OEM and Tier One suppliers must move to employ a comprehensive financial and operational review of their supply chain.supply chain, financial stability, automotive manufacturing, BBK ratings, supply base

William G. Diehl

English

Research Papers in Economics

Remarks to the Automotive News Manufac-
turing Conference in Nashville May 17
e live in an ultra-competitive
automotive market that puts
relentless pressure on the sup-
ply chain to drive out waste. In
fact, if I were to tell you that I’m going to
announce a sure-fire way to save a couple of
nickels on every component, I’m sure many of
you would start taking notes.
Does the figure $665 million get your
attention? A recent story in Automotive News
said one supplier bankruptcy would cost its cus-
tomers at least $665 million, including loans
that will never be repaid, parts price increases,
operating subsidies, and professional fees.
It’s been said that experience is the best
teacher, but this is a tuition cost you really don’t
want to pay. In order to head off future distress,
many OEMs (Original Equipment Manufactur-
ers) and Tier Ones (the first or primary supplier
in the chain) are carefully analyzing the opera-
tions of their suppliers. This is a sound approach.
What about the financials? In many cases,
the same proactive approach and depth of under-
standing regarding the financial viability of
these suppliers seems to be overlooked, and as
we’ve seen the results can be costly. The most
effective approach is a comprehensive proactive
process that carefully monitors both the opera-
tional and financial health of your supply base. 
Let’s face it: the reality is that a supplier
can be producing and delivering a lot of prod-
uct, even a high-quality product, but if the sup-
plier is losing money on the product, it’s going
to run into trouble. Or that supplier could be
profitable on your business, but if it is having
problems with its other customers unbeknownst
to you, the result can still be financial distress.
It’s not news to any of you that a growing
number of automotive suppliers have headed to
bankruptcy court in recent years. In fact, since
2000, a total of 64 suppliers have filed for bank-
ruptcy protection in the United States.
To understand the financial situation of the
supplier base, let’s take a look at some data on
the trends for publicly traded U.S. suppliers.
You can see in the figure on page 18 that, over
a 10-year period, the gross margin trend line is
down—from 24.7 percent in 1997 to 17.7 per-
cent in 2006. Notably, the most severe declines
have been in the two most recent years.
Another way to look at the picture is to
examine total debt for the same suppliers over
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S ASSESSING FINANCIAL S
A recent story in Automotive
News said that one supplier
bankruptcy would cost its
customers at least $665 million.
by William G. Diehlthe 10-year period. On average, total debt has
grown from $246.8 million in 1997 to $430.5
million in 2006—an increase of nearly 75 per-
cent. The data show that the biggest acceleration
in total debt occurred between 2005 and 2006.
We get a better view of the supply base
from analysis resulting from our own propri-
etary product, BBK Ratings, a model we use for
many of our clients. The model looks at both
public and private company financial data,
determines overall financial strength, and
assigns a grade from A to F depending on the
potential for distress over the next 12 months.
Based on our BBK Ratings analysis of a
number of large, global suppliers, we estimate
that 22 percent of the supply base could be
financially distressed, which is relatively con-
sistent with other surveys. We define a company
as distressed if it has a grade of C, D, or F.
So the auto supplier industry data in total
indicates that gross margins have declined, total
debt has gone up, and a significant number of
companies face the prospect of financial dis-
tress. Although excess capacity in many seg-
ments has been a significant contributor, it is
not the only factor.
These studies were based on looking at
publicly traded companies, but obviously that’s
only half the picture. What about private com-
panies? In a separate study, BBK focused on
privately held companies. A look at the data
shows that 46 percent of these companies were
17
continued on page 18
STABILITY OF SUPPLIERS
Based on our BBK
Ratings analysis of
a number of large,
global suppliers, we
estimate that 22
percent of the
supply base could
be financially
distressed.
R
y
d
e
rrated as having some degree of potential dis-
tress with a C, D, or F grade. That is more than
double the percentage for publicly traded sup-
pliers.  By the way, more than two-thirds of sup-
ply base companies are privately held! 
That is how the financial health of the sup-
plier industry looks from 30,000 feet. But if
you’re an OEM or a Tier One, what does all this
information mean in terms of managing your
