This document discusses strategies for managing supplier risk. It recommends using commercial credit reports and monitoring tools, which are similar to those used for receivables management. A three-step process is outlined: 1) Determine information needs about suppliers' financial stability and ability to meet commitments. 2) Evaluate credit report alternatives based on data coverage, quality and sources. 3) Set up credit monitoring to receive early warnings about supplier financial events that could disrupt the supply chain. Following these steps helps select the right reporting tools for effective supplier risk management.

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By Adam Ortlieb
Assessing Risky
Business
According to a 2003 study by Ernst &
Young, the supply chain is one of the
last, best areas from which to reduce
costs in a company's operations. Many
Supply chain executives can better manage sup-
plier risk with the same processes and tools that
credit managers use to safeguard receivables.
companies continue to find greater efficiencies by implementing
single-source strategies and Just-In-Time operations with leaner
inventory requirements. The downside is that aggressively stream-
lining your operations and leaning more heavily on suppliers adds
greater supply chain risk. When your supplier does not deliver,
there is little time to react and, perhaps, no safety mechanism or
excess inventory to fall back on. As the exposure to financial loss
grows, many companies look for strategies to avoid third-party
mishaps that can adversely affect supply chain performance.
Commercial credit reports and related tools can provide a
means for mitigating supplier risk and should be considered as
part of a comprehensive supply chain risk plan. With data about
a supplier's resources, track record for managing financial obliga-
tions, and principals or officers, credit reports can give you valu-
able indicators. You can also use credit-monitoring tools as an
early warning system; advance notice that a supplier has incurred
a major change to its credit file allows you to respond more
proactively.
Not all reports are identical, however, and the same product
from different suppliers can vary based on the breadth of infor-
mation, data quality and data sources. By employing a simple
three-step framework for selecting the right reporting products,
you can be sure that you are buying the best information for
managing risk in your supply chain.
Step 1: Know What You Need to Know
The fundamental question is whether your supplier will be
able to satisfy its supplier commitments for the foreseeable
future. Ask yourself:
• Are there financial risks in doing business with this supplier?
• Does it have the financial resources to support your operations
(e.g., technical support, logistics, R&D, etc.)?
• What kind of sales growth can it support?
• Whom else is it doing business with?
• Is this company highly litigious? (Does it tend to get involved
in lawsuits as a defendant or a plaintiff?)
IJ
•What is the track record of the company princi-
pals or officers?
" 3
Adam Ortlieb is general manager for Nielsen Information Company, Huntington
Beach, California. To contact the author or sources mentioned in this article, please
send an e-mail to author@ism.ws.
Inside Supply Managenrent
.• What assets are pledged as collateral?
• Do any derogatory public records exist (liens, judgments, etc.)?
The goal is to compile your list of data requirements in advance,
emphasizing points that address the underlying business issues.
By sticking to the areas that directly impact your business, you
will be better prepared to sort through alternative products. More
importantly, you will be sure to identify a product that helps you
determine on which suppliers you can rely.
Step 2: Evaluate Alternatives
Commercial credit reports from multiple suppliers often
present overlapping data elements, such as:
• Payment history: Your supplier's ability to pay its suppliers is
crucial to your overall supply chain performance.
• Derogatory public records (including bankruptcies, liens and
judgments): Obviously, a multimillion-dollar judgment could
spell doom. The dollar amount may not be the only yardstick,
however. A tax lien, for example, may involve fewer dollars
but should not be ignored.
• Payment trends: A pattern of increasingly late payments is
a reliable indicator that a company is headed for trouble.
Reports may use "days beyond terms" or similar verbiage
to characterize payment behavior.
• Trade balances: Use this data to determine whether a com-
pany is overextended. Or, verify that a supplier has not mis-
represented its resources (read: a bigger, more established
company should have a commensurate credit history).
• Delinquency prediction scores and decision tables: Just as
credit managers do, supply chain executives can streamline
the evaluation process by automatically approving, declining
or referring for further analysis based on credit score strength.
