Bankruptcy
Layering into the supply chain review matrix, one-third (1/3) of all public company suppliers are financially stressed and carry above-average failure risk. Even before failure, however, it is crucial to recognize the disruption risks that can arise before a restructuring or liquidation filing. Suppliers routinely take action in an effort to survive for their own best interest, which can impact their customers:
Customers will experience incrementally more issues with financially distressed vendors than financially stable ones, i.e. having healthy suppliers will only upgrade supply chain durability and resilience.
Proactively Manage Financial Risk
Supply chain workflows can be enhanced with AI-driven bankruptcy prediction models to streamline the financial review process, particularly during RFPs. The 96%-accurate FRISK® score and the 70+%-accurate PAYCE® score provide daily updates on public and private companies, respectively. By creating a supplier/vendor portfolio and leveraging bankruptcy scores, supply chains quickly and effectively stratify their counterparties by risk category to identify their healthiest and most distressed suppliers.
In early March, we explained how supply chain subscribers use the FRISK® score to enhance their existing processes for contingency planning and actions. Essentially, the FRISK® score allows subscribers to measure supplier financial risk and any material changes over time. When a supplier becomes distressed, procurement managers can proactively improve outcomes by opening discussions to address worst-case scenarios and/or adjust contract terms. This might include raising reserve inventory, buying extra sole-sourced parts/components, purchasing disruption insurance, accelerating negotiations with alternative suppliers, etc.
Suppliers can be further evaluated by reviewing other important report features, including:
- Supplier financial news, e.g. country and company-specific risks
- Financial statement ratio and trend analysis, e.g. changes in profitability and efficiency
- Industry peer analysis, e.g. comparing R&D and maintenance spending versus alternatives
- Bond agency ratings and research published by Moody’s, Fitch, and DBRS Morningstar
- Management, discussion, and analysis (MD&A) disclosures to identify financing issues
- Altman Z’’-Scores, another commonly used bankruptcy warning signal
- Dollar-weighted payment history trends to monitor smaller private companies
When supplier failure becomes probable, purchasing managers should take further action to alleviate lingering risks. While public company suppliers can secure emergency financing to avoid major supply chain disruptions, scenarios may involve unforeseen force majeure clauses, workforce layoffs, and plant shutdowns that can cause unanticipated interruptions.
All these supplier financial risk tools will help your team make more informed decisions and improve your company’s long-term growth and profitability.
As companies recover from the global COVID-19 pandemic, supplier financial risk has only worsened as corporate debt increased throughout the crisis, unlike any other downturn. Can your suppliers withstand another massive economic fallout? If not, your company should further prioritize supplier financial risk to thrive in the years ahead. To learn more about our workflow integrated solutions, contact us and we will walk you through the service to enhance your company’s processes.