Bill Michels is CEO for ADR North America, based in Ann Arbor, Mich.

I recently polled several client chief executives, CFOs, chief procurement officers and vice presidents of supply chain management, and the No. 1 topic wasn’t finding customers in an economic downturn, it was protecting their supply chains from financial risks.

Let’s face it, even if your company is in a good market position to weather a recession, that may not be the case for your suppliers. What would happen if one of your key suppliers failed? How long would it take you to respond? Which customers of yours would be in jeopardy, and would you be able to win them back if you lost them to a supply disruption?

The reality is that we all operate in a global economy, and it doesn’t look good anywhere, including the once rapidly developing economies in China, India and Russia. With financial markets in chaos and credit tightening, smaller strategic suppliers around the world are unlikely to get the credit lines required to run their businesses. It’s no wonder these executives are assessing their risks. It’s a smart time for all of us to take stock.

Managing the risks from a troubled supplier takes three basic steps:

• Assess the strategic importance of your suppliers using a portfolio analysis
• Assess the health of the suppliers that leave your company most vulnerable; and
• Prepare strategies that mitigate the risks you identify.   
  

Supplier Portfolio Analysis
While it would be great to have a full assessment of every supplier to your company, it’s more cost effective to focus on those that put you most at risk. A portfolio analysis is a useful tool to identify those suppliers. Set it up by sorting your suppliers into four broad segments based on two factors: the difficulty of replacing the source and the amount of the expenditure. This is broken down into:

1. Acquisition segment – You are buying easy to replace commodities and they make up a low percentage of your overall spend.
2. Leverage segment – You are buying commodities, but they make up a significant percentage of your overall spend.
3. Critical segment – You are buying specialty items protected by patents or proprietary processes that would be difficult to replace, but they are not a significant part of your overall spend.
4. Strategic segment – You are buying items that would be difficult to replace and they are a significant part of your spend.
   

Clearly it makes sense to concentrate your attention on the third and fourth segments, because these are the items that make you most vulnerable. As you are doing this analysis it might make sense to consider a third dimension to this matrix – the size of the revenue that each item helps generate.

For instance, a patented clutch disk might be worth $15, but if you need one to sell every $150,000 Ferrari from your factory, it’s worth putting the supplier on your priority list.

Supplier Health
It’s very rare that a supplier will fail without warning. Listed below are key signs to identify a supplier that might be in trouble, which puts you at risk, as well.
Warning signs you might notice in your operations include:

• The supplier fails to support sales;
• Your firm stops getting necessary shipments due to breakdowns;
• The supplier begins failing to meet on-time or in-full deliveries for any other reason;
• Management’s responses to requests for information or service are vague, inconsistent or not focused on the issue;
• The supplier begins using your technical support consistently; and
• The supplier increases the number of consultants involved in your orders or your issues.
  

Warning signs you might notice in your business office include:

• The supplier begins asking for price increases;
• The supplier constantly requests pre payment, early payments or accelerated payment terms; and
• The supplier engages business turnaround specialists.
  

Warning signs you might notice on a supplier visit include:

• The supplier does not appear to be making required investments;
• The supplier fails to appropriately cut costs during economic downturns;
• The supplier begins using factoring companies or other third parties to maintain cash flow;
• The supplier has deteriorating accounts receivable and payable;
• There is a big imbalance between payable and receivable days;
• The supplier reports successive negative variances from projections; and
• The supplier has rapid growth in sales volume.
  

Warning signs you might notice in outside sources include:

• The supplier experiences loss of business or market share;
• Public records report delinquent taxes; and
• Executives start selling significant amounts of stock.
  

Risk Mitigation Strategies
If you are paying close attention to those suppliers most crucial to your business, you have already adopted an important risk mitigation strategy, because forewarned is forearmed. Proper due diligence before you buy, and periodic supplier audits during the life of a contract will generally lead you to preventive tactics, which are generally much less costly than mopping up after a disaster.

To create risk mitigation plans for a supply chain, assemble a good cross-functional team from purchasing and logistics, operations, engineering and finance – or a mix that makes sense for your company – and consider possible responses to weakening or failed suppliers. These may be as simple as stockpiling parts or as complicated as re-engineering a product.

It’s tempting to stop your analysis with your direct vendors, but a thorough plan will probe all the way through a supply chain to raw materials, if necessary. And always include cost estimates for implementing your strategies, as well as the costs of a supply disruption, so you can calculate which strategies are most likely to pay off if they are required.

Regardless of the condition of the economy, all companies can benefit from a good program to effectively select and manage suppliers and maintain a current risk mitigation plan. Suppliers can run into trouble at any time, so conduct internal training to assist purchasing agents, accounts payable, quality control and plant managers in dealing with suppliers and recognizing the warning signs.

Gone for now are the days of a rising economic tide that is floating all boats. As the waters recede during this global recession, it takes a good navigator using all the tools at his or her command to steer clear of supply chain troubles lurking under the surface.

Bill Michels is CEO for ADR North America, based in Ann Arbor, Mich. To contact the author or sources mentioned in this article, e-mail This e-mail address is being protected from spam bots, you need JavaScript enabled to view it .