Wednesday, January 26, 2011

Pre-qualification - Qualifying the Supplier’s Risk

There are five major areas for Supplier Risk
  1. Financial
  2. Market
  3. Hazard
  4. Operational
  5. Contractual

The financial risk to a Supplier is their liquidity and cash flow which can be impacted by external influences such as interest rates, foreign exchange, available credit, and aging receivables.  That can be identified from their financial statements.

The Market risks to a Supplier occur from competition, changes in the industry and competition, loss of customers, and general supply/demand changes. That should come from your knowledge of the industry.

The Hazard risks include natural and man made hazards that could interrupt performance.
These you can’t predict well.  For example a Supplier may be in an earthquake active area, but when will they occur..

The operational risks include performance problems that exist or could occur, things that can impact labor such as illnesses, labor disputes, political unrest, and what I call dumb management decisions. These can be partially identified by pre-qualification of the Supplier.

The contractual risks of a Supplier includes both what the Supplier is obligated to provide to other customers and the specific risks the Supplier is unwilling to assume in their contract with the Buyer.

The hardest of these to predict is the operational risk associated with dumb management decisions. These are usually decisions that have not been thought through to understand the impact. Here’s an example, a major electronics component supplier facing a temporary downturn in business layed off an entire plant staff. When demand returned, they sought to rehire all the workers. The problem was that many of the workers were foreign workers and because of the economy the local government was unwilling to allow them to be re-hired to work in the country where the plant was. They had a plant but a huge shortage of trained workers to operate it, and the result was they were unable to meet demand for an extended period. I’m sure anyone that has been in procurement for any period of time has had an experience where a Supplier is not performing because someone made the wrong decision.

You try to understand Supplier risks as part of sourcing decisions, whether you invest in second sources, and if you must hire the Supplier to decide upon what terms in the agreement are needed to help manage the Supplier and the risk.

Many time the best way to understand if there are operational risks that you need to be concerned about is to visit the Suppliers locations to see what that do, how they do it and look at the suppliers they use, the processes and tools they use and the rework or returns area. I was once asked take a look at a Computer Monitor Supplier in Brasil while I was there setting up a plant. What I saw was a plant that was a giant step back in time with no auto insertion equipment being used. Components were being inserted by hand. I also saw a large re-work area where the products when tested didn’t work and immediately decided that they had operational risks that weren’t worth trying to deal with. The cost of labor was so cheap they would never make the investment in automation equipment that would be need to improve their quality.       

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