The ticking time bombs in your supply base

It seems a little counter-intuitive to watch the various measures of the economy and worry that the sky is about to fall. After all, the stock market continues to climb to record heights; corporate profits are solid; the unemployment rate is the lowest it’s been in more than a decade; even with the talk of interest rate hikes, interest rates continual near record lows; and consumer confidence is great.

What’s not to like? At the same time, I keep waiting for the sky to fall, the shoe to drop or any other cliché you can come up with. Part of that comes from having co-owned a retail store with my wife for nearly 33 years – retailers preternaturally take a dim look on business conditions because crazy stuff, like two days of rain, can sink your sales. And part of it comes from the occasional news report, like Toys R Us filing for bankruptcy or the one in the Wall Street Journal the other day that GE is slashing its forecasts, reducing spending by $1 billion and exiting $20 billion – that billion with a B – of its lines of business. Hey, I own GE stock!

Moreover, it may seem a little odd to read about procurement on a materials handling website. But, whether you’re an end user who is going to purchase a materials handling solution or a solution provider who sources from other OEMs or sells to an end user who may not be able to pay its bills, we all have potential supplier issues.

And, part of it is conversations I’ve had over the past few weeks with James Gellert, chairman and CEO of RapidRatings, and Jerry Flum, who is CEO and chairman of CreditRiskMonitor. Both look at the same economy you and I look at and fret.

“I’m not worried about a top in the market although will occur,” Flum told me last summer. “We’re living in an over-indebted world: Debt levels are too high and at low interest rates.” Flum is not so concerned with privately-held companies that have less access to funds in the credit markets; his concern is publicly-traded firms that have ramped up their borrowing in recent years. “Their debt levels are higher today than in 2007,” he says.

Gellert had a similar message when we chatted last month after I read a blog on the impact of artificially low interest rates. “We’re in the ninth year of an unprecedented credit cycle that has meant more borrowing with more refinancing to come,” Gellert said recently. “Companies with extensive supply chains have hidden time bombs based on suppliers that have loans they’ll have to refinance in a different credit environment.” Gellert specializes in the other side of the supply market, which is privately-held companies.

Both remarked on the relative complacency amongst supply chain risk managers, which might be best summed up by Gellert: “Supply chain risk managers tell us they haven’t had many defaults so they don’t have to look at financial risk. But you can’t look at the last five years and think that they’ll apply to the next five years.” As they say in the mutual fund industry: Past performance is no indicator of future performance.

Now if these guys sound a little like the cops who are going to pull the plug on the party because of noise complaints – or Darth Vadar – it’s because they both get paid to fret, worry and look for those IED’s in your supply base so you don’t have to. What’s a supply management manager to do to avoid getting caught short in a supplier crack up, as happened to any number of manufacturers following the recession? The short answer is to sign up for a credit risk monitoring service, like those offered by Flum, Gellert and their competitors, and let them do the analysis and worrying for you. But regardless of whether you subscribe to a credit risk service, there are some steps supply management and risk management professionals might want to consider.

Here are a couple of bullets from Flum and Gellert:

First, and perhaps the simplest, is to acknowledge that the environment going forward is not going to be the same as the last few years by adding financial risk to the other risks you’re following in your supply chain. “Inattention to financial risk can affect your profit margins,” says Flum.

Second, don’t silo the way you look at the various potential risks in your supply chain. “We’ve found that there’s a correlation between financial risk and quality or delivery problems,” says Gellert. In other words, operational issues like late deliveries may be a precursor to a financial collapse or a supplier with financial issues may end up skimping on quality control or logistics to cut costs.

Finally, realize that a comprehensive risk management program that includes a financial analysis of suppliers is more achievable than many people think.

Let’s hope those ticking financial time bombs have a long fuse and aren’t an imminent threat. At the same time, given the length of the recovery and stock market climb, recessions and pull-backs are inevitable. Taking precautions today may pay off in the future.