About the Author: James H. Gellert is President and CEO of RapidRatings, a financial health data and analysis company.
Those who expect a quick end to the supply chain crisis will be very disappointed.
Port safeguards, shortages of truckers, plant closures and shortages of raw materials are contributing enormously to this current wave of crisis. But a second wave is looming on the horizon. This wave will be more difficult to identify and too many companies focus only on the current crisis without appreciating the risks of the sequel.
Generally speaking, public and private companies around the world have reduced short-term risks during the pandemic by adding cash and debt to their balance sheets. Despite this step, many took more risks from a long-term perspective. How can this happen? In these cases, the underlying business of the companies may improve as long as the cash lasts, but if they don’t, they need to get more cash to save more time. If businesses fail to solve their debt problems, they either fail or start taking shortcuts that create unseen problems for their customers.
Financial failure of a supplier is never good, but at least it is often clear. The degradation of a supplier can be more insidious, creating risks that are more difficult to see, but which are costly and potentially damaging to their customers.
The second wave of the supply chain crisis will come from suppliers who are deeply degraded by the challenges of the past 20 months, where operational, reputational and financial risks are introduced for their downstream customers. This will happen when companies cease to be able to address the problems of cheap and historically easy to access capital.
Here is how it will play out.
A vendor that cuts IT spending can create cybersecurity risks for its customers. Whoever delays products or cuts R&D spending is less innovative and responsive to a customer’s product development and agility. A supplier that takes shortcuts when it comes to health, safety, or upgrading manufacturing equipment introduces issues of durability, quality control, and lead times, leading to reputational risk issues, business continuity, income disruption, inventory management and working capital efficiency.
Since March 2020, we have seen companies from all industries raise capital to avoid business bankruptcy or to deal with operational damage caused by Covid-19 and the first wave of the supply chain crisis.
While government interventions such as the Paycheck Protection Program have helped, the liquidity and low interest rate environment supported by the Federal Reserve Bank since the 2007-2009 financial crisis has created a market momentum where almost any business can leverage. loan capital. As a result, pension funds and other asset managers have spent the past 12 years chasing yield in this low interest rate environment, stretching the credit spectrum to buy exposure to riskier companies in order to achieve their returns. benchmark returns. At the same time, more and more providers of debt capital have emerged, creating a largely unregulated and untested asset class of alternative credit providers. These two forces have supported businesses and provided affordable capital to even the smallest of private companies in a typical supply chain.
Businesses across industries, from automotive to entertainment to retail, borrowed more, increased their cash flow against short-term debt, and made up for an incredibly tough operating environment. In the meantime, many sub-segments within these industries have become increasingly risky, but for the temporary capital increase.
There are signs of stress even in industries that performed well, like semiconductors and microelectronics, which had enormous pricing power during the first wave of the crisis. The RapidRatings Core Health Score measures the long-term strengths and weaknesses of companies. Among companies with sales of $ 50 million or less in the semiconductor industry, the average score is now 40 on our 0-100 point scale, one point above our high risk category. Over 90% of businesses that failed in the past 20 years were rated 40 or less. That said, this sub-category of companies has an average financial health score – which measures short-term default risk – of nearly 60, giving it the largest delta between short-term default risk and the long-term basic quality of the sector.
Based on our experience evaluating public and private companies in 150 countries, regardless of industry, private companies represent 75% of the average Fortune 1000 company’s supply chain. As private firms’ access to capital decreases, the resilience of the chain also increases.
Bottom line: At some point in the not-so-distant future, these companies and others who are facing a mountain of debt will need financing (or refinancing, as the case may be), and many will be unable to raise cash flow. an affordable price. rate, if applicable.
Cracks in the credit market are already starting to appear. Chinese real estate developer Evergrande’s distress sends shockwaves across Asia. The Fed’s decision to start tapering has put investors in the bond markets on edge. These problems add to a long list of concerns: P3 funding has long been exhausted. Inflation now appears to be sustained rather than transient. There is significant volatility in risky assets, including high yield bond index cash outflows, cryptocurrency fluctuations, and rapid changes in more stock markets. All of this, added to the unease about the Omicron variant, means that a perfect storm will catch many vendors who have significantly underperformed, if not outright failed.
Fortunately, one of the biggest trends in supply chain risk has been working with suppliers. Private enterprise providers recognize the business value of transparency and are more open to disclosure of financial data; intellectual property; information security; environmental, social and governance initiatives; and other sensitive material. Supply chain risk professionals who engage with these suppliers to understand their financial health are best positioned to help mitigate issues and build the most resilient supply chains possible, creating value. for customer and supplier, and helping the world’s investor relations professionals and CFOs communicate trustworthy stories built on true resilience.
Despite all of this, there is still work to be done. Many of these professionals will need more support and resources. In 2022, there will be close scrutiny from shareholders on who controls the narrative of their companies’ supply chain risk management strategies. This magnifying glass will also focus heavily on how they prepare for the next set of risks. Although the risks, by themselves, cannot be eliminated, they can be managed. Especially as a second wave approaches, it is essential to know what these risks are. To be clear, the sky is not falling today. That said, supply chain risk managers need to look up.
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