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Supplier Financial Health: Don't Wait for the Worst, Reach out and Talk!

Supply management research has established the axiom that firms are no longer operating independently, but indeed are part of an extended global network that is subject to high degrees of volatility, increasing customer expectations, and is subject to major forms of disruption risk. However, what is not well understood is whether supply manager behaviors have shifted to reflect this broader paradigm shift. One of the major threats to the global supply network is supplier financial default. Financial theory has explored the impact of default in the context of investments, such as when a firm suddenly defaults, investors learn about the default threshold of closely associated business partner firms. This updating leads to “contagious” jumps in credit spreads of business partners, and can rapidly spread. An example is the default of Argentina and the associated immediate spread widening on debt of other South American countries (most notably Brazil), as well in the business context of buyer and supplier firms.

The issues around supplier financial health has generated increased traction at the federal government level. Apple and Coca Cola are two of the major companies who this summer signed on to a White House program called SupplierPay, a voluntary program in which companies commit either to pay small suppliers faster or help them get access to lower-cost capital.  SupplierPay is a voluntary program in which companies commit either to pay small suppliers faster or help them get access to lower-cost capital. SupplierPay builds on the federal government’s QuickPay program started in 2011. It sets a goal of having small-business contractors get paid within 15 days of delivering a product or service. Quicker payments can strengthen small companies’ cash flows and make them less likely to need to borrow.

This first became a major issue during the 2009 global downturn.  Across multiple industries, suppliers in North America, Europe, Asia, and Latin America all experienced a sudden drop in volume, leading to a uniform financial threat and risk of default. Suddenly, the risk of massive tiers of suppliers facing obliteration became a reality. Traditional methods of supplier risk mitigation involve diversifying risk, multiple sourcing, or switching suppliers, which are not effective in situations where entire regions, industry segments, or supply chains are experiencing financial distress. This is particularly of concern in emerging countries, where major shifts in economic conditions bank lending rates, or currency issues increase the likelihood of supplier bankruptcy. Supplier default risk exposes buying organizations to higher levels of supply chain disruption, as suppliers often cannot meet contractual obligations in a state of bankruptcy.

While Supplier Pay is certainly a step in the right direction, a recent research study I’ve conducted with Marcos Paolo, a colleague at a university in Brazil, has found that supply managers need to do more than this.  One of the major issues is that suppliers may not be willing to discuss their challenges for fear of losing business, so it is up to supplier relationship managers to instigate these discussions.  Perceived supplier financial health is a measure of a responding buyer’s perception of financial health; whereas supply disruption involves a major financial incident that is discovered “after the fact”. (The most common of these during the 2008 period included disruptions to operations, sudden price increases, erratic deliveries, or layoffs that result in capacity shortfalls. Our research finds that higher levels of information exchange through direct communication can have an immediate impact on buyer’s understanding that a supplier is or is not able to withstand a major economic downturn or financial rough patch.  Perceptions may also be a function of suppliers who request contractual modifications and shorter payment periods. In cases when perceptions are modified by direct supplier intelligence, buyers can take actions to ensure risk mitigation, flexibility, and redundancy through contract renegotiations. Through cognitive processes, Yates and Stone (1992) articulate a four stage sequential process in which the situation affects judgment of loss, which influence overall evaluations of risk, which drive risk mitigation action. The converse of this is a situation is when buyers are unaware of the extent of supplier distress in an equivocal environment that is unanalyzable. In the absence of meaning, this can lead to suppliers suddenly declaring bankruptcy with no prior warning.

Supply managers should also be aware of the telltale signs: requests for early payment, delivery problems, social media activity, or other factors that may indicate a supplier may be experiencing financial difficulties. In this case, don’t be afraid to ask for a “sit down”, and have an open and frank discussion about their financial challenges. This may be well worth the time, and avoid a lot of potential problems in the long run.