As access to capital tightens, is winter coming for your suppliers?
The era of artificially low, or in some cases zero, interest rates from central banks continues. But for how long? When the Federal Reserve raised rates by a mere quarter point in June 2017, corporations breathed a sigh of relief. However, the medium-term bias is still to higher rates. What’s more, the slowdown in inflation has many concerned about rate hikes in the short-term. The anticipation of interest rate hikes continues to make headlines for Wall Street, but isn’t exactly piquing the interest of supply chain and procurement leaders. That doesn’t mean it’s a non-issue, though. On the contrary - it’s a very big issue and here’s why.
Understanding the masking effect of easy access to capital
For the better part of the last decade, institutional investors have been investing in riskier and riskier investments as they seek yield in this low-rate environment. They’ve been dipping lower in the credit quality pool of companies to get the highest possible yield as opposed to more normal environments where they’ve been able to generate decent yields without taking as much risk. This has created an environment where companies with weaker financial health have the same access to capital as those companies that are much healthier. In a more normal interest rate environment, like the one we’re (albeit slowly) approaching, those weaker companies would inevitably fail or be forced to sell their entire business in whole or in parts. In this historically conducive environment, though, many have forestalled failure and refinanced outstanding debt or financed less than healthy businesses that normally wouldn’t have survived in the past. In other words, their easy access to capital has enabled them to “kick the can down the road.” Refinancing, over and over, has kept them alive and masked their underlying operational inefficiencies.
Given the complex mix of financial, supplier management, and operational issues, alignment between CPOs, Chief Supply Chain Officers (CSCOs) and CFOs is an important step. One of the challenges is differing perspectives on risk and the link to underlying Financial Health. Better understand the breadth of risk and its relation to global financial health trends with the AT Kearney & RapidRatings whitepaper, “Is Your Luck Running Out? Managing Supplier Risk in Uncertain Times.”
How will your suppliers fund themselves when access to capital tightens?
The Fed’s interest rate boost in June signaled a change in the interest rate bias, although the timing and frequency of interest rate raises are anything but clear. When interest rates rise more over the next few years, debt will become increasingly difficult to refinance and suppliers with weak financials will be unmasked. Companies with underlying inventory inefficiencies and piles of debt, coupled with increasing global trade volatility with latent risks, can quickly explode into major problems that bring operations to a halt and impact global supply chains. For your broader supply chain, it means that you could now be holding relationships with weak suppliers that have flown under the radar.
The higher rate environment that lies ahead will make it harder and costlier for weak suppliers to fund themselves over the next 4-5 years. A recent analysis of 25,000 public and private suppliers’ FHRs reveals just how prevalent this borrowing has been:
- Public Companies: 91% have short-term debt; 76% have long-term debt.
- Private Companies: 81% have short-term debt, 64% have long-term debt.
If this mountain of debt is not refinanced or is refinanced at a higher cost, suppliers will feel significant impact and customers will feel the pain. Where will that hit supplier and commercial partner finances the hardest?
- Raw material and finished goods inventory financing
- Trade and supply chain financing
- Cash flow from borrowing to support overall business operations
3 Strategies to Build Supply Chain Resilience
Companies don’t default overnight, and that’s great news! Our research shows that when financial health falls into higher risk categories, both operating and quality performance declines. As obvious as that seems on the surface, what’s not so obvious is how much advance warning will you need to implement a risk mitigation strategy to protect the bottom line. A few weeks? A couple of months? A year?
With a solid supplier risk strategy and predictive financial health analytics, you would have visibility into the short-term (12 months) and long-term (2-3 years) financial condition of your public and private company suppliers. Recognizing financial decline affords you time to mitigate a supplier disruption to maintain business continuity.
Here are three strategies to get ahead of the issue and build supply chain resilience:
- See the big picture of risk across critical supplier segments by developing heat maps of value at risk (VaR) across your portfolio of suppliers, based on levels of financial health.
- Bring forward-looking supplier financial health into your supply, supply chain and business planning. Leading companies integrate supplier financial health projections 18-24-36 months into the future across sales, operations and business continuity planning.
- Review strategies and policies on either working with key suppliers for strengthening their financial health as interest rates rise or re-sourcing high-risk suppliers – before their deteriorating operating performance hits your revenue and reputation.
The bottom line is your supplier’s risk is your risk, and low interest rates won’t be around to save the day forever. Don’t be left out in the cold with winter coming to financially weaker suppliers and partners. Use financial health to see what your competitors don’t - seeing these trends well into the future can be your competitive advantage.