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Manage Distressed Suppliers

Author(s):

CAPS Research

September 2012, Inside Supply Management^® Vol. 23, No. 7, page 32

CAPS Research: Promoting Supply Management's Best Practices
While the economic turmoil over the last few years is weakening, supplier solvency issues remain.

The early identification of supplier default risk and the management of financially distressed suppliers have become important issues for buying organizations. Many anecdotes highlight how sudden supplier financial defaults can result in severe losses in sales, production and reputation, as well as damage relationships with downstream customers. Mitigating this specific risk for companies requires implementing organizational capabilities to correctly detect a supplier running into financial distress, devise appropriate remedial actions and gather such experiences in repositories of organizational knowledge for future actions.

CAPS Research sponsored a study with the primary focus of examining how buying organizations deal with existing suppliers that face financial distress. Research included interviews with managers from 18 companies representing a variety of products and services in Europe, the Middle East, North America and Latin America.

Key Findings

The study uncovered significant differences among companies in terms of how information about distressed suppliers is scanned and interpreted, how responses are devised and how companies learn. Based on these observed differences, the interviews provided insights into the factors that determine buying organizations' behaviors.

Findings from the cross-case analysis suggest that particularly intercompany trust, resource dependence, risk orientation and salvage power are the factors that shape its behavior and risk management approaches. In contrast to trust and risk orientation, which are arguably rather soft factors, dependence and salvage power pose hard restrictions to the buying company's room for maneuvering. In a nutshell, its increased trust in a supplier reduces the company's monitoring efforts and, if responses are elicited, sets its preferences toward more supportive and collaborative actions (bridging). Low levels of trust, however, render the buying organization more suspicious and cautious.

Dependence also makes a buying company more cautious in terms of scanning, interpretation and action. In case of a financially distressed supplier, dependence pushes a buying organization into supporting (bridging) actions. The stronger its risk orientation, the more importance the organization attaches to the issue of financially distressed suppliers and the more pronounced its need for stability. Consequently, this trait makes buying companies more intrusive in their scanning efforts and more responsive in their actions.

Finally, salvage power is an important rationale buying organizations use to determine their actions. If a buying company disposes of any possibility to salvage a distressed supplier (that is, due to differentials in company size — "ant versus elephant"), the organization is pushed into supplier switching behavior, even in situations where dependence and trust would suggest cooperative and supporting behavior.

Recommendations

The study reveals several recommendations for buying organizations:

• Supplier defaults can cause severe supply chain disruptions. Consequently, buying organizations are urged to tackle these risks just as vigorously as they tackle other business risks.
  
  
• The risk of supplier default can be measured by the probability of default and exposure (resource dependence).
  
  
• As in any other risk management setting, there is a trade-off between taking the risk and spending resources on risk management. Consequently, buying companies have to carefully evaluate how much risk and cost they are willing to take or incur for reducing the risk of supplier defaults.
  
  
• There is no one-size-fits-all solution for dealing with the risk of supplier defaults. It all depends on the probability of default and the individual exposure.
  
  
• The number of suppliers to be scanned and the scope and intensity of scanning increase a buying organization's information processing needs. To avoid information overload and ensure economical use of resources, supply managers have to carefully determine how much information they need to mitigate their risk of financially distressed suppliers.
  
  
• Resource dependence not only increases a buying organization's exposure, but also may force it into expensive bridging actions to salvage a distressed supplier. Thus, important suppliers (where there is a high level of dependence) should be monitored thoroughly (high scope and high intensity) and action plans prepared in advance.
  
  
• Good supplier relationships can have a cost impact, because a high level of trust decreases the uncertainty of the scanning process. For critical suppliers, buying organizations should attempt to build relationships based on trust and relational exchange.
  
  
• Buying companies may not always possess enough power to support or even salvage a distressed key supplier. In these cases, it is particularly important that an action plan be prepared that details solutions to avoid supply chain disruptions.
  
  
• Noncritical suppliers should be monitored on a selective basis and less frequent level to ensure an efficient use of resources.
• Documentation systems help to translate tacit data into explicit knowledge and can prevent organizations from repeating errors and incurring costs.

The full report, Financial Distress of Suppliers: Causes, Management, and Consequences, by Christoph Bode and Stephan M. Wagner, is available at www.capsresearch.org.

For more information, send an e-mail to author@ism.ws.

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