We’ve been contacted by many clients concerned about the financial stability of their key strategic suppliers. With the ongoing COVID-19 crisis impacting businesses on a truly global scale, it is an unfortunate fact that some may not survive the commercial strains that will be pulling at them. Realistically, there may also be a small minority of suppliers who will play up the effects of the pandemic, so careful consideration will be necessary to ensure that you are able to focus on the more needy cases. Public sector organisations also need to take into account recent Government guidance (PPN 02/20 on payment of their suppliers).
That being said, this is also a subject which should be considered for when we are out of this pandemic, as there will be businesses that:
- survive the lockdown, only to find it too financially traumatic to restart in the ‘new normal’ world of social distancing and rolling lockdowns,
- survive even this, but teeter on the brink unsure of their future and this will impact on their ability to maintain service levels,
- simply fall into difficulties that have little or nothing to do with the coronavirus.
How much responsibility should you take for keeping your supplier(s) afloat and how much risk should you allow yourself to engage in while doing so? The answer will ultimately be a considered one. How do the benefits to your organisation compare with the risks inherent in such an action? This article looks to provide a little insight into these factors to give you the tools to determine whether this might be a path that generates good value for you.
Today’s Strategic Supplier Market
From the many thousands of service providers and suppliers that have existed over the years, a few have grown into international giants, taking on multimillion-pound government contracts, employing tens or hundreds of thousands of people, setting up offices around the world and monopolising the major projects and outsourcing landscape. For the longest time they were the strategic supplier untouchables. Until recently…
The shock that reverberated through the halls of Westminster and across the plains of the private sector when first Carillion, then Interserve failed was almost palpable. How could organisations that had become such a part of the commercial landscape fall so far, and seemingly so fast (though of course, in hindsight it’s easier to piece together the audit trail that led to the situations both organisations found themselves in)?
But the reality is that companies, no matter their size, are only a few bad decisions (or an economic downturn/pandemic) away from tough times. And, as an incisive client, you will have recognised this and planned for the possibility that one day a) they may need your help (what this article is all about), or b) you already had the foresight to analyse how and why they may find themselves beyond help, and that’s when the actions you have already taken to protect your service provision are so important.
We have a rather unique insight into this, having ourselves worked to support our client’s strategic supplier relationships across three previous major financial crises (in 2000, 2007 and 2016), helping hundreds of clients to build, maintain and, in some circumstances, exit with minimal negative impact their strategic supplier relationships.
How Vulnerable is Your Strategic Supplier?
By no means the only factor, but certainly one of them, in the determination of the fragility of your supplier’s financial position is how it is funded. If venture capital backed, they can ask for more funds to make it through the desert of a crisis, although, of course, they will usually have to be prepared to give away an additional portion of ownership of their company.
If they are stock market listed, they can always go cap in hand to their shareholders for more working capital through a rights issue, and it’s quite likely that they will get it. However, if they are privately funded, then their future may often be in the hands of banks or other lenders, who some might suggest have been less than generous in their keenness to bail out struggling businesses over the last few years.
So, if your strategic supplier is genuinely struggling on the financial front, and as we’ve already established, many may well be right now, what should you do? – let nature take its course, or get involved and ‘invest’ in your strategic partner’s success because you recognise that their survival may well be your strategic success, and their failure could cost you dearly?
Advance Payments for Purchasing Services From Your Strategic Supplier
As you’ll know, an advance payment is rarely a first choice for a client, when often the remuneration for a service is only given when that service has been appropriately delivered. However, in these extreme circumstances, advance payments can be utilised to both shore up a supplier’s financial wellness and provide a basis for better client value. A win-win for all concerned.
Firstly, to consider advance payments, you’ll know there needs to be at least a base level of commercial trust between you and your strategic partner, either through the relationship you have built up or through the data you’ve gathered on them as part of your due diligence process.
If there is a downside to this, it’s the risk you are potentially taking on. What happens if, despite all of your help, your supplier financially fails? You could well find yourself at the back of a very long queue of people looking to get their money back and by the time you get to the front, who can say whether there will be anything left to share out?
Therefore, it’s important to critical friend check the risks you could face and, just as importantly, to appreciate how they can be minimised.
Four Key Risks Inherent in Paying Strategic Suppliers in Advance and How to Mitigate Them
- Key Risk #1: The vulnerability of your supplier’s current financial position
We consider it good practice to not only assess the financial stability of a supplier at the outset of a relationship, but to build into that relationship periodic reviews (every 6–12 months) to maintain a current picture in order to identify issues well in advance of them impacting on your service delivery. This can be achieved through the not so humble bank reference – an indication of the bank’s perception of the financial liquidity of your supplier.
Two things to remember when requesting a bank reference on a supplier are: 1) you can ask for one whenever it suits your needs, 2) you should explain, with crystal clarity, the criticality of the service your supplier is providing so that the bank can more carefully consider the wording of its response, providing you with the most accurate perception information you could hope for from them.
- Key Risk #2: Your supplier’s dividend payment commitments
A supplier that shares its company ownership with others may well have dividend payment commitments to live up to, the financial reward of share ownership. How can you know that the money you pay your supplier in advance won’t go to paying these shareholders, rather than staying in the business to continue to fund the services you’ve contracted them to supply?
It is, therefore, vitally important ahead of any payment, that you: 1) determine whether dividend payments are due and, if so, discover when they are due, or if an assurance is made by the supplier that dividends will not be paid to sensibly preserve cashflow, then 2) look to get a signed agreement from a senior director of the supplier that confirms they are not going to pay any dividends for a pre-defined period – say 12 months, and 3) if they are going to pay dividends, decide whether the risk of those payments outweighs the benefits of an advance payment, especially if a portion of the money is not going to continue to be invested in the services.
- Key Risk #3: Will your supplier be able to access trade credit if needed?
When a supplier’s financial position is fragile it may become more susceptible to cash flow issues, necessitating access to trade credit, i.e. invoice factoring or invoice discounting. The cost of these financing options can be high, often up to 1% – 4% of gross invoice value.
The answer could be as simple as you stepping in to offer them a comparable deal, so your invoices do not have to go through the factoring/discounting route. You could always explore the offer to pay them in advance, with the agreement they share a proportion of the fees with you as a discount, to what they would have otherwise have paid out to the factoring/invoice discounting company.
- Key Risk #4: The supplier’s ability to deliver what you have paid for
After everything you might do to help by paying in advance, it is still a possibility that your supplier could fail financially. You will have done all that you should with bank references, ensuring the money you spent with them went where it should and offering them alternatives to factoring, but sometimes a supplier’s demise is inevitable, so what can you do to protect yourself in these circumstances?
The answer is, insurance. The insurance that you and your supplier are covered by.
Your supplier’s professional indemnity insurance can be claimed against in order to recover the sums you paid in advance for services not delivered. And supplier default insurance can often be taken out by a client (before you pay the supplier) to cover payments made in advance to suppliers who then do not deliver the services you paid for.
COVID-19 will leave commercial victims in its wake, as well as human ones. It just makes sense to invest in the knowledge you will require to recognise, identify and assess the significance of the risks you might face should your supplier get into financial difficulty, the things you can do to help them to help you, and how to minimise the potential for a negative impact on your organisation while maximising the opportunities it could throw your way.
Good luck, stay well, and do let us know if we can provide you with any guidance.
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