360° Vendor Management

Managing an Outsourcing Vendor’s Financial Instability

One of the principle concerns of any vendor manager is monitoring your outsourcing vendor’s financial instability.  Witness the recent failure of Axium, Hollywood’s payroll vendor and owner of Ensemble Chimes Global, previously one of the leading managed services providers of contract labor.  When Axium filed Chapter 7 bankruptcy, Hollywood clients and a wide variety of their vendor management system clients (which included Fortune #3 General Motors, Fortune #7 Ford, Fortune #21 UnitedHealth, unranked Toyota, and other companies such as Morgan Stanley, Kaiser Permanente, AT&T, and BellSouth) were left with significant vendor management problems that crippled their IT and operations teams.  In some cases, such as several Hollywood production teams, writers, and, believe it or not, swimsuit models, received paychecks that bounced.  It is a classic story of a vendor meltdown that impacts customers.

It wouldn’t be concerning if there wasn’t so much consolidation in the outsourcing industry.  It also wouldn’t be bad if  so many of the vendors weren’t private and therefore not subject to external audit and public disclosure scrutiny.  Finally, it wouldn’t be so critical if companies weren’t outsourcing key business processes - processes and technology support teams that take months or years to climb learning curves and stabilize.

However, the industry is consolidating, the vendors are private (or based in countries with accounting rules that are not as strict as US or European standards), and clients are outsourcing major business processes.  Imagine if you lost your entire application development or call center team overnight?  Scary, right?

The pundits of the total meltdown concept will point to business continuity planning or multi-vendor sourcing strategies.  No doubt, both of these items will ease the pain.  If you haven’t built a business continuity planning or considered a multi-vendor strategy, do it.  Now.

However, the ramp-up curve following a vendor meltdown takes time and customers will feel the impact.  Here are a few items that vendor managers should focus on:

• Create Communication Channels - Simply monitoring a company’s financial statements (assuming they are made public) is insufficient.  There are points of failure that are not disclosed publicly, such as organizational changes, changes in banking relationships, and investor changes (acquisitions, new partners/major shareholders, and divestitures).  Good vendor managers create informal communication channels with their vendors to obtain insight into potential future changes.  Furthermore, financial performance should be part of quarterly reviews (our suggestions for quarterly review are found here).  Remember: just because a company is private does not mean it cannot share financial results with you.  Require audited financial reports be provided on a quarterly basis, as well as disclosure of any material change to the ownership or financial standings of the company.
• Predicting Failure and Advance Notice - With few exceptions, financial failure is not sudden.  While SEC or other government regulatory groups’ rules may prohibit sharing information in advance of public earnings announcements or other irregular communications, financial failure can be predicted.  Use the Z-Score methodology.  Stephen Guth discusses the use and formula here.  Here is Wikipedia’s page.  Every quarter, the VMO should plot the Z-Score of its suppliers and track it, potentially using a rolling three quarter average to predict the next month’s performance.  Staying ahead of failure by predicting is critical to the success of your company and customers.
• Define Failure - One of the most common discussions in contract negotiations is termination for the vendor’s financial insolvency.  This discussion must end with a clear quantitative definition of insolvency.  This could be based on a financial ratio, revenues, sequential quarterly financial trends, liquidity, line of credit usage, or other triggers.  The worst triggers are Chapter 11 or 7 (especially 7) filings.  The reason is that once the company goes into bankruptcy procedures, your ability to obtain concessions for moving work to another vendor is limited.  Of course, just because a company triggers the clause, it doesn’t mean you need to terminate.  However, the financial health of your vendors results in sound operational results and reduced risk is easier to live with.  Sticking with financial failures out of loyalty to them creates unnecessary risk.  You have to fervently believe the company will turn the corner in a reasonable period of time.

Once failure has occurred or has been predicted, vendor managers must act quickly.

• Decide Internally Your Next Steps - Meet with internal customers, executives, and stakeholders.  Present the information, discuss the risks, and decide on next steps.  Do not let internal politics interfere with taking action.
• Failure Doesn’t Require Separation - All companies have bad quarters, years, or cycles.  Misery begets misery, as they say.  However, remember that termination is your last option. Vendors can turn the corner.  They can be purchased by their competitors or other investors.  With that said, during times of financial difficulty, expect the vendor to reduce administrative costs, cut investments, and not work as hard to retain staff.  The results could be delayed implementations, lower service levels due to lower morale and turnover, and possible technology glitches.  While service level credits will reduce the costs of poorly performing vendors’ services, they don’t fully offset the impact to your company or your customers.
• Meet with the Vendor (Frequently) - Meet with the vendor immediately and discuss the situation.  Seek additional information and ask the vendor’s CEO and CFO to participate in the meeting.  Understand what the vendor’s perspective is and ask them for their “Get Healthy” plan.  Review the plan.  Ask questions.  Draw your own conclusions and take next steps.  Remember, the actions you take, particularly if you’re a large client of the vendor, could complicate the vendor’s ability to manage operations, financial relationships, and people.  Coordinate efforts, but be deliberate.
• Plan B - In most large environments, a multi-vendor strategy provides clear alternatives to the financially struggling vendor.  Even in smaller environments, it pays to have a secondary vendor standing in the wings.  This is when parallel negotiations that end with a single winner help - because the loser has an almost fully negotiated contract that can be rapidly finalized.
• Termination - Have your bases covered.  Read our article on terminating an outsourcing relationship here.

Have you walked down lovers’ lane to discover financial instability rocking the foundation of your relationship?  How did you handle it?  Leave a comment and share your thoughts with others.

This entry was posted on Tuesday, March 18th, 2008 at 6:01 pm and is filed under Outsourcing Vendor Management, Vendor Management. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.