4 Steps to Mitigate Supply Chain Risk

9 JUNE 2019

Companies that rely on suppliers to provide goods or services will always be exposed to the financial risks. When the economic environment is difficult, there often are casualties, suppliers that go bankrupt as a result. Due to the US China trade war and an economic slow-down in China, in 2019, the number of companies filing for bankruptcy in China is expected to increase by one-fifth, while last year this number had surged by 60%.

Take precautions

SMEs in China accounts for 95% of all businesses, 60% of GDP share and 80% of labor force. However, loans granted to SMEs were seriously disproportional and many SMEs are now facing financial difficulties during this current economic downturn.  As a result, when they are unable to pay their debts, financial institutions refuse to provide them with the short-term loans needed for daily operations. When companies are on the verge of running out of cash, they will be forced to cut costs at the expense of lowering product quality and extending delivery time, and when companies do so, bankruptcy is not far away.

 

Based on best practice sharing from some global leading companies, the following four steps can help you mitigate supply chain risk  at an early stage before a crisis starts.

  1. Determine which suppliers to pay close attention to

  2. Keep tracking trade information and legal issues of these suppliers

  3. Eliminate the problem in its infancy

  4. Create a robust internal system committed to minimize the risks

Determine which suppliers to pay close attention to

Many suppliers do not need to pay special attention, they are financially sound, always meet delivery timelines and quality standards. Only those suppliers struggling to be on the verge of bankruptcy need your special attention.

However, it is not easy to know which suppliers have financial problems. Even for those who have special training in financial statements and cash flow analysis, early warnings are often difficult to be detected.

 

Companies often rely too much on financial data to predict whether their suppliers are experiencing financial crises. Although this is easy, there are certain flaws. The financial report analyzes the company's past performance, and these performances do not reveal what it will encounter in the future.

 

There are other deficiencies in the way many companies rely on financial analysis. This method is only for large companies, but 70% of suppliers are just SMEs that are not listed. They are often not obliged to disclose any financial information.

 

From our experience, the best way to identify a problematic supplier is first to see if there is a problem with the industry in which the company is located. Has the supplier recently changed the bank and whether the quality of the products it supplies has declined? What does it mean if a supplier changes to a bank? Is this just a normal change in business or is the credit situation of this company worsening? What does the decline in quality mean? Is it just because it tries to use different raw materials, or is it because it wants to quickly deliver the goods to receive cash that allows it to breathe? Finding the answers to these questions makes it easy to see if the supplier is in trouble.

Keep tracking trade information and legal issues of these suppliers

Once the problematic supplier is identified, the next step is to keep tracking the trade information and legal issues of these suppliers. At the same time, you should pay close attention to the management personnel and shareholder changes of these companies.  If a company suddenly has an increase in the number of contractual disputes or loan disputes with different financial institutes, the company is at high risk of financial default. A sharp plunge in a supplier's export revenue and no. of shipments alarms the risk of receiving your next order.

Eliminate the problem in its infancy

Once a supplier is found to have problems, the company should act quickly to eliminate the problem in its infancy.

 

Before taking an action, the company should first review its payment terms. Failure to pay suppliers in a timely manner can cause serious problems for them, especially when the industry is in a downturn. Therefore, you first need to assess whether the payment period for the supplier is too long. You should assess whether it is possible to alleviate the difficulties encountered by suppliers if they collect  a quick payable. Companies that pay suppliers on time have actually taken the first step to reduce the risk of supplier bankruptcy. Although this will put some pressure on the cash flow, it is quite beneficial in the long run.

 

In general, there are three ways to nip problems in the bud, namely short-term recovery, long-term recovery, and ending supply relationships. The approach can be as simple as hoarding inventory of key components, or it can be complicated and costly, such as acquiring a supplier.

Create a task force dedicated to minimizing the risk

When a company takes action to cope with a crisis brought about by a supplier during a downturn, it usually happens when the problems begin to emerge.  Therefore, the company must have a function dedicated to preventing supplier problems in the early stage.

However, it's not easy to establish such a function. On the one hand, employees who understand finance and accounting lack understanding of the key drivers of supply chain operations; on the other hand, those who deal directly with suppliers have not received training on how to analyze financial statements.

 

To solve this problem, the company must establish a cross-functional task force with members from the finance department and the purchasing department. With the right information and processes, the team can quickly respond to supplier issues that may arise in the future. Benefiting from the task force who has been like a lookout at the watchtower, there is no need to reassign personnel or to re-engineer the process. Ideally, the team can develop an objective set of indicators to assess the likelihood of supplier risks.

 

The world is unpredictable. Some suppliers are looking to collapse, but miraculously survive. Some seem indestructible, but they get into trouble overnight. However, if a company chooses the right people and empowers them with reliable data, and has the right processes in place, it can minimize the supply chain risk.

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Jamsine Song

Head of Risk Analysis @ tiidan

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