With consumer spending on the decline, companies are obviously worried about the solidity of their customer bases. But there are risks to be considered at the other end of the supply chain as well. A recent poll conducted by Ernst & Young LLP Transaction Advisory Services identifies supplier instability as another source of growing concern. The trend "is putting added strain on U.S. companies already battling the fallout of the economic downturn on many other fronts," the firm said. The poll finds that 67 percent of companies would be "adversely affected" if one of their top three suppliers failed. That might not sound like news to companies with outsourced operations, but Ernst & Young partner Mark Short said supplier risk "is an order of magnitude greater than it has been in decades. Companies are faced with deteriorating cash and credit conditions, and at the same time, an increasingly complex, integrated supply chain."

The stability of immediate suppliers isn't the only issue, Ernst & Young says. A deeper problem is the collective health of all suppliers within a multi-tier network. "A supply chain is only as secure as its weakest link," notes Short. "In a complex, integrated supply chain, the likelihood that a critical supplier will encounter financial duress grows exponentially." The current economic crisis threatens to magnify and speed up the failure of key suppliers, he adds, "leaving unprepared companies without recourse. Even companies with contingency plans in place find themselves unprepared to react as quickly as market forces demand."

According to Ernst & Young, companies should take steps to identify supplier-based risk, focusing on three essential steps. They should enhance due diligence and predictive modeling for "mission-critical" suppliers. They should set up a system for responding to troubled suppliers before things get out of hand. And they should boost their knowledge and resources related to the termination of supplier relationships, due to bankruptcies and other actions. Successful supply chain managers, Ernst & Young says, will stick to original payment terms (except in cases of distressed situations), become more proactive in communicating with suppliers from the standpoint of financial performance, and develop contingency plans to cope with the failure of critical suppliers.

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