Until a couple of years ago, companies could have been largely forgiven for thinking that if they were supplying to one of the world’s largest retailers, their money would be safe. But fate has dealt some cruel blows in the latest global financial crisis. In December 2008 the UK’s largest independent entertainment retailer Zavvi was forced to go into administration when it was crippled by the collapse of Woolworths’ Entertainment UK wholesaling division. The wholesaler was Zavvi’s main supplier and its demise left the store unable to take customer orders. The high-profile collapse taught companies two invaluable lessons: firstly, don’t be over-exposed and overly dependent on a single source supplier and secondly, that any company – no matter how big – can go bust and potentially take your organisation with it.
Just a month prior to Zavvi’s collapse, a November survey of 40 chief procurement officers or equivalent executives carried out by management consultancy Accenture found that more than 70 percent were more closely monitoring the financial stability of their suppliers and almost three-quarters were increasing their focus on supplier relationship management. The same survey also found that nearly 20 percent of respondents reported that their suppliers were unable to meet their supply levels or needs and for almost 15 percent, suppliers had been put out of business or forced to merge with other companies. In a more recent survey called “Risks in 21st century supply chains” published by Aon, the insurance broker, 91 percent of respondents reported that their supply chains have inherent risk, up from 78 percent in the 2008 survey.
Even for companies such as Intel, the US semiconductor manufacturer, which outsources only about 10 percent of its production, stepping up the level of scrutiny of its external suppliers is an important strategy. “We’re having to watch our supply line and make sure of their financial health and whether they can stay in business and are financially sound,” said Brian Krzanich, the company’s vice-president and general manager of manufacturing and supply chain.
In October, Royal Philips Electronics, the world’s leading maker of light bulbs and healthcare solutions, announced plans to bring down its operational costs by up to 30 percent over next two years, by reducing the number of IT suppliers from around 800 to 10 and outsourcing more application development and support projects to India. “As part of our One Philips, One IT initiative, we plan to consolidate our data centres (over 400 currently), bring down the number of suppliers and move more work to our centres in India,” said Maarten J de Vries, IT and supply management, member group management committee, Royal Philips Electronics. “We want to leverage our outsourcing partners and Indian operations more than ever before,” he added.
Unilever has also instituted a new supplier management team to accelerate the pace of its tough IT cost reduction programme. The household goods manufacturer, which makes products including Marmite, Dove soap and Domestos bleach, is attempting to cut 40 percent from IT operational expenditure from 2007 to 2011, and it has so far carved GBP 960m from costs.
The company has admitted that it has a “fragmented” approach to technology which is dependent on too many suppliers – a result of a previous aggressive merger and acquisition strategy. Unilever has moved to cut suppliers “dramatically” after at one point using 160 vendors for 1,200 applications. It has cut 20 percent from application costs by moving to “one or two” key related service suppliers, and has cut 30 percent from testing and upgrade costs by moving from 10 suppliers to one in this area.
Marks & Spencer has also taken the decision to cut its supplier numbers. “M&S has been reviewing our supply base across clothing and food, and the approach we have taken has been consistent. This approach has been to consolidate business into fewer suppliers,” M&S executive chairman Sir Stuart Rose wrote to a manufacturer who had implored him to reconsider the termination of their trading relationship.
Sir Stuart has been locked in a battle to revive the fortunes of M&S since he was appointed in 2004 and critics say that the suppliers have taken much of the pain. The first step was to cut their number and to simplify the retailer’s labyrinthine supply chain. The second step was to ask the remaining manufacturers for a “margin contribution” – a business euphemism for lower prices. Named Operation Genesis by Sir Stuart, the industry quickly nicknamed it Operation Genocide. Northern Foods, M&S’s biggest food supplier, closed its factory in Fenland, Lincolnshire, with the loss of more than 700 jobs last year, when it walked away from a deal to supply Italian ready meals. Hain Celestial, a sandwich maker, put the staff of its Luton factory on consultation when it lost a contract this year.