• Financial statements and analyses: Audited financial statements
may only be available for publicly traded companies.
• Uniform Commercial Code (UCC) filings: These filings provide
another measure of leverage and are required when company
assets are pledged as collateral.
• Commercial finance relationships: It may be important to
know with whom else your supplier is doing business.
Although the breadth of information should be a major deter-
minant of your chosen report, it is critical to understand how dif-
ferent suppliers compile information. Specifically, some reports
may include self-reported information, while others only include
objective third-party data. One solution is to avoid using reports
www.ism.ws December 2004

2. with self-reported data when assessing privately held companies,
or small to mid-sized firms, where information is published under
less scrutiny internally.
It also is critical to understand the depth of information available,
or "data quality." There are pros and cons to every supplier, but
focus on understanding how reliable the information is for your
decision-making process. Finance and credit managers may be
more familiar with some of these concepts, so it is a good idea
to tap into their knowledge to measure the robustness of various
reporting alternatives. Also, be sure to ask for statistics to back up
suppliers' claims. Some important questions for assessing data
quality are:
• How many trade lines are maintained in the database?
• How frequently are credit-line data updated?
• How strong is collections information?
• How extensive is the public-record information?
• How well is your geographic region covered?
• How predictive is scoring information?
• How much information is available on principals, officers and
executives?
• How well are small businesses covered?
• What data is self-reported?
• How extensive is international data? How is it delivered?
Also, consider secondary factors when appropriate. For example,
if you are a smaller company with a smaller budget, you may need
to avoid mandatory purchasing contracts. Or, you may need the
convenience of online reporting. These factors can also be useful
to break a tie when you find that multiple suppliers offer a report
that meets your requirements.
To assist in the decision-making process, or to help justify a
recommendation to switch reporting suppliers, some buyers will
generate a decision matrix, assigning a quantitative ranking for
each reporting option. This process can be accomplished with
the following steps:
• List the decision criteria, obtaining input from the relevant
stakeholders.
• Assign an impact weighting to each variable based on the
relative importance of each factor.
• Multiply each score by the impact weighting.
• Tally the weighting-adjusted scores for each report.
• Communicate your results as needed to justify your
recommendation.
This simple quantitative approach is often helpful in overcoming
objections or historical biases held by colleagues or superiors.
Step 3: Avoid Surprises via Credit Monitoring
Once you have selected a supplier, it may be appropriate to
monitor that company's credit on an ongoing basis. This type of
service is like an early warning system, providing e-mail or other
notification that a key supplier has experienced a major credit-
related event that could eventually impact supply chain perfor-
mance. The value of a notification service is the ability to be more
proactive when a supplier is in trouble. The degree of need for
this service is primarily dependent on the potential financial impact
of a supply chain interruption. The greater the impact of a sup-
plier not delivering, the stronger the need to monitor its financial
health.
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strategtes and solution&;
The more robust account-monitoring services provide a
greater range of the following:
• Flexibility in the number of accounts to be monitored
• Immediate notification for more urgent credit events (e.g.,
bankruptcy)
• Flexibility to "tune" your alerts so that only useful information
is received
To maximize the effectiveness of this service, you should only
select notification triggers that will motivate your company to
take immediate action once an alert is received. For example,
one of your suppliers may be regularly involved in small claims
suits as a necessary part of its collections activities. Rather than be
overwhelmed with judgment notifications, consider tuning your
public-record alerts to exclude judgments below a specific dollar
amount.
By identifying the information that will help you make informed
decisions abollt potential partners, you will be better equipped to
pinpoint the right reports for managing your business. With these
criteria identified, you can screen the various reporting tools more
efficiently. Mo~e importantly, by incorporating the right reporting
tools into a comprehensive supply chain risk plan, you will be
better prepared to predict third-party mishaps and react to them
more proactively, minimizing the impact on your business. ism
© Copyright Institute for Supply Management~. All rights reserved.
Reprinted with permission from the publisher, Institute for Supply
Management, Inc.'"
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