A note on the authors: This article was co-authored and published simultaneously by Dave Stowe and Anna McGovern. Their combined procurement and supply chain leadership experience spans over 45 years across CPG, Life Sciences, Packaging, and Plastics industries.
Introduction
While an event like COVID-19 radically shifts the market and may only happen once every 100 years, regular business continuity planning by a company prepares them to survive and thrive. Good gamblers know to bet “all the chips on the next dice roll” is extremely foolish – so why think “let’s just survive and get through this crisis and return back to normal?” If a company barely survives this crisis, let it be a wakeup call to deploy robust business continuity planning as major disruptions will continue to be part of the marketplace.
Managing supply risk is about developing detailed knowledge about your supply base and taking prudent steps to minimize business impact from small and large “black swan” disruptions (9/11, 2008 financial crisis, natural disasters, pandemics, etc.) While Order-to-Cash is critical to a company’s revenue stream, it is also vital to incorporate solid Source-to-Pay processes into business continuity planning. How businesses treat and work with their suppliers in times of crisis is the difference between surviving or dying. Further, those who do it well will not only survive, they will thrive.
Leading companies know the importance of managing supply risk is like great athletes’ development of “muscle memory” through structured exercises. These companies work on a regular basis to improve procurement and supply management governance. Namely, the policies, processes, systems, and organization structure needed to purchase goods and services. How much better do leading companies perform over average companies? A study commissioned by the Institutional Shareholder Services (ISS) and authored by Lawrence Brown and Marcus Caylor from Georgia State found companies with a high Corporate Governance Quotient (CGQ) had 5-year returns 7.91% above the industry average. In comparison, companies with a lower CGQ had 5-year returns 3.95% below the industry average.
Like a world-class athlete, leading companies form cross-functional committees to follow good business continuity planning protocols on a regular basis. Reviewing the Source-to-Pay process involves procurement, supply chain, finance, internal audit, quality, and IT perspective on the risk in each of these elements. In general, a well-developed and executed supply risk plan reviews and revises the following four elements throughout the year:
- Supply Chain Resiliency
- Supplier Financial Stability
- Data Security
- Contract Life Cycle Management
Supply Chain Resiliency
In the event of a crisis, immediate action is required to protect mid- and long-term results. To be able to do so, the business continuity plan needs to protect the revenue stream by examining all the processes from order-to-cash to source-to-pay. It is helpful to consider questions such as:
- What are the most critical products and services in your revenue stream?
- What products or services will you always protect to preserve sales?
- Are products on backorder due to supply issues?
As you examine each of the workflows along your value chain, what is the secret sauce to success? It starts with communication!
Communicate – Often, Effectively and Promptly!
The best lines of communication are the most open with internal and external stakeholders along the value chain. Clear, effective, and transparent communications are essentials in all business scenarios. In crisis scenarios, it is even more so, especially if you need to secure ongoing support from customers, employees, suppliers, investors, and regulatory authorities. Companies will want to keep customers apprised of any impact to product or service delivery.
If contractual obligations cannot be met because of supplier or production disruption, working closely with your suppliers is critical to minimizing the impact. Communicating options to your internal stakeholders and business leaders and getting their buy-in is essential to the success of the Procurement team. What are some actions you can take to work with your supplier partners to mitigate the risks and accelerate supply?
- Ongoing, ensure a primary and secondary source of supply. Whenever possible avoid sole source decisions. Communicate to your business partners alternative suppliers or alternate materials and get these qualified quickly.
- If sole source decisions cannot be avoided, ensure you have negotiated adequate capacity for your requirements. Communicate a rolling forecast based on agreed intervals and communicate demand changes in a timely manner.
- A key lever to pull during times of crisis is specification management. How standardized and harmonized are your specifications? Expediting approvals, expanding tolerances, and considering alternate materials will help you secure accelerated supply availability.
Integrating the supplier teams with R&D, Engineering, and quality is an essential part of the communication strategy.
Supplier Financial Stability
Rigorously evaluating your supplier partners’ financial health is a fundamental role of the procurement team. At minimum here are the 5 basic steps to take to mitigate risk to your business from your supplier base:
1. Research the company’s credit history. Running a D&B Hoovers credit report is the easiest way.
2. Get references and call them. You will learn a lot by speaking to other customers.
3. Get their financial statements. If they are a public company look at their annual reports. If they are private, there are a lot of other means to get information, such as internet sources, state agencies, public records, or their own website. When reviewing available documents:
- Calculate the Supplier’s Profitability Ratios: If a company is not profitable, it likely will not stay in business for long.
- Calculate the Supplier’s Liquidity Ratios: Liquidity ratios provide a measure of the supplier’s ability to meet short-term obligations and therefore the supplier’s sustainability.
- Calculate the Supplier’s Activity Ratios: Activity ratios look at a supplier’s ability to convert balance sheet accounts into cash or revenue.
4. Verify bank information. Get the supplier’s bank information and find out how long it has had the account. Using several banks and switching frequently is not a good sign. Do they have a revolving line of credit? This affirms their creditworthiness.
5. Assess the impact your business volume will have on the supplier. This is a critical step. Will your volume help grow the company—or stretch it too far? Understand the supplier’s business growth plan. Partner with those that continue to invest in their business.
Monitoring and Safeguarding Supply based on Financial Viability
Major crises like COVID-19 present procurement teams with a challenge they may not have experienced —the risk of losing suppliers and entire supply chains due to bankruptcy.
Successful businesses will employ significant efforts to safeguard their supply in times of crisis. Typically, they implement an advanced supplier risk management system that includes three actions: (i) identifying supplier criticality; (ii) monitoring supplier health and lead times; and (iii) ensuring the survival of critical suppliers.
