Suppliers that kill

Some of the questions we ask when conducting our valuation interview with business owners revolve around the distribution of suppliers. This is why:

  • In the sale of a business, there is no holding guns against people’s heads. Buyers make honest and considered decisions. The purchase of a business has often been compared to the purchase of a home. This is very far from correct. Buying homes is a pressure buy. Usually one very limited sighting on a Sunday afternoon, followed by an agent telling you that there are several other parties about to make offers. The bank may do what appears to be a due diligence by way of a valuation, but really is nothing more than an exercise to determine whether or not it will recover its money in a similar forced sale process. By comparison, depending on the type of business, the supplier situation is key to value.
  • Agency type businesses, for instance may have only one supplier. This is not at all unusual. A business may have been started up for the sole purpose of supplying a particular widget. In a competitive environment that widget gets all their attention, and they end up in a position where they will kill for their widget, because all other competing widgets are rubbish… “Can’t you see?”

A bloke called me a little while back. He had been approached by his only supplier. They wanted to buy his business. “What is it worth?” said he.

He wasn’t very amenable to the possibility that it was worth very little under the current circumstances; nobody else would be able to buy it. He effectively had only one bidder, and that bidder held all the cards. A gave him an idea of what it would be have been worth if supplier had no interest in buying him. And so he went to them with that price.

They turned him down, offered him something substantially less, and he knew he was on a hiding to nothing. So he did not sell.

The supplier honoured its supply agreement with him, but opened up its own shop in South Africa, not far from where he operated. It took two years for them to take all his business away from him, but substantially less time to kill off his business. It was only his determination “to show them”, that caused him to lose everything else as well.

  • A really successful manufacturer of mutis makes a strategic decision to not buy in bulk and save a few Rands buying everything from one supplier. Instead he has a policy of buying the bulk of his material from a single very reliable supplier, and the rest from two others. From time to time he shifts the proportions around, at a cost because he’s not always buying at the best price. But he keeps good relations going with them all, and pays them promptly. None of them are likely to go out of business, but then he never knows when one of them might be hit by a flood, an accident, one of their other customers going into business rescue, a key person being arrested, a shortage… He keeps his options open. A little less profit for much more security.
  • Suppliers are taken over in mergers which their customers have no control over. Recently a flourishing business was notified by its supplier that it had merged with a much bigger competitor. (Actually that’s a takeover, if you think about it) Over the next year things settled down as the cultures mingled. Then a letter from the supplier: “We have decided to rationalise our agency in South Africa”. Three months later, with no alternative product available, he was negotiating with his local competitor for as friendly a takeover as could be mustered in the circumstances.
  • Suppliers go out of business too, you know. There is a drama playing out at present where a big supplier has gone into business rescue. Its own suppliers are not very happy at not being paid, and so it is struggling to get deliveries, to produce enough to satisfy demand. Through the business rescue process, his suppliers are having their supply contracts renegotiated, forcing them to cut into their own margins. Meanwhile our innocent friend is left trying to hustle into his competitors’ suppliers so that he doesn’t go down a similar road. His competitors have also seen the opportunity to start a small price war. Nothing like offering an alternative product at a better price, available now.

Generic products tend to have many suppliers they can choose from. This mitigates the exposure to suppliers, as we say.

Specialist products often struggle with spreading their supplier risk. Specialist agencies are a nightmare, but make up for this weakness through other strengths which their unique offerings add to the bottom line.

How is the value of your business affected by your exposure to suppliers?

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