Using Financial Health to Understand and Prioritize Risk Hotspots
With the rise of disruptive incidents from cyber-attacks, to natural disasters, to geopolitical uncertainty, it’s no wonder that 83% of all companies expect to implement a procurement risk management strategy within the next three years. In a recent report “Managing Supply Risk: Are You Prepared for a Black Swan Event?”, A.T. Kearney and RapidRatings identified the top global trends that will likely impact supply chains in the coming year. Their magnitude brings a level of uncertainty that makes a risk manager’s life particularly difficult. For a closer look at the Top 5 predictions likely to impact supply chains in 2018 and beyond, download the whitepaper.
As risk grows, so too do the expectations by key business stakeholders such as CEOs, CFOs, COOs, etc. for the role that procurement can and should play in managing supply chain risk. Although leading procurement organizations are systematically leveraging a wide portfolio of risk management techniques to keep risk at bay, such as risk impact analysis and financial risk management, a majority of companies have yet to even implement risk strategies on more than an ad hoc basis. Many point to a lack of budget and resources, but when the tools they do have are focused, they can effectively filter out information noise and come away with actionable insights.
Financial Health Should Be a Priority
To better combat supply chain risk, how does an organization initiate a program? For less mature programs, there may be no obvious place to start. Ideally, you would evaluate all types of risk for your organization. Practically, you need to prioritize. The best Key Performance Indicator (KPI) for determining a company’s ability to not only weather unforeseen disruptions like these, but also to expand when business may be good or invest in infrastructure and resources, is financial health. Financial health is the gateway to understanding a company’s underlying strengths and weaknesses and speaking one single language for business decisions, providing a universal benchmark for choosing whom to partner with in the short- and long-term. For procurement professionals, it is the most efficient way to gauge the risk level of their entire supplier ecosystem.
Three Key Financial Health Trends
- Private company financial health decreased by more than 2 points among all U.S. Private Companies, and by almost a point among non-U.S. private firms from 2016 to 2017. Both numbers are now below their 10-year averages.
Public and private Brazilian and Chinese companies reached peak financial health in three years following the financial crisis. Since then, the average financial health of companies in those two countries have dropped by 20.3% and 11.5% respectively.
- Financial risk management can be systematically applied across the supply chain to predict what companies are susceptible to larger, one-time events.
Comprehensive Risk View Combats Supply Chain Disruptions
In identifying high risk suppliers, it’s first important to identify the suppliers that are most critical to your organization. Most would do this by simply narrowing in on spend, which, though it does represent one factor, does not capture everything that your organization needs to pay attention to. You need to create more dynamic criteria for evaluating the criticality of suppliers that goes beyond just spend. Some factors our clients focus on include single or near single source suppliers, significant intercompany relationships, concentration risk (when you are a dominant or main customer of that supplier), and client or product facing suppliers. From there, our clients can begin as simple as possible, by looking at the geographic distribution, for instance, of their critical suppliers. Prioritizing risk hotspots is then made easier by looking at long-term financial health from a bird’s-eye view.
The chart below depicts the average financial health of companies in BRIIC countries from 2008-2017. Organizations with significant amounts of supply coming from Brazil might be particularly concerned with the decline in financial health over the past five years. Consequently, they will pay extra attention to suppliers or qualify alternate sources of supply in the area.
Once armed with this information, risk management teams can begin collecting the necessary data to measure the risk associated with their suppliers in that geographical region.