Risk management requires tough questioning

Here is a startling statistic: 49,895 businesses filed for bankruptcy in the US federal courts during the 12-month period ending September 2011. Think that’s a big number? It is - but it’s 14% lower than the number for the 12 months that ended in September 2010. In other words, business bankruptcies in the US have gone down despite a less-than-stellar economy. From a macro-economic perspective, that’s good news. From a micro-economic perspective (that is, your own personal business world), it’s only good if none of your key suppliers were among the companies going bust.

Supplier bankruptcies - especially unexpected ones - can wreak havoc on a supply chain. One of the major lessons for procurement over the last couple of years is that supplier financial risk is real, which is why supply chain finance programmes are gaining attention. It’s also why CPOs invest a lot of time and effort in checking suppliers’ financial stability. But, such analysis isn’t easy.

Sure, you can examine a balance sheet. But you can’t stop there. Growing receivables could mean the supplier has weak collection standards. Top-line revenue may be growing, but it may not compare favorably with revenue growth in the supplier’s industry. Margins may not be keeping pace either.

How to get at vital information like that which is not immediately apparent on balance sheets? “You need to have personal conversations with your suppliers,” says Rose Kelly-Falls, senior VP of supply chain risk management at Rapid Ratings. They should be polite conversations, certainly, because, after all, you want to be establishing collaborative relationships, particularly with key strategic suppliers. In fact, regular and frank conversations are an essential element of efforts to turn suppliers into business partners. But during those conversations, you should make a point of asking some pointed business questions and telling suppliers you expect straight, honest answers. In other words, get comfortable asking some very uncomfortable questions.

Prior to Rapid Ratings, Kelly-Falls was head of commodities purchasing at Rolls Royce North America, and has been involved in several conversations of this kind. She gave me a few suggestions for what to ask:

“Ask suppliers if they think they’ll lose business next year,” she says - and what industries they might lose that business from. But that’s not all. There’s also the issue of their access to cash.

“You should also ask them if they have maxed out their line of credit,” she adds. “In fact,” she says, “ask them if they have breached their bank covenants.” In other words, have they missed any payments to their banks? No doubt, you and your finance partners can think of many other questions to ask.

Tough questions, indeed. But the answers can be more revealing than a simple examination of a balance sheet.

And while you’re at it, you should encourage your tier-one suppliers to ask the same questions of their suppliers.

Hopefully, your suppliers will maintain their financial health. But don’t bank on it just because their balance sheets look good.

Paul Teague is US contributing editor of Procurement Leaders. To subscribe to the magazine, click here.