From the February 2011 issue of Treasury & Risk magazine

Best Friends Forever

The flow of credit from financial institutions all but froze starting in late 2008, and although it has thawed somewhat, suppliers' financial risk remains at the top of their corporate customers' concerns. What happened in the car industry as the credit crisis struck in the fall of 2008 was a harbinger of the closer ties that now bind companies to their suppliers. Plummeting car sales had dire ramifications for parts suppliers, many of which depend on their sales to the manufacturers.

French carmakers Renault and PSA Peugot Citroen publicly promised support for their suppliers. And in 2009, BMW helped bail out Edscha, a German manufacturer of sunroofs the luxury car company uses in its Z4 convertible.

A second trend is the push toward "just-in-time" inventories, which allow for more efficient use of capital and reduce the risk of excess inventory should demand unexpectedly drop.

Outsourcing introduces many more risk variables into the supplier equation, including transportation and political risks, while the just-in-time approach to inventories makes each of those variables much more critical to control and hedge.

An industry of research firms offers windows into supplier risk, but none covers all the bases. Credit rating agencies, for example, assess publicly issued bonds and very large bank loans, but the agencies are renowned for the tardiness of their warnings. In any case, most companies' suppliers are too small to have rated debt. Moves in the prices of credit default swaps can indicate credit problems in a more timely fashion, but only the biggest debt issues generate credit default swaps. And many suppliers are private companies, most of which rely on bank loans and private placements, rather than issuing public debt.

Firms such as D&B, CreditRiskMonitor and PrimeRevenue scrutinize a long list of risks in addition to credit risk, including operational disruptions and brand risk. They aim to be more timely than the rating agencies by scouring a vast array of data and news sources to provide predictive scores and alerts warning of potential supplier troubles.

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