Credit risk analysis: why you should evaluate your suppliers first

Raise your hand if, before this year, you’d never heard of a semiconductor or what it may have to do with your car or your smartphone. 

You’d be forgiven for failing to foresee back then how the semiconductor shortage would impact global trade for a lot of large corporations. But now companies need to draw lessons from the situation and apply them to their credit risk analysis.

Semiconductors are essentially computer chips that work as the hub—or “brain”—of an electronic device. They became prized commodities due to our changed consumption patterns during the pandemic. While factories shut down, confined people the world over pumped up orders of TVs, video games and computers. Combined, these phenomena caused a global semiconductor shortage. This drove prices up across the value chain, but also halted the manufacturing of products such as smartphones, tablets and vehicles. The shortage of these tiny chips created a cascade effect, with companies like General Motors, Samsung and Sony unable to hit their sales targets or keep up with the surge in demand.

What does all this mean for my clients? Traditionally, companies coming to me are concerned with their customers’ risk grade, based on a thorough analysis of their financial situation, sales prospects and macroeconomic factors (such as geopolitics). They look to their  trade credit insurer  to answer the question, “Is it likely that this buyer will be able to pay their debts to us?” Following the pandemic’s shock to supply chains, companies are now starting to realize the importance of looking at the supply side, too, to ensure that they can keep their own production and sales up. 

Even prior to the pandemic, insufficient supplier diversification was considered the fourth top reason for business insolvency. Say you buy 30% of your product from one supplier: if they have a problem, so will you. The problem could be due to import/export issues, raw materials or consumption patterns, and have sudden and devastating effects on your business, as their customer. 

The issue intensified during the pandemic. For example, a lot of US companies that relied heavily on importing raw materials or components from abroad saw their production halted. Relying too heavily on imported goods also puts your company at greater risk in the event of political instability, as tariffs imposed on imports from a particular country can suddenly inflate your costs.

You need to know your customer, but it’s equally important to consider how you source your products. When looking upstream, ask yourself a few key questions about other companies in your value chain: 

• How stable are they? 

• What context are they operating in, and how have they performed financially over time? 

And when it comes to supplier diversification, it’s essential to think both in terms of your individual suppliers and geography. Are all your suppliers concentrated in the same part of the world? Do you primarily rely on a small handful of suppliers? If all your suppliers are from abroad, can you add some domestic suppliers to the mix? 

From a product perspective, companies now want to make sure they make good decisions by obtaining a credit rating not just for their customers, but also for their suppliers. And key to this is using comprehensive data. 

It’s essential to seek partners that understand the importance of assessing suppliers comprehensively, delivering more than the classic credit risk analysis. At Euler Hermes, we leverage our experience and expertise in trade credit insurance to investigate companies’ past and present, looking at both micro- and macroeconomic factors to understand where these businesses are headed. This is next-level risk mitigation for our clients.