Good news: The economic crisis that has plagued the global economy is over. According to a recent International Monetary Fund (IMF) report, global growth is projected to increase from 3% in 2013 to 3.7% in 2014 and 3.9% in 2015. Finally, members of the electronics supply chain can breathe a sign of relief and stop worrying about financial sustainability. Well… not so fast.
Actually, I believe that now is the time to double down on the focus on financial sustainability in the supply chain. Here's why.
Economists worldwide agree that the global economic crisis will not be truly over until the employment picture improves. Yet, in the European Union (EU), there are nearly 20 million people unemployed. Unemployment remains high in the US, and even China is potentially facing an employment crisis. John Marshall, writing in the Economist about a recent commentary by Gordon Orr, chairman of McKinsey Asia, said rising costs are forcing “Chinese firms to do more with less and increasingly rely on technology and innovation.” As a result, hundreds of millions of rural Chinese workers have little room for advancement in the region's increasingly innovation-focused economy.
Now, you might be thinking that, since creating jobs requires economic growth and the IMF is predicting growth, then there's nothing to worry about. I disagree.
In the EU, for example, we are noticing that there is a credit crunch that you would not normally expect in a more positive economic environment. So, while consumer confidence is increasing, OEMs' ability to keep up with this demand may soon diminish as working capital reserves are exhausted and banks resist lending due to the ongoing overhaul of the European banking system.
A major provision of this overhaul is the international Basel III banking standard, which will require banks to increase their capital reserves to better insulate them from the exposures that prompted so many bank failures during the 2007-8 financial crisis. Though full implementation of Basel III is not expected in the EU until 2018, it already appears to be influencing banks' credit strategies. A US version of the Basel III Liquidity Coverage Ratio (LCR) is set for implementation by 2019. The Organisation for Economic Cooperation and Development (OECD) estimates that Basel III will likely slow GDP growth by 0.05% to 0.15% annually.
In this environment, it is critical for companies to monitor their financial exposures up and down the supply chain. For example, you may have a customer that looks financially sound, but its end customer may struggle. On the supply side, in order to assess your suppliers' ability to support you in the long term, you need to look not at their financial health, but you must also be aware of potential issues with their suppliers, particularly smaller niche suppliers where you may not have a second source.
Though some believe that the responsibility for financial sustainability rests entirely in the finance department, the health and viability of customers and suppliers is most definitely a supply chain issue. Your best bet is to work closely with your corporate finance representatives to assess and monitor your partners' financial situation. At Avnet, our credit and finance people will sometimes accompany sales to customer meetings so that we can ensure we have a strong understanding of their business strengths and potential vulnerabilities.
In addition, you can also gather vital financial information on customers and suppliers via their financial reports (for public companies) and use credit agencies like Dun & Bradstreet. In EMEA, it is also common to work with credit insurance companies.
The current economic environment is very different from previous cycles. In 2008, everyone was feeling the pinch. Today, there is a great deal of variability between regions and market sectors. As business swells, you must keep in mind that if credit is tight, working capital will become tight, and all of a sudden growth becomes constricted. Therefore, it is more imperative than ever for members of the supply chain to stay on alert.
Finally, here are some suggested tools and strategies for mitigating financial risk in the supply chain from Wells Fargo Treasury Insights.
- Trade letters of credit
- Supplier finance models that include a buyer-approved invoice and nonrecourse early payment to the supplier
- True sale of concentrated receivables
- Credit insurance to protect against payment default
- Accounts receivable puts, which provide insolvency protection to the supplier