Daily Archives: December 1, 2010

Should Companies Really Be Building Their Own Credit Scoring Capabilities?

As per a recent article in Market Watch, a new report issued by Oliver Wyman, in collaboration with the Association for Financial Professionals, suggests that companies must develop their own credit scoring capabilities to prevent supplier defaults from jeopardizing their supply chains. In The New Weakest Link in Your Supply Chain: Supplier Credit, they say that companies can no longer rely solely on credit ratings from credit rating agencies to evaluate their suppliers’ financial vulnerabilities.

While I agree that credit scores are not enough, because it can be a few months before a credit score reflects a supplier with failing financial health as it will typically take a few months of missed payments before the credit score accurately reflects the supplier’s financial health, I don’t think that developing sophisticated scoring is the answer. First of all, your average company is not going to have the expertise to even begin such an exercise. Secondly, the whole point is to detect when a supplier might be in financial distress, not score them.

Would not careful monitoring of shipments, payments, and quality be enough? Most suppliers who are in distress are going to either be late with payments, late with shipments, or cutting corners in production, leading to a drastic decline in quality. If you can catch this behaviour early, then you can tell when a supplier might be distressed and start to make back-up plans, all without sophisticated credit scoring. And that’s what’s important. Not how much complexity you can throw at the problem.

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Manage Uncertainty Like an Engineer

Like microchip fabrication and other complex engineering tasks, the supply chain is full of uncertainty. The best way to handle uncertainty is to deal with it up front, instead of trying to sweep it under the rug in the misguided hope that if the corners of the rug are stapled down, it won’t escape and manifest as a supply chain disruption. So how do you attack uncertainty head on? You approach it like an engineer.

A recent blog post on the HBR blogs on how engineers manage uncertainty had some great advice on how to handle uncertainty like an engineer.

  • Acknowledge the Uncertainty
    Ignoring it never works. Do your best to quantify the worst-case scenario, to mitigate as much of the uncertainty as you can, and to deal with the repercussions should it come to pass. For example, if you’re shipping a lot of product from China and the cargo ship sinks, and the holiday season is fast approaching (and it’s when you do 70% of your sales), if you have a dual sourcing strategy in place, you would quickly ramp up (overtime) production in the manufacturing facility where product can be manufactured and shipped to your warehouses in less time than it takes to ship them from China.
  • Have a Plan
    Working through a plan to deal with potential uncertainties helps to not only deal with repercussions when something happens, but to minimize the chances that something unexpected will happen in the first place. For example, if you realistically expect that 3% of products shipped to you will be faulty, you will order 103.1% of expected demand.
  • Break Down the Process
    This lets you analyze each step carefully and understand not only where the risks can arise, but how to mitigate the risks and prevent them from occurring in the first place. If the risk is transportation, because there is a high risk of a truck being hijacked for valuable components, you’d add security and possibly split the shipment in half to increase the odds that at least some product makes it to you quickly.
  • Teamwork
    If all team members on a cross-disciplinary team work together, not only is there a greater chance of identifying all uncertainty, but there is a greater chance of coming up with production plans that minimize uncertainty due to more creative power being available. For example, let’s say the product is fragile and the uncertainty lies in how many units will survive multiple shipments from factory to warehouse, warehouse to store, and store to consumer. More mind power increases the chance that a sturdier design will be found or that better packaging will be identified.

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