By Ankit Kohli
Modern supply chains are characterized by close integration of suppliers with purchasing organizations, where suppliers are viewed as strategic partners who enable clients to add scale and capabilities, become more efficient and drive innovation. Therefore, it is not a surprise that supplier risk management is getting increased attention from the CPO’s office.
However, while supply chains have evolved over the past years, supplier risk assessments are still often equated with the unilateral approach of reviewing financial performance to ensure that suppliers are not staring at insolvency. But there is a fundamental problem with such assessments – they are post facto in nature, and are highly dependent on the financials reported by the supplier.
More importantly, such financial assessments point only to the symptoms (financial health indicators), but fail to identify the causes (underlying business conditions) that actually result in deterioration of a supplier’s financial health. As a result, by the time financial performance of a supplier hints at insolvency or a liquidity crunch, it is too late for the purchasing organization to take corrective action. Additionally, these assessments do not analyze the sustainability practices of suppliers, leaving the buying organization exposed to a great degree of sustainability and reputational risk. (Remember how Apple was criticized for labor law violations done by its suppliers in China?)
Therefore, what buying organizations need are risk assessments where the analysis of financial health is complemented by the assessment of business performance and sustainability performance of suppliers (especially the critical ones), to identify risk signals ahead of time and gain greater visibility into risk areas. And while there are many business and sustainability parameters that suppliers should be assessed on, here are some of the more critical ones.
1. Growth of the core market in which the supplier operates: Is your supplier focused on a growing market or a declining market? For example, most traditional document management and archiving suppliers are facing an existential threat due to digitization and the resulting decline in paper usage. So, unless your supplier is responding to this trend by adding digital archiving solutions, future growth is likely to be at risk.
2. Ability to retain and grow market share: The movement in your supplier’s market share is indicative of its ability to innovate and respond to competitive pressures. Sustained loss of market share is usually one of the first indicators of a supplier heading toward financial stress in the medium to long term.
3. Ability to respond to technology trends: Technology usage is disrupting operating models in most industries. Therefore, it is important to know whether your supplier is adapting to such trends -- and passing on the benefits to you in the form of improved delivery and potentially lower cost. The document management case above is one such example. Another one that fits the bill here is the changing face of the business process outsourcing (BPO) industry, where robotic process automation is emerging as a credible alternative – from a cost as well as quality viewpoint – to human intensive repetitive tasks that have so far been outsourced to BPOs in low cost destinations. Again, the inability of suppliers to respond to this trend will put a question mark on their future.
4. Diversity in revenue base: Is your supplier overly dependent on a certain set of clients or a particular business segment or geography for its revenue and profitability? If yes, then the chances are that the loss of one such client, or slowdown in a particular segment or geography, could have a material impact on the supplier’s ability to sustain operations: a clear risk area which buyers should be aware of.
5. Stability and effectiveness of the senior management: Does your supplier have a stable senior management team that has designed and is implementing a well-defined growth strategy? A lot of churn in the senior management or frequent changes in strategic direction is an early indicator of impending financial stress that the supplier might face. A word of caution here: A stagnant senior management is not always good. What is important is its effectiveness. So, it is important for businesses to create a growth path for existing executives and on-board new members that bring in skills and qualities that are in-sync with evolving market conditions and the company’s long-term business strategy.
6. Hedge against macroeconomic and geopolitical developments: Tumbling crude, weakening of European currencies and strengthening of the U.S. Dollar, volatility in Greece, and instability in West Asia are some of the key macroeconomic and geopolitical themes right now. In such a scenario, it is important for buyers to understand if their core suppliers are exposed to one or more of these risks. For example, suppliers which have a heavy European client base might witness a decline in top-line due to weakening demand as well as falling currencies.
7. Responsiveness to changing regulations: This is especially true for the financial services industry, where stricter regulations being imposed by FCA and SEC are testing the willingness and ability (financial as well as operational) of suppliers to respond to such changes. The myriad regulatory controversies surrounding Ocwen Financial Corp. is indicative of the threat posed by regulatory risks.
8. n-Tier supply chain mapping: Is your supplier dependent on its suppliers for delivery of its core products or services? If yes, does your supplier have a sound supply chain management process of its own? Mapping the interdependencies in your supply chain is critical to understand the risks emanating from tier-II and tier-III suppliers. Automotive OEMs like Ford and Toyota have already instituted processes to map their extended supply chain and improve contingency planning.
9. Threat from natural disasters: Over the past decade, natural disasters have impacted many a supply chain – remember the 2011 Japan earthquake which disrupted supply chains worldwide? With intensifying global warming, climate-related disasters are only expected to increase so it is important to understand if your supplier operates in a natural disaster prone region. If yes, what business continuity planning does it have?
10. Governance frauds and ethical misconduct: Organizations worldwide are moving their supplier base to Asia and Latin America. However, while such a strategy helps optimize costs, it also exposes the buying organizations to risks emanating from governance and ethical misconduct of suppliers – ranging from violation of labour laws, human trafficking, wage disparity, lack of an independent board, etc. Therefore, it is important to understand the implementation of policies put in place by your suppliers to ensure compliance with local laws and with your code of conduct.
11. Environmental risk: Your suppliers may be responsible for a significant share of your overall environmental impact and poor environmental management on the supplier end can draw reputational risk. For example, does your supplier work towards minimization of its carbon footprint? The lack of such policies not only poses a reputational risk, but might also attract regulatory penalties for the buying organizations.
12. Social risk: Does your supplier work towards development of local communities that might have been displaced due to its operations? Does your supplier have a formal structure in place to manage other stakeholders including its own employees? Lack of such processes and steps can result in social unrest among the local communities, employees, and even governments, thereby exposing your supply chain to a high degree of social risk.
The above are but a few of the critical areas where supplier performance needs to be assessed and monitored. Remember, these are the underlying factors which impact supplier performance, and financial results are nothing but a by-product of these factors. So, unless procurement organizations analyze suppliers on such parameters, they will always be a step behind in proactively identifying risks in their supply chains, as standalone financial assessments are reactive at best.
Image credit: Flickr/Robert Couse-Baker
Ankit Kohli is the Founder of Pure Research Private Limited, a procurement intelligence firm. Ankit and his team work with procurement teams worldwide to create secure and sustainable supply chains, based on actionable research on suppliers and categories.