Companies are extending longer payment terms to customers. At the same time, they are assuming greater inventory costs to cope with weaker suppliers. In the process, their working capital is becoming strained.
Consider it the curse of recovering from a prolonged global recession. To ramp up their businesses, many companies have started to sell more to less creditworthy customers than they did before the global financial crisis. At the same time, their existing customers’ financial strength has declined.
The trouble with this is that a cash-strapped customer can often have an even larger impact on a company’s results than a weakened supplier. After a supplier went bankrupt, one global manufacturing company quickly began to examine the financial strength of its entire supplier network only to discover that the company’s ability to forecast customer demand accurately was equally important to optimizing its supply chain.
As customer credit weakens, the volatility in supply chains will rise in part because some customers will try to change the pricing in their contracts. For example, Chinese steel mills have been trying to pay foreign mining giants for iron ore on a more frequent basis ever since they reneged on quarterly contracts when spot ore prices tumbled in 2008.
So-called customer “soft defaults” will also become more common. Already, many customers are delaying their payments, instead of declaring a default or ending a contract. In the meantime, these customers are asking companies to extend them credit to pay for their products until they finally go bankrupt – and leave the company holding the bag.