Supplier Dependence – A Silent Assassin
Something that's often overlooked by small business owners which can create significant business risk is a reliance on suppliers. When I say suppliers, I'm not just talking about suppliers of products, but also suppliers of services, even suppliers of referrals or suppliers of software you might need for your business. Anything that your business is dependent on, that you use in your business. Business owners often make the mistake of assuming that those things will just continue to be made available to them.
When I talk about business risk, reliance on customers is something that business owners understand. If you're turning over a million bucks and 95% of that's just coming from one customer, people understand that without that one customer, they probably don't really have a business left. People understand that you don't want all your eggs in one basket from a customer's perspective, and you'll have multiple customers.
Don’t underestimate Supplier Dependence.
What's often overlooked is the supplier side of the equation. There's an expectation that just because we're the customer or we're paying someone, that arrangement will continue forever. Because we're the customer, of course, they will deal with us and we're always right. This isn’t always the case. When it comes to supplier relationships, there are a few scenarios that could happen that could have a detrimental outcome on a business.
Supplier goes bust.
What happens if your supply goes broke? Say you're dependent on a product from a supplier and they're your sole provider of that product, and they get broke. Well, you're left with nothing to sell and you could be stuck. And if your business is entirely dependent on that supply, well you don't have a business left. So don't assume that a supplier can't go broke. Even businesses of quite large sizes can go under. You just must look at the building and construction industries to see that. What do you do about it? The best approach is to source multiple suppliers. Larger corporations do this, but it may be worth small business owners doing it too. If you're going to enter an arrangement where you're going to be using a supplier for a particular product or service, and your business is heavily dependent on that, do a financial health check on the supplier if you can before you agree to take them on because if they fold and it's going to impact your business.
You could have a great relationship with a supplier, and they have a corporate takeover. And it could be perhaps a strategic takeover by a competitor of yours, who's doing some sort of a vertical integration that aims to not only take over that business but also takes over that business with the aim of shutting you out. You're left with nothing if they are your sole provider. Again, what do we do about it? Well, ideally you don't have all your eggs in one basket. But if you do, and you're heavily reliant on that business, get contracts in place. Don't just assume that this will go on in perpetuity.
Is your relationship with a business or an individual?
This one is something I think most people underestimate. Have a look at your suppliers. Do you have a relationship with a supplier business, or do you just have a relationship with an individual at that supplier? You might find that your whole relationship was with the person and not the organization. And one change in personnel might mean that whatever arrangements you previously had in place could cease, or certainly cause things to become unstuck.
Is there location risk?
Where is your supplier located? Maybe you're dealing with an overseas supplier, for example, you're getting some stock produced in China and you've got an intermediary that's making all this happen for you. If they suddenly go, you're left with nothing. You may not actually have the contacts or the ability to communicate directly with the factory you're getting from. And if there's no handover, if they've left or if they've been made redundant or fired, well you could be stuck. What do we do about it? Well, again, document systems and relationships. Insist on having multiple contacts within that organization so that you've always got a backup plan if you need to contact someone.
My supplier retires, what now?
What if your supplier just retires? This does happen. You might be in an industry where you have an arrangement with a supplier who performs some of your critical tasks for your business. And if that's a highly skilled role that's in short supply, retirement might disrupt that process. I've got clients that use architects in their building business and they're reliant on that architect. If they pulled the pin, they'd have no one. So again, I would have multiple relationships if you can and insist on having contracts in place, and most importantly, just have an open dialogue about the future.
The same dependence risk would apply if you've got a steady stream of referrals coming from one area or one person, and you have a great relationship with them and they're just feeding you the work. They are a supplier of your customers if you like. And look, if they could be in an associated industry just feeding it works and you become so reliant on them, then if something happens with that relationship, the work stops, you might find yourself in a situation where you've become overdependent on that person.
Another example here is changes in supplier circumstances. Things outside your business are outside of your control, and a situation might arise where a supplier can just make far more money selling their limited supply of goods and services to another customer. A classic example of this might be if you're buying product from China and there's an exchange rate movement in the market, perhaps between the Chinese currency and the U.S. Dollar, and it now becomes far more profitable for your Chinese supplier to sell to your United States customer because they can make far better margins. You might be left where they just cut you off and you're left without a product to sell. Again, lock it in with a contract.
Now, a big one that I'm sure many business owners can relate to, based on the last 12 months is supply interruption. What happens if outside of your control, a supplier can't get you the products that you've ordered? The pandemic is fresh in our minds. You just must look at the new car market. Pretty much all the car factories across the planet shut through a three- or four-month period. That's caused a massive backlog. Now with the changes in the Australian rules, there's high demand. There are low-interest rates and some great incentives so there's a real high demand to get plant equipment like vehicles and other equipment in. But dealers can't get the stock on the shelves to sell. They just cannot supply their product. So similarly, I have a client, he came to me and he was in the lounge suite industry. A long time before he was a client of ours, he was telling me his story about how he had an excellent arrangement with an Indonesian lounge maker. He would supply him with lounges, amazing quality at low cost and they were super reliable. The supplier enabled him to really ramp up his business. His business became quite profitable, and he scaled his business off the back of this. That was fine until there was a major fire in the factory and the stock was lost. And effectively, he said it took about six months to repair and rebuild the factory before that supply could be reconnected.
So, what do you do about it? Again, this just comes down to having alternate suppliers. Also, as part of your risk analysis, you'd really need to weigh up what would be the cost of holding say six months extra stock, or even three months extra stock versus the cost of losing supply for a few months? You might weigh up that, okay, we're better to be overstocked and have the holding costs and the interest costs, because at least that is a known cost rather than if you're going to be completely obliterated by an outage of three to six months where you can't sell anything. That might just be a cost of doing business of having that backup stock in play.
When it comes to supplier relationships it is important to understand the potential risks to your business. Work through the various mentioned risk factors and see what applies to your business and make no assumptions that the status quo will be in place. Look at the likelihood of each risk. I know some of these things might seem unlikely, but also look at the size of the damage to your business should something happen. That will then lead you to a course of action where you either take steps to reduce the likelihood of the event happening, or you take steps to reduce the damage that would occur if the event did happen. I strongly recommend you do this assessment on an annual basis because as your business grows and evolves, so will its risk. And so will your supplier's risk change and evolve as well.
For an in-depth appraisal of any supplier risk in your business or some guidance on how you can put an annual risk appraisal in place, speak to one of our Business Advisory experts by calling us on (02) 4353 3889.