It’s not ghosts and ghouls that should concern you this Halloween — the dead are walking among us. Zombie companies are everywhere. They’re hiding in plain sight, feasting on cheap capital. But as interest rates rise, their survival becomes increasingly tenuous. If you have zombies in your supply chain, beware, it might only be a matter of time before you’re disrupted.
Indebted monsters can drag you down
While zombie companies are far removed from the ravenous hordes of decomposing human remains depicted in shows like The Walking Dead, it doesn’t make them any less scary. The term was first applied to finance by academics studying 1990s Japan, eerily known as ‘The Lost Decade.’ It describes heavily indebted companies that can basically afford the interest payments on their loans, but not much more. Even worse, these companies can’t spur growth, depend on banks for financing, and are just one event, market disruption, or poor quarter away from insolvency or a bailout.
Zombie companies have a contagion effect on the industries and economies they operate in. Take Japan, for instance, where zombie companies were cited as the cause behind the long-term stagnation of the economy. They impeded the growth of other companies in the market, contributed to low productivity and stagnated wage growth.
Beware — the infection is spreading
There are more zombie companies around the world than ever before. A recent study by the Bank of International Settlements (BIS) found that the presence of zombies has increased significantly since the 1980s in advanced economies. They believe that 12 percent of companies in 14 developed markets are zombies today. This is up from 2 percent in the 1980s.
So what’s given rise to the zombies over the past few decades? The answer is a cocktail of cheap money, dogmatic behaviour within companies, and lenders reluctant to clean up their balance sheets.
In theory, low borrowing costs should reduce the number of zombie companies. Lower rates should lower their interest expenses, giving them room to restructure the business and drive profitability. Instead, zombie companies have taken on more debt without adjusting their business strategy or practices.
The banks haven’t helped matters by providing these companies with ongoing funding since in a low-interest rate environment, there’s little incentive for them to realise bad debts and clean up the balance sheet.
Rules for surviving the zombies
With rates expected to increase over the next year, it’s imperative that businesses look deeper into the supply chain. It’s important to analyse the financial health of key suppliers on an ongoing basis and question anything that may be of concern.
If you find zombies are in your supply chain, beware. You might find they cannot fulfil order requests. You may see an increase in the cost of goods from that company as they pass costs through the supply chain. You may even have suppliers go bust, potentially causing significant supply chain disruption, especially if they’re a key supplier.
You’ll have to make a decision: do you keep working with them, or do you look for the products and services they supply elsewhere? If the former, you must put in place safeguards. This may require procurement to revise contracts and the terms they have with suppliers. Procurement may also look to foster a deeper relationship with its suppliers so it can proactively monitor their financial health and take appropriate measures.
Treasury also has a role to play. It can leverage various supplier financing tools to support the supply chain. Dynamic discounting, in particular, is a great tool to provide suppliers with access to much-needed funding while earning an improved rate of return on surplus cash. It works by accelerating payment of improved supplier invoices in return for a discount.
Treasury may also look to leverage its credit rating and use third-party finance to support key suppliers. With supply chain financing, treasury can provide early payment to its large strategic suppliers, while also improving its own working capital metrics.
Whichever strategy you use, ultimately, it’s time to be smart about the supply chain. The last thing you want this Halloween is for your supply chain to give you a fright in the dead of night.