How can manufacturers cope with bankruptcy risk of their suppliers
Let us take the scenario where a manufacturer-X is on the verge of getting bankrupt. All the Class-A suppliers (suppliers whose revenue share for this manufacturer is above 65% of their total revenue) would be having a high probability of getting bankrupt. Think about the buyers from other manufacturer -Z who sources from this supplier. As panic grips, this buyer would suddenly jack-up his schedules to avoid any eventuality.
Extend the scenario, where the manufacturers X and Z have multiple common suppliers, many of whom are Class-A suppliers of manufacturer - X. On seeing the stockpiling intensity of one impacted buyer, the other buyers of such bankruptcy-threatened suppliers would also follow-suit and start stockpiling. This fear-psychosis is developed over coffee-cup discussions and supported by informal approvals. From a short term perspective, it makes sense to beef-up your supply stocks to de-risk from any possible supply stock-outs and production line stoppages. But how long and how much can these healthy manufacturers block their working capital, especially when their own revenues are fast declining? The Catch-22 situation is “to risk running out of cash to prevent running out of supplies”.
Taking stock of the supplier, would reveal that this supplier is suddenly overwhelmed by flooding of orders with minimum lead times from customers, which till now only accounted for minority revenue share. This supplier would also have fallen under the stringent credit scan, squeezing any debt capital inflow. To meet these huge orders, the change-over costs, capacity augmentation etc. would be exorbitantly expensive. So what does the supplier do? Those orders which fetch the highest margin with lowest cost would be taken up on priority. Lowest cost is the key to the game, for pushing the orders from order books to shop floor. In most cases the supplier would also request pre-payment for meeting the orders, and compel the manufacturers to oblige. Net result, the healthy manufacturer – Z, not only doles out extra cash to meet the working capital requirement of the supplier, but also incurs the extra cost of increased safety stock. So, what do the healthy manufacturers do? There are some classical strategies manufacturers adopt.- Develop early warning system of supplier financial health: Keep a microscopic view of the supplier’s financial health by monitoring metrics like – days of receivables, days of inventory stock, debt-equity ratio movement, capital adequacy ratio etc. An increasing trend on the first three metrics or a declining trend in the fourth would send the alarm bells ringing. But as is the inherent issue with these accounting practices, most enterprises would craftily manage these metrics to postpone disclosure, and when the red marks actually surface, it would be the “eleventh hour”.
- Know your supplier’s supply chain: Using a telescope to observe and monitor the tiers of suppliers in the supply chain. Even though this activity seems most ideal, but it is most cumbersome and at times contentious. This is mainly because most suppliers would like to keep sway over their own suppliers, taking any external control as undue interference. Also suppliers of most proprietary components would not reveal their detailed supply chain.
- Develop alternate suppliers: This is one of those solutions easily suggested than implemented. But there are major constraints. The gestation time taken for the new supplier to develop a component is between 6~18 months depending on the complexity; but to make the supplier develop the close intuitive relation with the manufacturer would take years. Also certain technology constraints would also prevent any profitable exit strategy from the supplier.
- Know your supplier’s supply chain: Using a telescope to observe and monitor the tiers of suppliers in the supply chain. Even though this activity seems most ideal, but it is most cumbersome and at times contentious. This is mainly because most suppliers would like to keep sway over their own suppliers, taking any external control as undue interference. Also suppliers of most proprietary components would not reveal their detailed supply chain.
These classical strategies would not yield great results in the present circumstances. It is necessary for manufacturers to rethink their strategies. It is a stand these manufacturers have to take as a collective group. A stand-alone policy would not provide beneficial results. The manufacturers should identify other like-minded manufacturers who are willing to come forward, leaving behind their competitive silos, to forge partnership in supplier development and procurement. These minority revenue-share manufacturers should have a common dialog with their common supplier to redesign their products with high degree of common ingredients, common manufacturing jigs & fixtures, common raw materials, common storage and infrastructure and the like. In this way, the supplier would start treating these customers (manufacturers) as a single block. The commonization would drastically reduce costs and help postpone customization in the supply chain. This would de-risk the supplier to a large extent and would be always welcome. For the manufacturers, they only need to keep alternate arrangements for a fraction of their supplies, such as keeping dies for an external body shell of a component, when the internal core is common. This would reduce their risk as well at very low investment levels.
It is a case where the manufacturers collaborate to share the risk posed by suppliers. One major advantage would be that if the supplier comes up with any innovation in these common items, all the manufacturers who have partnered together stand to gain simultaneously. There is an added advantage for the manufacturers, of a strong bargaining power to keep costs low at the supplier end. In many manufacturing industries like automotive, where the bought-outs account for 65~70% of the Cost of Goods sold, a 20~30% reduction in cost would directly lead to a 15~20% improvement in operating margin at low investment levels. In these recessionary times that we are in today, every penny counts. Please share your comments and views on this; I am willing to hear your experiences and feedback
