We Won’t Get Fooled Again

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

11 comments on “We Won’t Get Fooled Again

  1. Himanshugupta
    February 26, 2014

    Europe's problem were pulling the economic recovery post recession. I think the situation is much better now. There are and will always be problems somewhere but as long as the fundamentals remain strong there should be no reason to panic. 

  2. _hm
    February 26, 2014

    I always listen in news that buisness has few 100B dollars or more in cash but they are aftraid to employ them.

    Why not use this reserve fund available with buisnesses?

  3. Hailey Lynne McKeefry
    February 26, 2014

    It's really important to plan for hard times when things are going well. Trying to rebuild the engine of the plane as you are heading into a nosedive is much, much harder.  I'm glad to see you putting forward a broader idea of sustainability–beyond the green elements. It's important to think broadly on the topic…and i think many leading organizations are moving in that direction.

  4. Hailey Lynne McKeefry
    February 26, 2014

    @_HM Don't you think that using funds is a huge risk in the minds of most organizations? Further, how would an organization discern how to use it wisely? It's hard to prove investments… I'm not sure my question would be “Why not?” but rather “why?”

  5. ahdand
    February 27, 2014

    Well maybe they are keeping it as a guarantee for the business. Maybe for emergency purposes. We are not brainy enough to figure out what it is for J

  6. Wale Bakare
    February 27, 2014

    >>I think the situation is much better now<<

    How do you mean? May be just a few nations, unemployment still on the high side though. I think the bank reform would accelerate positive improvement in every aspect. Particularly, credit facility to entrepreneurs.


  7. Brian Wilken
    February 27, 2014

    Thanks for your question.  The challenges with bank reforms is that it is mid-to-long term fix.  It should in theory provide a safer credit system as bank hold more reserves against the bad times and lessen the need for taxpayer to clean them up.  To get there however they need to clean-up their balance sheets of non-performing loans and then build their reserves. From a European perspective we did not really have a bad bank clean-up as in the US.  One may argue China may have this before them.  While the banks are “saving” they are not lending as much and are risk adverse which does not help the smaller more entrepreneurial businesses

  8. Brian Wilken
    February 27, 2014

    Admitted there is been a lot of press about cash sitting on the sidelines with various businesses.  When looking at the companies in US they have been slow to invest in more people and equipment and have been reaping the return of cost saving and business efficiencies.  In Europe, the earnings have not been as spectacular, which leads to less money to re-invest internally.  I think in many cases around the world most of the cash, sits with a smaller number of large companies.  They have the opportunity to invest in assets, people and working capital if they can find the right investment opportunity based on their business goals.  The small to midsize companies have less of a saving account to tap, so again they need to rely on the banks for their support. 

  9. _hm
    February 27, 2014

    @Brian: Thanks for clarification. Yes, small and medium business always have trouble finding money from bank. Can not they find some alternate solution to entice bank to come in open?    

  10. Brian Wilken
    March 4, 2014

    I think the challenge is to still find the right combination of carrot and stick to get the banks back to lending.  In Europe the ECB allowed banks previously to borrow quite cheaply from ECB in a hope that this would then in turn be lent out in the market.  Instead the money often found its way back into sovereign debt.  I think it will just take time for the banks to get back into normal operations, as recoveries from Financial Crashes take longer to be realized.  The return of growth to the markets should at least be positive sign to banks to chase better lending opportunities for higher returns, but it may be slower than we like.

  11. _hm
    March 4, 2014

    Now add to this dilemma of interference in Ukraine from both USA and Russia.

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