With businesses uncertain of their future, buyers are in a precarious situation. Companies must constantly monitor their suppliers’ financial health to be able to react before one of them goes under.

The uncertainty in today’s markets highlights the even greater need for trust and open communication between buyers and suppliers. With neither party knowing how events the next day, week or quarter will unfold and impact their business, both parties must look out for each other as they are dependent on one another for survival.

U.S. auto suppliers asking for federal aid last month highlights the aforementioned interdependent relationship. Bob McKenna, president of the Motor & Equipment Manufacturers Association, which represents some 400 automotive suppliers, this week tells IndustryWeek that “without appropriate action [by the federal government], automotive suppliers will be unable to return to required operations without shuttering facilities or closing entire companies. This would devastate the domestic auto industry and deepen the economic crisis.”

Without suppliers, carmakers cannot build their cars. Without carmakers, auto suppliers would have no business. So how do buyers and suppliers keep this cycle from happening?

According to AMR Research (via IndustryWeek), the buyer/supplier relationship should be a truly collaborative process, “with the supplier communicating well in advance of any anticipated failure or disruption.” Maintaining good relationships is therefore vital.

Marion Luckhurst, supply chain director at VT Group, the UK defense company, tells the Financial Times that “too often suppliers are afraid to reveal they are in trouble until it is too late. We have said: ‘Come and talk to us. Don’t be afraid.’ We think of it as a two-way street: when things are going well they can help us if we have worked through the bad times together.”

By talking to all critical suppliers and building a good relationship, companies will have a better feel for what is going on, the Swiss Federal Institute of Technology (ETH) explains to the Financial Times. “Trust is very important and suppliers tend to remember companies who have been good to them.”

By knowing the financial viability of its suppliers, companies can then make a decision whether to aid in keeping their suppliers from going under or adjust their businesses to cope with losing certain suppliers.

If the company decides on the latter, Ken Koenemann, value chain practice leader with TBM Consulting Group Inc., explained to IndustryWeek that companies should “start looking ahead because the process of contracting with a new supplier and completing the qualification process can take several months.”

To prevent disruptions to their operations, businesses need to be on the lookout for symptoms that a supplier may not weather the financial storm. AMR Research advises sourcing teams to keep an eye out for the following warning signs:

• The supplier has a large part of its businesses in depressed industries;
• It has raw material shortages or cannot meet the agreed lead times;
• It has heavily cut investments in R&D or resources;
• Product quality is deteriorating;
• The supplier has entered into significant contracts with new customers;
• Staff is being laid off;
• Additional discounts are offered for early payment or require cash in advance;
• The supplier is restating earnings and outlooks;
• It has high-labor content that requires a large weekly payroll; and
• The supplier has absorbed heavy investments on new products that are delayed to extend the time to break even.

If any of these warning signs appear, Daniel Corsten, a professor in supply chains at Madrid’s IE Business School, advises companies to “talk to suppliers immediately; they may be too proud initially to confess to the scale of their problems.”

Companies will be better able to spot these signs or take action before these red flags pop up by setting up a rating system for suppliers’ financial performance, ETH says. In many cases, paying attention to cash flow is more important than profitability. The institute also advises companies to swap information with their competitors who source from the same people to get a full picture.

“Look closely at who else are they supplying,” Luckhurst says. “If there are a lot of contracts with a troubled company, then that needs looking at.”

Identifying your suppliers’ suppliers is another strategy. Have details of the sub-suppliers of your main components makers. “You have to break down the anonymity of your supply chain,” Corsten says.

ETH proposes that businesses check their different suppliers for interdependence — if they supply the same companies, industries or countries. Research by ETH suggests that if one supplier in a particular area goes bankrupt, the probability of other suppliers in that sector becoming insolvent rises. Companies cannot assume they can merely switch to another supplier in the same industry if one ran into financial trouble.

In these uncertain times, companies need to have stability in their supply chain at the very least. This is not an easy task, of course, but establishing open communication and strengthening relationships with suppliers is one way for companies to solidify their business during an unsteady economic climate.

Resources

An Eye on the Supply Chain
by Richard Milne
Financial Times, March 23, 2009

10 Warning Signs of a Supplier in Peril
by Nick Zubko
IndustryWeek, April 1, 2009

Buyers Beware!
by Nick Zubko
IndustryWeek, April 1, 2009

Study: U.S. Automakers Need to Change Sourcing Strategy
by Jonathan Katz
IndustryWeek, Jan. 12, 2009