16 Jul 2012 Vendor risk management – using supply chain finance to mitigate risk
Many suppliers will offer a discount for early payment. The decision to accept the discount is normally based on two factors. Are you in a position to pay the invoice early? (i.e. are your purchase to pay processes efficient enough to do so) and secondly, the size of the discount. What is not normally considered is arguably the most important factor of all – the mitigation of risk.
In challenging economic times, there are many businesses that go under – not because they have a poor business model – not because their order book has dried up – but because they run out of cash. This is a vendor risk that is traditionally extremely difficult to mitigate.
Supply chain finance – a critical component of vendor risk management
Mature procurement organizations routinely manage vendor risk. Ensuring that their supplier base is stable is a fundamental procurement function. A vendor risk management strategy will usually focus on financial strength and stability as well as other non-financial factors such as corporate social responsibility, ethics, environmental factors and political risks. However, these risks are nearly always managed reactively or retrospectively.
Financial strength for example will be assessed based on last reported accounts – at best a snap shot of the financial standing 12 months ago and if these reviews are held annually the risk assessment is often 2 years out of date. This is no better than a tick in the box to say the risk assessment has been performed. It does little if anything to alert the business of an imminent financial collapse of a key supplier.
Suppliers will never hold their hands up and declare that they have severe cash flow problems. It makes no sense. Indeed, there is a view that to offer discounts is an indication of problems and suppliers sometimes present this as a reason not to discount and this leaves buyers exposed.
Embedding supply chain finance arrangements such as dynamic discounting into a supplier relationship provides an opportunity for both parties to develop better cash flow. It also provides an important safety valve for a supplier during turbulent times and for the buyer, it helps to mitigate the risk of the supplier failing.
Pete Loughlin can be found on twitter @peteloughlin