Supplier Concentration: Where the Credit Risk Sits

A lender is used to asking who pays the borrower. It asks less often who the borrower depends on, and the answer can matter as much. A dealer holding one manufacturer's franchise, a processor with one source of a raw material, a software reseller whose product is licensed from one owner: each has revenue that exists because another business keeps supplying it. If that business stops, the revenue stops with it, however loyal the customers are.

Dependence alone is not the risk. Plenty of businesses buy most of their inputs from one supplier because it is the best, and could switch in a month if they had to. The risk is dependence that cannot be undone quickly: an exclusive range customers ask for by name, an input with long qualification times, a licence with no substitute. That is the case where the supplier's choices, not the borrower's, decide what the business earns next year.

The first number is share: purchases from the largest supplier as a share of total purchases, and the revenue and gross margin that depend on those purchases. The second is time: how long the borrower could keep trading if supply stopped, which depends on stock on hand, the notice the agreement gives and how long a replacement would take to arrange. The third is terms, because a supplier does not have to leave to hurt the business. It can shorten the credit it gives, which turns into a working capital need overnight.

The fourth is title. Suppliers commonly sell on retention of title terms, keeping ownership until they are paid. In New Zealand and Australia such a term is a security interest under personal property securities law, and a supplier that registers it on the PPSR in time can rank ahead of the bank's general security over the goods it supplied. In the UK a simple retention of title clause is not a registrable charge, so the register will not show it; the lender learns of it from the supply terms.

A forklift dealer, constructed for this page like every figure in it, is the regional distributor for one overseas manufacturer. Of its US$32m of revenue, 74% is that brand's trucks and parts, 16% is workshop labour on any make and 10% other ranges. The distribution agreement renews each year and either side can end it on six months' notice. The dealer buys US$20m a year from the manufacturer on 90 days' credit, and its bank lends against stock at an advance rate of 50%, the example's rate rather than a market norm.

The manufacturer's retention of title, registered on the PPSR, covers its stock until it is paid, so more than two-thirds of the stock line was the supplier's security before it was the bank's. Then the terms:

If the manufacturer cuts its credit to 30 days, perhaps because its own credit insurer has trimmed the dealer's limit, the dealer needs US$3.29m within a quarter, three times what its stock line will now lend. And if the manufacturer gives notice, the dealer has six months to replace three-quarters of its revenue. The workshop revenue survives; the rest depends on whether another brand will appoint it.

The two are read together because both make one outside party decisive, but they fail differently. A lost customer, the risk behind customer concentration, takes revenue with it and leaves the business free to sell to someone else. A lost supplier can leave the business with its customers and nothing to sell them. The lender's remedies differ. Against a customer the bank watches the debtor ledger and the buyer's credit. Against a supplier it reads the supply agreement, the supplier's own health and the supplier's claim on stock.

The two can also meet. A business that sells most of its output to one buyer and sources most of its input from one seller has its margin set at both ends by others. That is the reading behind a take-or-pay contract seen from the other side, and behind many files in How Banks Read Retailers.

DEFINED IN ONE PARAGRAPH → · RETENTION OF TITLE → · THE BORROWING BASE CERTIFICATE →

It decides the security first. A lender that counts stock without checking whose it is lends against goods another creditor can take, so supplier-financed stock is commonly excluded from a borrowing base or advanced against only after the supplier is paid. It decides the facility next. A loan whose tenor runs well past the supply agreement's notice period is a loan that outlives its revenue, so the bank may ask for the agreement to be renewed on longer terms, for notice to be reported to it as soon as it is given, or for a working capital line with room for a change in terms.

Statute helps less than borrowers expect. In the UK, and in Australia for contracts made since July 2018, the law stops many suppliers from ending a supply contract merely because the customer has entered certain formal insolvency processes. Those protections do not oblige a supplier to renew an agreement that expires, and they do nothing for a borrower that is still trading when the notice arrives.