Part of protecting the firm’s revenue stream is to identify supplier criticality. Supplier criticality needs to be reevaluated based on the risk of supplier insolvency. Which critical parts and how much volume do we obtain from a supplier? Which alternative suppliers are certified? What volumes can these alternative suppliers provide?
Once supplier criticality is identified, firms are required to monitor supplier health and lead times. To monitor supplier health, successful firms should leverage the buyers’ information on the lead times which suppliers were committing to orders or requesting earlier payments.
During times of crisis, you must ensure the survival of critical suppliers. Communicating frequently with them and being a “customer of choice” is often beneficial for firms during more comfortable financial times. In a crisis, it is important to reduce the financial burden on your suppliers. They will remember this after the crisis and continue to offer preferential treatment. Paying invoices ahead rather than stretching payment terms can ensure a preferred customer rating that allows additional favors in the future. Paying COD also helps smaller businesses keep you in supply. There are concrete steps to take:
- Taking inventory ownership from suppliers to ease their financial burdens is a great way to partner with your suppliers in a crisis
- Giving your suppliers short term loans or working directly with their suppliers and paying their invoices is a way to protect your firm.
- Demand management – Working with your suppliers to ensure ongoing plant utilization and continuity of their labor supply is a critical step to protecting their financial viability.
In the post-crisis environment, you can remember which suppliers behaved poorly in bad times and reduce or eliminate their volumes in the future.
To protect the firm in times of crisis, be sure to have flexible contracts. Many firms negotiate long-term contracts with suppliers to benefit from discounts. However, once locked in, volume or price reductions often depend entirely on the goodwill of suppliers. Successful companies will consider fluctuations in demand when defining their contracts. It is best to define volume commitments in ranges so that you avoid underutilization penalties.
Data Security
As businesses move to digital platforms where company data is electronic and shared with suppliers, customers, regulators, and the public, it becomes everyone’s responsibility to support data security protocols. From a supply risk perspective, the procurement team will need to manage the supplier data transmission process through cloud technology and other applications.
Although brand name companies like Microsoft, Amazon, SAP, and Oracle have world-class data security built into their offerings and platforms, many other suppliers use and share sensitive data through their applications and/or cloud technology which may not provide adequate security. To understand how quickly supplier applications can compromise company information it is helpful to remember Target’s 3rd party breach of consumer financial data that rocked the marketplace not too long. As a result, procurement teams need to work with their colleagues to document and manage supplier electronic information – payment details, service data, production schedules, design data, protected information, etc.
A good example to illustrate procurement’s role in managing supplier data is in the maintenance of the supplier master data file. Daily, in midsized and large companies, supplier information must be updated either from adding new suppliers or editing existing supplier information. This process requires collecting and verifying important information such as: banking account, corporate entity name, tax identification and remit to address. Millions of dollars in payments depend on the validity and protection of this data.
Documenting the vendor master update process, clarifying segregation of duties, and linking these to financial system tools is critical. Having a detailed understanding of the review and approval flow along with the correct checks and balances will ensure proper update of supplier information as well as compliance with internal audit requirements.
Contract Life Cycle Management
A Contract Life Cycle Management (CLC) process and system provide procurement, legal, and business teams with valuable information about suppliers and contractual risk. However, it is not enough to have a CLC system act as an electronic file cabinet storing supplier contracts. The real value is the integration between contracting guidelines, workflow, and a system which provide teams with the ability to quickly analyze contract issues. As teams look at this process through the lens of supply risk, they can start identifying data fields essential to analyze thousands of contracts. Working with colleagues in sales, marketing, finance and legal, they can move beyond basic supplier information (legal entity, address, point of contact, etc.), to document additional fields of information critical to analyzing supply risk. Starter questions to help look at supply risk are:
- Is this supplier a sole source, single source or dual source?
- Can we break down supplier contracts into categories such as direct material, technology, services? What category level can we break this down to?
- Is this supplier based outside of the US and if so, how are disputes resolved?
- How many of our contracts have “Force Majure” clauses? What are the limitations of these clauses?
- Do we have enforcement clauses? If so, which suppliers are impacted, and what leverage do we have to enforce clauses?
Even in good times, it is necessary to use CLC data to manage categories. One of our clients in the medical diagnostic market a few years ago realized a major resin vendor was going to discontinue a specialized resin. As a result, they needed to stockpile that resin to cover 18 months of production while they transitioned to a new resin. Upon analyzing the contract data, we realized the vendor’s decision to produce that resin was at their sole discretion. While the supply contract had been signed over 10 years before, having access to contract data for all the other resin suppliers provided the team with an ability to look at the entire resin plastic category.
Business Continuity Planning and Execution
For an organization to develop “muscle memory” needed to make business continuity planning and execution an active part of their business, they deploy a cross-functional approach to provide a comprehensive perspective on supply risk and processes, policies, systems, and organizational structures. The composition of a cross-functional team depends on several factors including company size, industry economics, regulatory requirements, and board requirements. In general, though, it is important to have representatives from:
- Procurement/Supply Chain/Operations
- Research & Development
- Internal Audit
- Finance
- Sales
- IT
- Quality
Additional members can be included on an ad-hoc basis driven by changes in business conditions.
While the “crystal ball” predicting a business’s future with 100 percent clarity is yet to be developed, leading companies know they can protect their business by including both Order-to-Cash and Source-to-Pay processes in their business continuity planning effort across these four elements:
- Supply Chain Resiliency
- Supplier Financial Stability
- Data Security
- Contract Life Cycle Management