In today’s precarious economy, you need to be concerned about more than your own company’s health. You also have to pay attention to the state of your suppliers’ affairs. When a struggling vendor goes out of business, you might find yourself scrambling to fulfill your own orders. And, of course, even a solvent supplier can experience a major disruption due to flooding, a fire or another calamity.
The consequences for your business, however, can be dire—anything from lost sales to a more substantial threat to your bottom line. “Losing a supplier potentially is a very, very serious problem, and it can make or break a company,” says Ken Gaebler, a small business expert and head of Gaebler Ventures in Chicago.
Here’s how to protect yourself:
Draft contracts with the worst in mind.
Sit down with a lawyer and think through the possible problems a vendor might experience, anything from quality problems to bankruptcy. Then build safeguards into the contract to protect your company. “Think in terms of worst-case scenarios,” says Gaebler. For example, many companies that depend on specific software suppliers demand that the vendors hold their source code in escrow, she says. The reason: The firms would be able to get access to the code if the vendors were to declare bankruptcy. Also, make sure you have the right to get out of a contract if a supplier experiences a crisis and find an alternative, if necessary.
Have a back-up.
Sure, it’s tempting to streamline operations by reducing the number of vendors you use. But you’re better off spreading the wealth and having at least two suppliers of an important product in your arsenal. That way, you hedge your bets in case one vendor can’t come through. It's best to evaluate how important specific suppliers are to your company. If you determine that losing one would result in more than a 5 percent drop in profits and would hurt cash flow and future business potential, then it’s vital you look for back-up providers.
If you lose a supplier and you haven’t already found a substitute, however, then your only choice is to find other vendors—quickly. Start by contacting trade associations and bankers for recommendations.
Understand your suppliers’ financials.
If a vendor’s problems are financial in nature, there usually will be warning signs well before a crisis occurs. For that reason, you should monitor the health of key suppliers so you have plenty of warning and time to find a replacement. To that end, ask important vendors to show you their financial statements regularly. “If they won’t, then you should go to a supplier who will,” says Jerry Mills, CEO of B2B CFO, a Phoenix, Arizona-based company supplying temporary CFOs. At the least, according to Mills, it means vendors aren’t interested in working with you as a partner; at the worst, they have something to hide. “Suppliers that have good working capital and are solid will let you see that data,” says Mills.
Talk to your insurance agent.
According to Gaebler, you might be able to get insurance that protects you from a service interruption. Or, you can try to require that your vendors arrange for such coverage for themselves, so a disaster will be less damaging to them and, as a result, to you.
Expect to pay more.If you need to change suppliers suddenly and with little notice, chances are your new vendor will raise costs. You’d probably do the same thing if the situation were reversed. But, you may not have the money on hand to meet the additional expense. And that may require you approaching your banker for more credit. Ultimately, says Gaebler: “You need a rainy day fund to get you over the bumps in the road that will inevitably happen when a supplier is down for the count.”