Supplier Beware: What to Do When Your Customer's in Trouble
By Tim Weed & David Priestley
Universal Advisor, 2005 Issue No. 3

“Auto Supplier Files for Bankruptcy”
Despite the frequency of this headline, it still has the power to send shudders through the spine of many a business person, leading to questions like, “Could this happen to one of my customers?” “How can I monitor the health of my key customers?” And, “What can I do to minimize the impact of a bankruptcy filing on my business?”

Daimler-Chrysler, Ford, and General Motors continue to struggle with market share erosion, rising legacy costs, and operating losses. Reduced volumes, rising commodity prices, and unrelenting price concessions have already contributed to the bankruptcy filings of several large Tier 1 suppliers, most recently Delphi, and more are expected in the future. If your company resides in the domestic supply chain, it’s crucial to be aware of the classic signs of trouble and what you can do to avoid or minimize these problems.

The Warning Signs
Most companies that file for bankruptcy provide numerous signals to outsiders beforehand. Through publicly available information and day-to-day interaction, a distressed company provides data that should raise concerns for its vendors.

Public companies and many large Tier 1 suppliers with public debt publish audited financial statements that are available to the public either through their company website or through the Securities and Exchange EDGAR website (www.sec.gov/edgar). When reviewing these documents, don’t just look at the bottom line, but assess the trends and ratios of the following items:

• What are the overall sales and operating profit trends?
• Is the company highly leveraged compared to others in the industry?
• How much cash and available credit can the company access?
• Are insiders buying or selling their stock positions?
• Are there any contingencies or other unusual items that run the risk of becoming exponentially large?

Private companies are a bit more challenging; they don’t generally share their financial statements, and credit agency information is often insufficient to draw conclusions. The most direct information a supplier can accumulate is from its own financial records on the overall sales trends and on the aging of accounts receivable.

Frequently, the best source of data comes from your employees. Salespeople know who’s been visiting the customer and whether a key officer has suddenly resigned with no explanation. Delivery drivers observe the plant activity levels and can potentially discover extraordinary costs associated with expedited freight or containment. Engineers discover problems with new product launches or with warranty issues when resolving customer complaints. Finally, accounts receivable hear that customers are being stretched due to cash shortages.

How Can You Protect Yourself?
If one of your customers is starting to weaken or appears to be headed for bankruptcy, what does it mean for you as the supplier, and what can you do to protect yourself in the short and long term?

When all signs appear to suggest a bankruptcy filing is imminent, a supplier should immediately consider implementing one or more of the following actions:

• Require all future payments be done on a cash on delivery or cash in advance basis
• Contact your customers’ customer (e.g., the OEM), and get a payment guarantee through a comfort letter
• Have your attorney review contracts and purchase orders to determine what other options you have, including the implications of holding production parts and tools hostage

If one of your key customers files bankruptcy, you should immediately contact an experienced bankruptcy attorney to determine your rights and obligations. There are certain issues that need to be investigated and acted upon immediately to obtain the most advantageous outcome for your company.

If your customer is weakening, but a bankruptcy filing appears to be one to three years away, a supplier has additional options to consider:

• Make sure your costing system accurately calculates the profitability of each product and customer. If certain customers or products are significantly below average profitability, establish a plan to improve your processes to achieve average profitability, or consider asking the customer to take back the parts.
• Evaluate the long-term viability of current customers who have below average profitability levels. Have these customers undertaken the necessary changes to help achieve average profitability? Can they close any critical gaps with competitors?
• Carefully consider the risks associated with any significant capital expenditures for under-performing customers. How easy can you unwind any commitments? How much of these customers’ commitments do you have in writing if litigation becomes a necessity in the future?
• Set credit limits, and strictly monitor payment terms or any deterioration.
• Have a well-thought-out negotiation strategy before dealing with annual productivity improvement commitments.
• Select future customers and product families where your company’s product provides a differentiated value and the customer’s prospects are strongest.
• Focus sales and marketing efforts on the strongest customers in the marketplace. The time frame for getting new business from new customers is measured in years.
• Manage customer concentration to avoid heavy reliance on any one customer.
• Avoid new business that’s low value-add.
• Evaluate the risks of a program going offshore.

Supplier Beware
The restructuring of the domestic supply chain is underway and won’t be letting up anytime soon. Even if you’re one of the top-performing companies, it could severely affect your business if one of your customers were to file bankruptcy. Too many instances of failing customers could lead your company to a similar fate. It’s crucial to know the signs of distress, watch for them, and act accordingly.

Implications of the New Bankruptcy Law
The new bankruptcy law went into effect on October 17, 2005. Here are a few of the major provisions likely to have an impact on future bankruptcies. The law:

• Limits the amount of time to operate in bankruptcy and have the exclusive right to file a plan of reorganization
• Requires leases to be accepted or rejected within 210 days of the filing
• Grants administrative expense priority to all creditors for goods delivered within
• 20 days of the petition date
• Expands reclamation claims to shipments in the 45 days before the petition date
• Provides strict limitations on the payments of retention bonuses and/or severance packages to key employees
• Provides for new limitations on the pursuit of preference claims
• Authorizes the U.S. trustee to adjust the number of members and the makeup of the official committee of unsecured creditors to account for small business representation
• Requires creditor committees to provide information received from the debtor to other creditors represented by the committee