A new framework for supply chain risk management

It is precisely due to the issues faced below in supply chain risk management that we require a new approach in supply chain risk management. Read on and tell me what you think. Are we facing the same issues? How are we managing these risks?

The idea of a "crisis cell" might suggest counterterrorism more than it does corporate risk management. But at Safran, the French aerospace and defence company, it is the name of a team charged with responding to the ever-increasing pressure on its global supply chain.
Safran's crisis cell monitors the group's 4,000 suppliers, which receive €5.3bn ($6.7bn, £4.5bn) in total a year in return for products and equipment. Xavier Dessemond, Safran's purchasing director, says the aim is to deal with the problem in "a preventative manner". He adds that while no supplier has yet experienced great difficulties, "We know there is a crisis and we know our industry will be probably affected".

It is a growing concern for manufacturers worldwide. Companies' supply chains have become far more global in the past decade, with the consequence that stress from the financial crisis is spreading quickly to suppliers large and small. It is testing the global supply chain to an extent rarely seen and spurring companies in industries from aerospace to retailing to take extraordinary measures.

VT Group, a leading British defence group, is a good example. The former Vosper Thornycroft has a solid business, as many of its orders come from the UK government. But in the past two weeks it summoned its leading 100 suppliers - which account for about 70 per cent of its £500m ($740m, €580m) annual supply budget - to a meeting.

The message from Paul Lester, chief executive, was stark: "If you get into financial difficulties, don't delay but come and talk to us. You are probably better talking to us than banks, because banks aren't really doing their jobs right now and we can help."

Possibilities for help include paying suppliers in cash earlier, giving them longer orders or even lending them workers, says Mr Lester. At Safran, Mr Dessemond says his company could put capital into its suppliers, help them obtain aid from government agencies or change payment terms - but all only in "exceptional cases".

Mr Lester says simply: "We want a bloody good supply base. And we are just nervous that, particularly among SMEs [small and mid-sized enterprises], somebody will get into difficulties."
A small software supplier to VT did go bust recently - the latest in a number of European supplier collapses, from Stankiewicz, the German car parts supplier, to several manufacturers that serve UK retailers.

All this marks a huge shift for many large industrial groups. During the summer, much of the talk focused on whether their suppliers had the capacity to keep up with demand. "It is amazing how the conversation has changed in the last few months," says Aaron Davis, the marketing director of Schneider Electric, the French energy management company.

Now, many suppliers are more likely to be calling to ask for bail-outs. The culprit is obvious, according to manufacturers: it is the banks. VDA, the German carmakers' association, accuses some banks of "making credit lines more expensive, withdrawing them or making credit due in the short term". Ratings agencies such as Moody's and Fitch point to the increased difficulties small and medium-sized companies face in securing credit from banks.

But the big companies may also be partly to blame. Many have squeezed suppliers mercilessly for years. The car industry is renowned for manufacturers suddenly imposing demands for 10 per cent across-the-board cuts in component prices. Likewise, UK retailers led by Tesco have succeeded in pushing payment terms with suppliers increasingly in their favour. Tesco has increased the time it takes to pay for some goods from 30 to 60 days.

Bart Becht, chief executive of Reckitt Benckiser, the consumer goods group, last month criticised such moves as making no sense. According to an industry insider, meanwhile, suppliers have complained in recent days that another large supermarket group has just asked for 15 per cent price cuts.

Julie Metelko, a business improvement specialist at PA Consulting, says that approach risks backfiring on large companies: "If suppliers aren't getting cash, then you risk taking them out."

That is why companies such as Daimler, the German luxury carmaker, and some of its rivals are looking at giving cash straight to suppliers in difficulties. "Three hundred thousand jobs are at risk in this industry - due to a crisis that was not caused by small and mid-sized companies but [which] is making them suffer massively," says Dieter Zetsche, Daimler's chief executive. Volkswagen, Europe's largest carmaker, has set up a special team to stop suppliers from collapsing.
Counterparty risk is well-known in the financial world, where it refers to the chance one side of an agreement will default. As it becomes a concept to be reckoned with in the real economy, manufacturers are checking their exposure. "We have got to look at risk in the supply chain much more closely. Is your Chinese supplier financially sound? Are they capable of maintaining your supply?" asks Tim Lawrence, a supply chain expert at PA Consulting.

