Key Takeaways
While cost savings are still king for procurement departments, seeking cost savings at the expense of everything else can have wide-reaching consequences that include credit risk.
S&P Global downgraded the credit ratings of 200 companies between 2020 and 2022 for supply chain issues.
As supply chain risk increases, procurement departments should seek to maximize visibility into their supply chains and take the necessary steps to minimize disruptions, therefore protecting the company's credit rating.
Supply chain risk is not just a concern for supply chain management professionals: it can also result in financial problems for companies. S&P Global reported in 2023 that it had downgraded the credit ratings of 200 companies from early 2020 to late 2022 which had run into supply chain issues.
While supply chain management professionals value cost savings, sometimes seeking cost savings can make a company’s supply chain more vulnerable. For example, many companies have adopted just-in-time inventory practices that involve the company keeping inventory levels to a minimum. This may bring about short-term savings for your company in the form of lower storage costs but a lower inventory level makes the company’s supply chain more vulnerable to disruptions. A vulnerable supply chain, in turn, increases the likelihood that a supply chain disruption will hurt your company’s credit rating, thus raising borrowing costs and wiping out these cost savings.
Credit ratings explained
S&P Global is one of the “big three” credit rating agencies along with Fitch and Moody’s. S&P Global’s rating system has roughly 20 different levels, with AAA being the highest (with the lowest probability of missed payments) and D being the lowest (with the highest probability of missed payments). All ratings from AA to CCC can have a plus or a minus added to signify lower or higher risk. Lenders consider these ratings when deciding whether to loan money to a company and what rate to charge. A company with an AA+ credit rating would enjoy a lower interest rate than a company with an AA credit rating, which is one level below AA+. A rating of BB+ or lower is considered “speculative” or “junk” debt, and the borrower will have to pay higher interest rates. Lower interest rates translate into lower financing costs, giving companies with higher credit ratings a competitive advantage. You can find S&P Global's credit ratings in order below:
- AAA, AA+, AA, AA-, A+, A, A-
- BBB+, BBB, BBB-, BB+, BB, BB-, B+, B, B-
- CCC+, CCC, CCC-, CC, C, D
How does supply chain risk impact credit risk?
Companies that face supply chain issues may find themselves unable to secure critical inputs, which could force them to scale down or even cease operations until the input becomes available again. This was the case for Nissan, which had its credit rating cut to BB+ from BBB- by S&P in March 2023 over concerns that supply chain issues would impact its sales.
Alternately, in some cases the company may still be able to secure an input but it will be paying higher prices for the product. This was the case for Weber, a manufacturer of outdoor grills, which had its credit rating cut to B+ by S&P in February 2022 due to supply chain disruptions which increased input costs and shipping costs.
Who is at risk?
Of the 200 companies that had their credit ratings downgraded, 30% were consumer goods manufacturers, 15% were manufacturers of capital goods and machinery and 10% were restaurants or retailers. Technology companies and manufacturers of cars and trucks were tied for fourth place, with each industry accounting for 9% of these downgrades.
Furthermore, a 2020 study found that higher fixed costs, higher debt levels, and higher levels of competition can make a company’s credit rating more vulnerable to supply chain disruptions.
Is supply chain risk increasing?
Supply chain risk appears to be getting worse over time as the risk of natural disasters, cyberattacks and geopolitical turmoil increases. McKinsey found that the average company can expect to experience a supply chain disruption lasting one month or longer every 3.7 years. As a result, the risk that your company’s credit rating will be hurt by a supply chain disruption is rising, which strengthens the case for supply chain resilience.
How can supply chain disruptions impact a company's finances?
Furthermore, the impact of a supply chain disruption can be high. In the same study, McKinsey estimated that over a decade, the average company can expect financial losses equivalent to 42% of one year’s earnings before interest, taxes, depreciation, and amortization (EBITDA) stemming from severe supply chain disruptions. Supply chain management professionals may want to weigh these potential losses against the cost savings from keeping minimum levels of inventory.
We can get a rough estimate of the financial impact of Nissan’s March 2023 credit rating downgrade. S&P Global wrote in 2019 that the yield on corporate debt with a rating of BBB- (like Nissan before March 2023) was 2.84 percentage points above that of a Treasury bond while the yield on corporate debt with a BB+ rating (like Nissan after March 2023) was 3.60 percentage points above a Treasury bond. Assuming these pre-COVID figures hold, this credit downgrade could raise Nissan’s interest rates by 0.76 percentage points. For a billion dollars in debt, this would translate to roughly $38 million in additional interest payments over five years. Furthermore, this only covers the credit costs. Supply chain disruptions that lead to credit rating downgrades can also shave billions of dollars off of a company’s market capitalization.
Actionable Insights
Fortunately, companies can secure their creditworthiness against the impact of supply chain disruptions. While companies with high debt levels, high fixed costs, and high levels of competition are more vulnerable, some industries are characterized by these so reducing debt, fixed costs, and competition may not be feasible. Furthermore, some companies may be able to reduce risks by holding more inventory, but this strategy may not work for every company because some inputs are subject to spoilage (such as nitrile gloves and N95 masks) or obsolescence (such as GPUs).
Supply Chain Mapping: Companies can get a more complete view of their supply chain by mapping their supply chain. A 2022 survey of 468 supply chain management professionals by Deloitte and the Chartered Institute of Procurement & Supply found that only 13% of the people surveyed had complete visibility over their supply chains while 71% had little to no visibility beyond second-tier suppliers. Mapping the complete supply chain, including second-, third- and fourth-tier suppliers, may help supply chain management professionals uncover hidden risks.
Dual/Contingent Sourcing: Dual sourcing involves using two suppliers for a certain good during ordinary circumstances while contingent sourcing involves identifying a backup supplier for emergency situations. Both strategies may help supply chain management professionals reduce supply chain risk, although there are some limits; if both suppliers are concentrated in the same region, dual/contingent sourcing may not provide much relief in the event of a natural disaster.
Regionalizing Supply Chains: Some companies are regionalizing their supply chains, which involves sourcing goods from the same region where they are consumed to reduce risks. For example, companies may still manufacture goods in China but sell these goods in China rather than in the United States or Germany. For products sold in the United States, companies may seek suppliers based in Mexico; for products sold in Germany, companies may seek suppliers based in Poland. Regionalized supply chains are shorter and less complex than global ones, which reduces the risk that they will be disrupted by wars, natural disasters, or issues with maritime chokepoints such as the Suez Canal or Panama Canal.
Follow ProcurementIQ on LinkedIn to get notified of the latest procurement news and market developments from our experts to yours.
