The financial crisis has caused an increased focus on risk management in the business world. The crisis hit many companies, investors and consumers hard and unprecedented government intervention was needed to prevent a major collapse of the world economy.
"Risk management is the identification, assessment and prioritisation of risks (as defined in ISO 31000 as the result of uncertainty about objectives, whether positive or negative), followed by coordinated and economical use of resources in order to minimise, monitor and control the likelihood and/or impact of undesirable events or maximise opportunities."
Enterprise Risk Management
The crisis has highlighted not only the financial weaknesses of countries and companies, but also the weakness in reputations. During a volatile market, a company's reputation can tip the balance. Research shows that since the crisis began, 31% percent of all companies increased their risk management awareness, with protecting their global brand and reputation as the main focus. Followed by the unpredictability of their markets.
Enterprise Risk Management includes the evaluation of resources such as human capital, products and services, as well as external influences such as government legislation. As the crisis has a global impact and continues, sudden bankruptcy is still a real option for many companies.
The insolvency of sliding roof supplier Edscha, for example, forced BMW to openly support its supplier with additional payments. This in view of a planned new production launch that threatened to stall. The increasing dependencies between supplier and customer, partly due to preferred suppliership, greatly increases the risks for both parties. Both companies had not installed adequate risk management processes to identify the vulnerability in time.
Globalisation is disrupting many global supply chains, which are so complex and extensive that traditional risk management is no longer enough. What is needed is an accurate monitoring process of suppliers, functions, processes and financial flows throughout the supply chain. If companies understand the need for a visible operational supply chain, then understanding a transparent financial supply chain cannot be left behind.
Although many statistics are already present in the global supply chain, they often miss the root causes that can disrupt the supply chain. This is especially true for supply chains, which add up to more than four tiers. More focus is needed on price escalations or volatility. Many companies blindly rely on commodity flow. And even if the company is not directly involved in commodity supply, your predecessors in the supply chain are. Such changes eventually translate with a swing effect towards your position.
It is not uncommon within the supply chain function for companies to focus on discrete information provision. Within one function, they directly control materials or services, and their procurement is overseen by professionals equipped to describe the strategic supplier and its risks. But such information is rarely shared cross-functionally.
Many companies focus their attention and energy on the supplier who fails to honour the standard agreement. Issues such as product quality or failure to deliver on time. Those suppliers are often seen as the critical ones. Such a one-sided approach can cloud your risk assessment. The central question should be: What would happen if my supplier cannot deliver for the next few months. What alternative sources are there. Who manages and owns product tooling? how long are product qualification cycles, what is the geographical impact of the business? Risk and strategic importance determine whether a supplier can be supported. Hence, it can be considered a major risk to the continuity the business.
Altman Z-Score
If financial information is available and you don't want to rely on subjective quotes and reports from analysts, you can apply the Altman Z-score. Introduced in 1968 by New York University, this score fits 5 financial ratios on a scale of 0-5. The lower the score, the higher the risk. It evaluates Working Capital to total assets, retained earnings to total assets, earning power before interest tax to total assets, market value of equity to book value of total liabilitities. Although the score is a general predictor, it can certainly help Supply Chain managers quantify and rank suppliers on potential financial risks.
Identifying your supplier's risk is one thing. Intervening is another. Often, bailout clauses are present in supplier contracts, but such an action can often be the last straw for your supplier.
Chrysler, prior to its own bankruptcy asked for up to 50% discount to its suppliers, including Aradco Management, a tier 1 supplier. With more than 90% of its revenue dependent on Chrysler, Aradco could not stand this huge loss of revenue. Unable to reach an agreement and a court ruling in Chrysler's favour, a union blockade eventually blocked Chrysler's attempts to get its parts with dire consequences.
Typical distressed supplier who suddenly ran out of cash. Further actions that would reduce their cash flow, as Chrysler did, results in immediate bankruptcy. So efforts should focus on reducing immediate cash out. Such as reducing the fixed contract base of employees, cut down hard on travel costs, reduce communication costs, eliminate non-recurring costs, including ongoing litigation costs. Such drastic cuts provide short-term relief in supplier cash flow. Further, the supplier will have to go on zoke to achieve a new lower base line FTE cost.
It is advisable during a global crisis to work with your troubled suppliers and their creditors to improve their cash flow position in the short term . Further, cost reduction should focus on profit recovery and align the supplier's organisation with a new future-proof vision in line with good supply chain risk management.
Hans Groen - Supply chain and performance management consultant