supply base? It means it is critical that you pay
close attention and actively monitor both the
various operational performance warning sig-
nals and the financial performance of your sup-
ply base. Why? Because the cost of not taking a
comprehensive approach will be a significant
and costly disruption of your supply chain.
So how do you implement a comprehen-
sive proactive process, especially on the more
elusive financial side? It starts with gathering
financial data. We all agree it’s relatively easy
to track public companies, because the data is
widely available. But it’s more difficult to track
suppliers who are privately held and have tradi-
tionally not been required to provide financial
information. However, that’s starting to change,
and a number of our clients are beginning to
request this data from all of their suppliers.
To monitor these private companies, the
three factors to consider are access to data, con-
fidentiality, and cost.
In terms of access and confidentiality, you
need to develop a system to gather accurate
information while at the same time maintaining
confidentiality if you are going to obtain the
suppliers’ trust and support. 
On the cost side, you want (1) a well
thought-out process to assess the critical areas
of your supply base and (2) an inexpensive
method that provides an accurate appraisal and
first filter of the company’s financial condition
without going to the expense of a full due dili-
gence. You can just choose one of the various
services such as BBK Ratings that provide this
type of information. As a first filter, it is a start-
ing point but does not by itself guarantee that
you can navigate around potential problems.
Data is good only if you put it to work.
How do you benefit from this type of mon-
itoring? The real advantage is the trend analysis
and the fact that you can see trouble developing
in advance and therefore work positively with
your supply base to ward off distress.
You will never eliminate all risk, but your
goal should be to significantly minimize sur-
prises. A monitoring process also allows you to
determine what next steps are needed to ensure
continuity of production by digging deeper if
needed.
Again, the critical fact is that you (1)
develop a comprehensive process as to how you
use the data, (2) gather the data, and then (3)
stay true to the process.A proactive process will
cost you money, but it will be a less expensive
alternative in the long run.
Why is this financial monitoring so criti-
cal? As we saw with our look at supply-base
financial data, a staggering number of suppliers
face potential financial distress. In addition,
there are at least three other key reasons. 
The first is that time is your ally if you use
it wisely and understand the problem. For
example, in one case a supplier was in a finan-
cially precarious position—in fact, it received a
BBK rating of F. In school an F is not a good
thing and results in remedial work or expulsion.
The same applies to your supply base.
The customer asked us to get involved to
see if something could be done. It turned out
that the problem was based on too much short-
term revolving debt, which was used to support
working capital. The structure of this debt put
the company into a high-risk situation. After
working to better understand the loan struc-
tures, with the customer’s support, the company
was able to go back to its lenders and obtain
more flexible terms and conditions.
The net result is that the supplier was able
to go from a high-risk position to a financial
standing receiving a solid A rating. This
improved financial position increased the
potential for the company to expand its rela-
tionship with its customer.
Publicly Traded U.S. Suppliers’ Gross Margin
30%
25%
20%
15%
10%
5%
0%
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
18
continued from page 17 It is critical that you
pay close attention
and actively
monitor both the
various operational
performance
warning signals
and the financial
performance of
your supply base. 
Over a 10-year period, the gross margin trend line is down—from 24.7 percent
in 1997 to 17.7 percent in 2006. The most severe declines have been in the two
most recent years. Additionally, total debt grew from $246.8 million in 1997 to
$430.5 million in 2006—nearly 75 percent. The biggest acceleration in total debt
occurred between 2005 and 2006.
S
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I
QThis is an example of a customer being
proactive in a positive way to work together
with its supply base to ensure stability. All par-
ties benefit.
Another lesson to take from this example is
the need to understand your supplier’s position
at any time. That way, if things start to trend
negatively, there is ample time to address the
situation—and the options are less costly com-
pared to trying to help at the last minute.
The second key reason financial monitor-
ing is critical involves the limitations of just
conducting an operations review. Most often,
