The Supply Chain: A Canary in the Corporate Coal Mine

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To avoid the fate of companies that collaborated with WorldCom, Enron, Vivendi and others, you must learn to read supply chain performance as a gauge of corporate financial fitness. SCM performance is a leading—not a lagging—indicator of a suppy chain partner's true economic situation.

From Enron to WorldCom, over the past months business scandals seem to have surfaced with little or no warning. Financial reports, as we've regrettably seen, are easily and too often manipulated. Auditors, the SEC, Wall Street analysts, the rating agencies, and Dun & Bradstreet have been completely clueless about predicting these debacles, and in some cases they have been complicit in committing them. But surprisingly, there's one canary that every company should look to while navigating the murky coal mine of corporate scandal: their own supply chain.

Today's accounting scandals cut straight to the heart of supply chain management and collaboration. Deceptive accounting was intended to fool other parties into believing that the offending firms were stronger and more successful than they actually were. For firms building a collaborative, interdependent supply chain across multiple partners, the impact of this trickery is colossal.

Companies that were counting on SCM-critical collaboration and support from firms such as ACT, Kia, Daewoo, Cendant, Qwest, Dynergy, Enron, Vivendi, WorldCom, or any of the host of banks that hide bad loans, now look foolish at best. Often, they have been left scrambling for suddenly scarce and costly capacity with new suppliers. Even more damaging, these companies' ability to deliver for their customers is now likely at serious risk, and their judgment is being called into question as well.

For example many firms that have sourced telecommunication in the past six months likely had Qwest and WorldCom on the list of bidders. Quite a few selected either firm, based on price and service promises, lulled into belief by the idea that a firm of that size could not fail. Now, those contracts are assets under the supervision of a bankruptcy trustee, or in the case of Qwest, potential collateral for working capital loans. How secure is a company's data, service, communications, and support in such a case, and for how long?

To avoid this fate, firms must learn to read their supply chain's performance like they listen to the hum of a plant or the sounds in a call center as a gauge of the health of the business. That's because SCM performance is a leading, not a lagging indicator of a collaborator's true economic situation.

Why? Because when things start to go sour within an organization, a reflexive internal squeeze kicks in almost immediately. The first areas to feel the impact of this survival squeeze are typically inventories and safety stocks, quality control, logistics, the quality of suppliers, overtime labor, and external spending on IT, communications, temp labor and outside professional assistance.

For a supply chain partner, these changes are usually manifested right away as out of stocks, lags in response time to service requests, partial order fills, late deliveries, rejected lots, delays or last minute diversions of product to other customers, and a general lack of communication.

These are clear red flags, but for most supply chain partners of a firm in trouble, they are often ignored in hopes that "things will return to normal". Or, foolishly, it is assumed that these are "one-time" problems, or that "it is only happening to us".

These assumptions and excuses are deadly. These are exactly the types of performance metrics that Supply Chain Managers routinely test for and certify with vendors before entering into preferred supplier agreements, certifications, and partnerships. It makes no sense to waive these standards for firms that are within a collaboration based supply chain—if anything, standards should be increased over time, under continuous improvement programs.

When a supply chain manager recognizes these indications of trouble in a SC partner, she should immediately do 6 things:

Notify the vendor of the seriousness of the performance changes and the possible suspension of preferred/collaborator status, as well as the next 5 steps in the corrective plan. It is imperative that the seriousness of the situation is conveyed, without panic or undue escalation, and that a path forward is mapped out. In the most common case of a good supplier undergoing stress you should emphasize the collaborative nature of the relationship, your willingness to help, and the criticality of time and communication to resolving the problem.

Make a site visit to the supplier and, in person, ascertain the supplier's prospective future continued suitability as a SCM collaborator. Be especially on the lookout for changes in staffing and personnel, changes in performance metrics and control charts, returns/repacks/holds/visual inspections, empty workstations (especially in support or customer service), rush shipments in or out, and crew strength.

Set up a step-by-step process to get the supplier back on track and/or re-certified. Treat this like a re-certification, not a temporary issue, and if appropriate get your own Quality, Legal, Operations, and Logistics team involved, too. They will have heightened sensitivity to specific details you might miss, and they will be able to tap into colleagues and peers to get a sense of the pervasiveness of the issues

Identify back-up suppliers and secure preliminary commitments if capacity is likely to become constrained in the event the primary supplier fails. In many cases it is possible to reserve capacity without actually placing an order, or to begin the process of qualification/certification with a new prospective vendor to reduce the lead time should the need to change arise. Many companies do this now, ensuring that such items as tools, molds, engineering documents, and other mission critical assets are secure, and that plans are in place in case they become unavailable temporarily due to a vendor's failure.

Tap into a syndicated supplier ratings network to ascertain whether the problems are widespread and systemic. For this purpose D&B alone is insufficient. Firms such as OpenRatings provide operational metrics on a syndicated basis, often using the same KPIs that the industry uses. OpenRatings even will provide a warning system based on SC criteria to warn of issues, even if your firm has not seen them (yet).

Explain and highlight the changes and the actions underway to manage the risk to the right stakeholders in the supply chain, especially ops and sales, with any risks or vulnerabilities highlighted. Clearly, a Supply Chain manager must be aware of the real risk to the supply chain that a vendor might pose, and not all cases warrant escalation to the "C" level.

However, logistics issues almost always need to be highlighted to Sales, and issues with vendors of direct materials almost always need to go to Manufacturing's leadership. It is important that a SC manager not be perceived as "chicken little", nor as a "CYA" manager. Key to achieving this positioning are using a calm tone, strong facts, and appropriate actions to correct the problem and assure folks that the issue is defined and in control.

One of the most important lessons from these recent troubles is that even the most sound partners may not be what they seem (though most are.) SC managers have a responsibility in their own position, but also to their company as a whole, to remain alert to the soundness of their partners. Whatever your thresholds are for intervention, now is the time to dramatically lower them—what firms could recover from 3 years ago is often fatal today.

It is wise to prepare contingency plans and identify and build relationships with back-up vendors, even for existing vendors that appear to be sound at the current time. As with most issues, it can be very helpful to define a formal process, with stage gates, warning levels, and remediation procedures.

Remember, this situation is likely to arise many times in the normal course of business, and only rarely will a vendor be on a path to either insolvency or legal trouble for unethical business practices.

If the telltale SCM warning signs are not identified and responded to quickly, companies may miss their chance to rectify the situation altogether. In most cases, it's only after problems arise in the supply chain that troubles are actually reflected in a collaborator firm's financials. And it takes from 30-60 days for financial problems to show up in rating agency reports and in the credit department of one's own firm. Often, by the time the true depth of the problem comes to light, it is too late for the supply chain manager to react—alternative suppliers are booked up, prices are rising, and senior management is demanding to know why something wasn't done sooner.

One of the unique features of the recent collapses has been the rapidity with which firms went from best in class to subjects of SEC, DOJ, State Attorney General, or NYSE inquiries or even indictments. In almost all of the most critical cases D&B, S&P, Moody's and Wall Street analysts' downgrades have occurred after problems hit the papers, and of course by then it is often too late to act.

Remember, be wary of the warning signs before signing up with a collaborator—how many deals were signed with WorldCom, Concert, Enron, or Kirsch at great prices just before they collapsed? The folks who signed those deals are now embroiled in divestitures, write-offs, bankruptcy, and litigation. How many firms could have read the writing on the wall sooner, in the form of degradation to service, quality, transparency, and communication?

The quality of collaboration partners is critical to the functioning of a supply chain. How healthy are your partners?

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