Many counter that they have double or triple sourcing, with suppliers for the same part spread across the world. "In tough times like these, you need as much as possible to keep two suppliers. Globalisation helps here," says Pierre-Jean Sivignon, chief financial officer at Philips, the Dutch electronics group. Don Gogel, chief executive of Clayton, Dubilier & Rice, the US private equity firm, says: "Globalisation is a big positive, as it has led to multiple suppliers around the world."
But doubts remain. One is over how quickly a supplier can respond to take over the capacity if one of its rivals collapses. Another is the fact that some components are so complex they are manufactured only by one supplier. Additionally, companies such as carmakers often use one supplier for each model or project, meaning changing component makers could take months.
Just-in-time delivery - long the mantra of many manufacturers worldwide - is also turning into a possible weakness in the supply chain. A problem with just one supplier can throw the entire system into chaos, as can shipping difficulties. Manufacturing experts say that for those and other reasons they are starting to see western companies bring back operations or suppliers from far-off countries in Asia to closer to home: eastern Europe or Mexico.

"We are hearing about it more and more - that companies that went to China and elsewhere in Asia for the low costs are facing rising energy and labour costs. So they are bringing production back closer to home either to the UK or more likely to eastern Europe," says Jane Lodge, head of the manufacturing industry team at Deloitte in London.
Reports suggest 67,000 factories in China closed in the first half of this year because of the slowdown in exports. Richard Meddings, chief financial officer at Standard Chartered, says the Asian-focused bank is looking much more closely at what is happening to small and mid-sized companies as well as exporters. But he says Asia is still holding up well: "It is coping quite well but the world is obviously slowing. The order chains are still working."
Once-booming countries such as Russia are suffering more. Yann Vincent, chief operating officer of Avtovaz, the country's largest carmaker, says: "We have suppliers that are crying. They say, 'If you don't pay us x million roubles, we won't be producing - because we don't have credit'."
Other big risks remain in the supply chain. One is the reduction of inventory levels - known as destocking - that is taking place across many industries. "There is a huge effect of massive destocking in all supply pipelines. Lots of people are waiting to buy things as they believe raw materials will only become cheaper. It is a vicious spiral," says Feike Sijbesma, chief executive of DSM, the Dutch life sciences company. Destocking has also occurred in retail supply chains in a big way despite Christmas being so close.

One factor driving the cuts in stock is the approach of the end of the year for accounting. Many companies are keen to have as much cash on their balance sheets as possible by year-end. Ms Metelko says: "Everybody is being much more aggressive this year, especially as they're looking at weaker demand."

Daniel Corsten, a professor at the IE Business School at Madrid, says these are desperate times for some otherwise solid suppliers: "Supply chains are generally in good shape . . . But what we see now is very worrying. Previously robust suppliers in terms of quality and reliability cannot finance their production cycle any more. Shrinking demand means that customers pay late, less, or default, and as a consequence suppliers receive theirs less and late. Counterparty risk has reached the real economy."

The troubles faced by Land Rover's Discovery four-wheel-drive vehicle shows how much havoc can be wreaked by a problem in the supply chain. In 2002 Land Rover, then owned by Ford, said it might have to stop production of the Discovery because the only supplier of its chassis - UPF-Thompson - had gone bankrupt.
The carmaker estimated it would have taken six to nine months to find an alternative supplier, putting 11,000 jobs at risk at Land Rover and its suppliers. The cost of having dual suppliers would have doubled the £12m ($18m, €14m) investment needed for the chassis, the company said at the time.

The end result was messy. KPMG, the receivers for UPF, demanded about £60m from Land Rover to maintain supplies of the chassis. Land Rover accused KPMG of holding it to ransom and the matter ended up in court. Under a settlement, Land Rover paid an estimated £15m to take on UPF's debt.

Land Rover said the case underlined the need to reform bankruptcy law. But, in an illustration of the complexity of such issues, UK ministers were unsympathetic as they believed the carmaker had negotiated an original price on the chassis that left UPF making a loss on every component.

Copyright The Financial Times Limited 2008