Cited: Reuters
Do you think this downturn is rough? What about those small industrial product suppliers? According to some analysts, manufacturers are going to discover that the smaller suppliers cannot rebound with them because they are basically out of business. That means manufactures woes are going to get worse as the demand for industrial products begins to rebound. Analysts are calling the small suppliers “zombie” suppliers. Big manufacturers cut their output so fast that it strained thousands of small manufacturers or suppliers that supply the industry with critical parts.
That has left the supply chain with an unknown number of suppliers who are dead but do not know it — companies so undercapitalized and overleveraged they will never raise the money they need to get their idle plants running again.
“Their lenders are going to say, ‘Sorry, we’re not going to increase our exposure with you because we don’t know if you’re going to make it or not,” says Bill Diehl, the chief executive of BBK, an advisory firm that does supply chain risk analysis.
And that, of course, would be a horror show for the publicly traded manufacturers that rely on these suppliers. It could leave them scrambling to secure components once the recovery starts — and missing some of the rebound’s benefits.
“That’s the bigger risk,” says Craig Giffi, the head of Deloitte’s U.S. consumer and industrial products practice. “They could be left unable to capture the upturn.”
NEW PARADIGM
In the past, suppliers were often initially insulated from the effects of industrial cycles because their big customers were slow to cut production — because they believed the downturn would be brief or because slow internal processes made quicker cuts impossible. However, the industry’s move from mass production to a build-to-order paradigm, and the outsourcing of many parts once produced in-house to outside suppliers, have changed all that.
That is a big reason why U.S. industrial output tumbled at a record rate in this downturn. Sure, demand evaporated last fall after the collapse of Lehman Brothers essentially paralyzed the credit markets. But manufacturers also reacted differently than they had in the past, immediately shutting down production at their own plants — and, by extension, those of their just-in-time suppliers.
“It’s never happened this fast before,” said Alex Blanton, an analyst at Ingalls & Snyder who has covered manufacturing since the 1970s.
The sector, in other words, is in uncharted territory. So concerns are high. “When you take 50 to 75 percent out of your purchases overnight 
… you can inflict terrible, permanent damage on your supply base,” says Eli Lustgarten, an analyst at Longbow Research.
During a recent meeting with analysts, Gerard Vittecoq, Caterpillar Inc’s (CAT.N) production guru, acknowledged that the company was already seeing “a lot of disruption with suppliers going bankrupt or having difficulty” — and the Peoria, Illinois-based company is still largely cutting output.
DON’T ASK, DON’T TELL
The banking industry’s troubles are adding to the uncertainty. Diehl at BBK believes many lenders, overwhelmed by the woes of consumer borrowers, have resisted foreclosing on distressed commercial borrowers — provided they keep their heads down and do not come looking for help.
“Lenders don’t want to have to pay the property taxes and everything else associated with keeping that stuff up once they foreclose,” he says.
“So as long as the borrower isn’t trying to request additional funding, they’ve basically been sitting still, even with borrowers who are in default, hoping that the market would come back and some of them will be able to survive.”
Giffi at Deloitte agrees. He says that “bankruptcy statistics aren’t indicative yet of the weakness that we’re seeing in a broad base of suppliers.
“Until those companies have to produce something — and to secure raw materials, to make a part, to hire more workers — no one will know how weak their balance sheets and credit positions really are.”
CONCERNS OVERDONE?
To be sure, not everyone thinks the industry is on the verge of a “Night of the Living Dead”-like supplier nightmare. An analysis by the financial information company Sageworks of the quarterly balance sheets of more than 1,000 small manufacturers — the kind that often produce parts for larger companies — found surprising signs of health.
While the analysis found that average profit per employee had tumbled nearly 50 percent at small manufacturers over the past year, other financial metrics have improved. The average quick ratio, for instance, a rough-but-reliable indicator of a company’s ability to pay its bills, rose to 1.7-to-1 from 1.4-to-1 over the last year. Any ratio above 1-to-1 is considered healthy. And cash as a percentage of total assets has improved.
“The robustness of the supply chain won’t be the same,” says Lustgarten. “You’re going to lose some of the marginal players and manufacturers that aren’t thinking about that right now will probably be facing some difficulties in the upturn.”
Melinda Crump, a Sageworks representative, believes suppliers “may have a fighting chance” if the economists are right and the rebound turns out to be a slow. She says this would allow companies that are still producing at lower levels “to rebuild economies of scale instead of being part of an overwhelming wave hitting the banks for large sums.” However, no one will deny that some suppliers will not return. no matter what shape the recovery takes, those suppliers are gone forever.
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My Take: Nobody ever thinks of the little guy in business, especially big guys. Very few business owners actually consider what happens when they either go out of business or reduce their business activities. In reality it is just like a snowball going downhill in winter, the ball gets bigger as it gathers more snow. When a big company goes out of business, all the companies that it works with the downline are affected.
That also includes the employees, they lose their jobs and it affects their family. This in turn affects how much these people can buy. They will not be able to buy Halloween costumes for Halloween, which in turn will affect the manufacturers who produce sexy adult Halloween costumes because they will not be able to afford them. This means that the manufacturer of those costumes will make less money and could possibly go out of business, affecting their employees and their financial status.
This is nothing more than one of those vicious circles that life throws everybody. Some analysts actually call it the domino effect because it starts at the top and works its way down. Unfortunately, it does not stop at the bottom it just keeps right on going.
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