problems begin on the manufacturing floor and
then migrate to the balance sheet, but a review
of operations alone won’t provide all the infor-
mation you may need.
When you conduct an operations review,
your supplier will show you only information
related to your own parts, due to confidentiality
concerns. This is why all the operational met-
rics you look at may come back positive but still
not tell the whole story. It may be that the sup-
plier is keeping up with your schedules and
delivering quality components to you on time,
and therefore you have a false sense of comfort
that there are not any apparent issues. But oper-
ations may not be going so smoothly with the
supplier’s other customers, and those problems
can eventually create financial concerns that
will affect your supply chain.
The good news is that consolidation of the
supply base should improve profitability via
improved utilization. The bad news is that the
survivors of this shakeout are larger and doing
business with more customers, making it even
more likely that your supplier will be affected
by its business dealings with another customer.
The third key reason you should get proac-
tively involved in tracking your suppliers’
financial condition is that many suppliers are
slow to recognize they may be heading for dis-
tress. The entrepreneurial mindset is a major
reason for this blind spot. A lot of suppliers,
especially the small and mid-sized ones, are run
by the entrepreneurs who started them. Their
ability to overcome obstacles has been para-
mount to their success. But like anyone else,
entrepreneurs can become susceptible to denial.
They don’t want to admit even to themselves
they have a problem that maybe they can’t fix.
We work with a number of private equity
firms that understand the importance of manag-
ing businesses in this difficult sector. However,
many of the new private equity and hedge funds
in the market don’t understand the nuances of
the automotive industry and get into trouble.
Unfortunately, by the time they acknowledge a
problem, it may be so late in the game that the
options are slim, the costs are expensive, and
the risk is very high for supplier and customer
alike. On the other hand, a customer who can
see the negative financial trends in advance can
provide a needed reality check and help a sup-
plier solve the problem while there are still
more favorable options.
So with a comprehensive operational and
financial proactive approach, OEMs and Tier
Ones can work more cooperatively with their
suppliers to keep the supply chain strong. This
requires trust and a close working relationship
between customer and supplier. The need for
closer ties is widely acknowledged today as the
industry responds to increasing pressure to pro-
vide consumers ever more features at less cost
while meeting stringent government mandates
for safety and emissions.
Although some are quick to blame the
OEMs and Tier Ones for their problems, the
reality is that suppliers also have a large respon-
sibility to do their part in minimizing cost. In
this drive for partnership, some of the players
are further along the curve than others. There is
no single cookie-cutter way to structure these
partnerships; every company has a different cul-
ture and corporate governance. But one factor is
certain: it is critical that suppliers be financially
viable in order to contribute to this partnership.
So to sum up my message today: 
  A staggering number of suppliers, both
public and private, are facing financial dis-
tress, and continued market consolidation
will not solve the problem.
  An operational review alone does not nec-
essarily reveal all. Product may be of high
quality and arriving on time, but the prob-
lem could be other customers or company
management.
  Knowing the complete picture of your sup-
pliers at all times gives you the ability to
take action sooner and make more favor-
able decisions. It’s good for both parties.
That’s why you need to initiate a strong
comprehensive proactive approach that
includes an operational and financial
review of your supply base.
The automotive industry is known for
implementing best practices, so OEMs and Tier
Ones must move to employ a comprehensive
financial and operational review of their supply
chain. It’s a strategy that will help suppliers
build—and sustain—the kind of partnerships
needed to be globally competitive.
Don’t be at the wrong end of the learning
curve. It could be very costly.  
William G. Diehl is president and CEO of inter-
national business advisory firm BBK.
19
A staggering
number of
suppliers, both
public and private,
are facing financial
distress, and
continued market
consolidation will
not solve the
problem.

Assessing Financial Stability of Suppliers: Avoiding Potential Distress

http://www.mtsu.edu/~berc/tnbiz/auto/bbk.pdf

Assessing Financial Stability of Suppliers: Avoiding Potential Distress

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