Opportunity costs
Yet, despite the opportunity the present financial crisis has given the world’s largest firms the capability to squeeze their supply chains, the credit crunch has highlighted the precarious nature of some companies’ dependence on specialist and niche parts manufacturers. In Germany, car manufacturer BMW was forced to bail out one of its key suppliers when it filed for insolvency in February. The luxury carmaker was about to introduce its new Z4 convertible and Edscha, a German manufacturer of sun roofs, door hinges and other car parts, was contracted to supplied its roof. A BMW company spokesman said: “We had no choice. To go to another supplier would have taken six months and we don’t have that. We had to help Edscha and try and stabilise it.” Edscha is still trading, but BMW remains so worried about disruption to its supply chain that it has increased the number of staff in its risk monitoring department to look only at components-makers.
The incident has prompted some of Germany’s largest manufacturing firms to revaluate their supply chains, and to leverage their clout to secure their own positions and to gain a competitive advantage by speeding up efforts to cut the number of suppliers they use. Car parts makers Continental and Schaeffler recently agreed on sourcing co-operation that would cut the number of their 5,600 suppliers by half. Siemens, Europe’s largest engineering group, even said it would cease ordering from as many as 74,000 suppliers this year – a fifth of its 370,000 purchasing partners.
“Such programmes have become very popular,” says Martin Raab, head of supply chain management at Capgemini Consulting. “Purchasing often adds up to 60 percent to 80 percent of overall costs. This is something where you can save a lot of money very quickly.” Many car industry executives hope that the crisis will lead to the long sought-for consolidation and reduction of capacity in the fragmented supplier industry. BMW has in recent years reduced the number of suppliers. The premium carmaker has also been talking to arch rival Daimler about co-operation, involving joint purchases. “Consolidation among suppliers will accelerate significantly,” said Herbert Diess, head of purchasing at BMW, earlier this year. “For us, this is the preferred way to make the industry more competitive.”
While organisations may welcome the benefits that reducing the number of suppliers in the long-term, the more immediate dangers of key suppliers going bust, failing to deliver, or choosing to exercise their influence to renegotiate contracts and terms and conditions in their favour are at the forefront of the minds of key decision-makers. Indeed, checking the integrity of the supply chain is a more pressing issue than trying to reduce their number, says Paul Howard, head of insurance and risk management at supermarket chain Sainsbury’s.
Howard says that organisations need to get greater assurance from their suppliers that they are still capable of delivering the requisite goods and services, and that their own supply chain management is robust enough to continue to function if it takes a knock. He says that, as a crucial first step, organisations need to conduct regular due diligence to keep on top of any potential supply chain management issues. “Supply chain management has always been a crucial area to our business and it is always highly placed on our risk agenda,” he says.
Howard says that organisations need to determine who their key suppliers are and work with them to develop and test a contingency plan that will allow them to still supply goods (to your company at least). “We have regular meetings with our key suppliers which can take place on a monthly basis. We conduct these at their premises and we assess their business continuity plans, trading risks, supply chain arrangements and risks, and solvency so that we are satisfied that risks are being managed appropriately,” he says.
Clarity at all costs
Companies should also insist on knowing who their sub-suppliers are, and also consider carrying out site checks at their operations. “The clue to the issue is in the title – ‘supply chain’,” says Howard. “Just looking at the companies that you directly source from would only give a very superficial review of the strength of your supply chain management programme. Organisations need to look deeper and see who their suppliers are sourcing from, and find out whether they are asking the same questions that you are asking of them.”
A mixture of incentives – such as putting some firms on a “preferred supplier” list – and penalties, such as charging suppliers for late or wrong delivery – can also help to ensure that suppliers ship their orders on time, says Nick Wildgoose, global supply chain product manager at insurer Zurich Global Corporate. “Having strict credit terms helps increase a company’s working capital and is also useful in flagging up late or overdue payments, which can be a significant warning sign about a company’s financial health. Having preferential terms for key suppliers also helps these companies go the extra mile for your business and could help your organisation stay afloat,” he adds.
Peter McHugh, partner in the commercial team at law firm Pinsent Masons, says that organisations need to ensure that management have established business continuity plans, and that the resilience of these plans are regularly tested to look for weak spots, such as where they may be reliant on single-source suppliers, or geographic areas that may be sourcing a disproportionate amount of goods. “You need to look hard at the arrangements that you have in place and ask whether they are still appropriate and if the level of risk associated with them is still low. What may have been a suitable, low-risk arrangement last year may not look so attractive now and so arrangements may need to be revised quickly,” he says.
But as well as preserving one’s own organisation from supply chain failure, some experts believe that organisations can also help keep their suppliers out of danger, and without the need to take over their business, as happened in the case of BMW and Edscha. Mark Perera, chief executive of the Procurement Intelligence Unit, a UK-based think-tank, says that the relatively new concept of supply chain finance could offer much needed support. Leading companies such as Sainsbury’s, Volvo, Syngenta, Nike and Royal KPN all use supply chain finance as a way of keeping their suppliers in credit.
The theory behind it is relatively simple: say, for example, that a baker supplies a supermarket with 1,000 loaves of bread every day at a total cost of GBP 5,000 per week. Ordinarily, the baker would then invoice the supermarket and wait 30 days for the invoice to be settled, depending on what credit terms had actually been agreed.
However, due to the credit crunch, the baker needs the invoice to be settled earlier so that it can continue its operations, yet the bank is reluctant to lend enough funds at a fair rate based on the baker’s risk and credit profile. However, using supply chain finance, the baker could receive an early payment by using the supermarket’s credit facility with its own bank. “It’s an easier solution than bailing the supplier out and will help guarantee the flow of goods,” says Perera.
Insuring the positive
Yet despite the options listed above, the most obvious tool for mitigating business risk is an insurance policy. However, the very type of policy that organisations want to buy to prevent insolvency – credit insurance – is in short supply, and credit insurers are much less willing to underwrite policies while the possibility of credit default is still high in some industry sectors.
Andrea Cropley, partner in the corporate group at law firm Nabarro, says that “there is a real paranoia about companies being refused credit insurance or an inability to get the appropriate limits, particularly in the retail and manufacturing sectors. As a result, companies need to be a lot more aware of the risks that could be present within their supply and distribution chains.”
Cropley adds that even in circumstances where companies are able to renew their credit insurance policies, they need to ensure that the same policy terms (at the very least) are being retained. “Insurers are less likely to be as generous in their terms as was the case a few years ago, so companies need to check that they are getting the appropriate level of cover that will protect them. In particular, she says, in-house legal teams need to check the details of their credit insurance policies. They must ensure that they have ‘retention of title’ clauses so that their organisations can at least reclaim their stock if a company they supply to goes bust.”
Clare Francis, associate at law firm Pinsent Masons, agrees that retention of title clauses are becoming much more important, but for credit insurers as well as policy-holders. She says: “It is becoming increasingly common for credit insurance policies to make it a condition that a retention of title clause is fully incorporated into their sales contracts. If you do not have such a clause effectively incorporated into your contracts with your customers then there is a risk that you are not complying with the insurance policy conditions and the policy could therefore be invalid.”
Francis says that some credit insurance policies specifically request an “all monies” retention of title clause which enables a claim so long as goods can be identified, even if specific goods cannot be matched to specific invoices. As a result, the precise wording of the clause can be critical. In addition, she says, it is important that the clause is effectively incorporated. This can be particularly critical if the organisation is trading on standard terms and conditions of business. Francis says: “If your terms only appear on post-contractual documents, such as invoices, then the term may not be incorporated which would put you in breach of your credit insurance terms. Worse still, if the customer has provided their terms then you could be found to be trading on their terms which will almost certainly not include any retention of title provisions.”
Experts fear that although numerous surveys find that companies feel that their supply chain’s risk profile may have increased, little of any practical purpose is actually being carried out. Wildgoose believes that “supply chain management is still being ignored by a lot of companies as a potential high risk area, even though the possible damage to the company caused by any disruption in the supply chain can be massive.”
“Organisations are more dependent on suppliers providing goods and services now than they ever have been before,” says Wildgoose. “The growth of outsourcing as a way to reduce costs and the global nature of it, such as having telephone operators in India and so on, can mean that major business operations are being carried out in far flung locations, thousands of miles away from the organisation’s actual market, which means that they can be difficult to audit regularly.”
“As a result, if anything goes wrong with the supply chain, it can be more difficult and expensive to fix,” he says.
