Rachel Elnaugh commented on my post So Cheap We Can’t Afford It asking:

Have you ever supplied Tesco? Then you will know it goes like this:

1. They approach you to supply them; you believe all your business dreams have come true.
2. You step up production and make the necessary business investment (often highly leveraging yourself in the process), believing this is a ‘long term partnership’ which will take your business to the next level.
3. Come Year 2 their buyers ruthlessly screw you on price, often demanding lower prices than Year 1, knowing you now cannot afford to lose the contract.

Of course if you do not comply with their demands there are plenty of other suppliers just ready and waiting to step in your shoes. This is not just Tesco, it is how all major supermarket/multiple buyers are trained and incentivised. It is a ruthless process. Of course the natural result (if you are a supplier) is to take the lower deal - and then cut corners in production to lower your costs.

While I’ve never supplied Tesco or any of the other Supermarkets I can well imagine that the experience is for many suppliers exactly as Rachel describes and I still believe that it shows that the majority of the fault lies with the suppliers. I hope to explain why I believe that in this post and to suggest what I believe the suppliers should do instead. Rachel does I believe has experienced selling to the supermarkets and talks about it briefly in an interview she did with The Guardian.

Despite never having dealt with the supermarkets but I have dealt with companies that have tried some of the tactics mentioned and I’ve made the mistake of relying on one customer for the majority of our trade and subsequently had them decimate our turnover almost overnight. I’ve learned from that and we now make sure we have multiple customers and work hard to ensure that no more than 20% of our business comes from any one source. I strongly suggest any business that relies upon a single customer for more than 20% of it’s turnover looks to find other customers to reduce it’s dependency on that single customer and while doing so ensures the dependency on that single customer is recorded as a significant risk in the companies risk register.

To address each of Rachel’s points:

1. When approached by any new customer you should be looking for the opportunities but also considering the risks. You should always be carrying out a credit check before extending credit and trying to check their record on late payment, to do so ask other suppliers and check the report produced by the Federation of Small Businesses (FSB). You should also use the Internet Search Engines to check them out, looking for (in this case) “supplying Tesco”, “Tesco squeezes suppliers” would find a number of articles that backup your points, in which case there really is no excuse for going into a relationship with the likes of Tesco with the naive view that “all your business dreams have come true”. After doing all of this you should be able to sit down and write a list of significant risks to dealing with the likes of Tesco.
2. If you make a significant investment to ramp up production on the basis of a single customer you’re becoming dependant on that customer for more than 20% of your business, so you should be doing so having noted that it’s a BIG risk. If you need to make a significant investment to increase production then you need to access the opportunity cost of that investment, the payback period and record those as risks. Should the investment be funded by borrowing then you have further risks to record.
3. If you’ve done your research as part of step 1 you will be expecting this and should have put in place a strategy to mitigate the risk, or have decided that dealing with the likes of Tesco is too risky for the business and the business should continue to grow organically. If you have put in place a strategy to mitigate the risk you will also be in a better position to negotiate with the customer - they won’t be able to force your hand by threatening to take the order elsewhere. Remember that if they want your product for a second year it’s because they are making money selling it. If they switch to an alternate supplier they may loose money.

So what risks would I record and what would I do to mitigate them?

The risks are:

• Late payment causing a cashflow crisis - firstly try to get paid on time, see my post How To Banish Bad Debts And Get Paid On Time for some hints and tips. You should also make sure you have an understanding of debt factoring and invoice discounting as these will provide ways to free up cash if needs be, but again factor the cost into your planning. Build a good relationship with your bank and arrange overdraft facilities in before you need them.
• Customer going bust - while it’s unlikely that Tesco or the other supermarkets will go bust, it can happen. Big businesses do fail and when they do so suppliers are unlikely to receive payment for outstanding invoices. In reality the best way to mitigate this risk not to depend on one customer for a significant chunk of your business. If you aim to keep each customer at 20% of less you should be well covered. The reality is that this isn’t always possible so you need to watch for warning signs and regularly review the risk.
• Staff risk - even if increasing production does not require a significant capital investment it may require the hiring of extra staff which can be a significant cost and therefor risk. It may be worth exploring the options to outsource areas of production and the use of contract staff or temporary workers.
• Risk of borrowing - if you will need to borrow to expand the business then you need to know what impact the debt will have on your business and consider the risks posed by late payment, non payment, interest rates and even the bank getting cold feet and calling in the debt early.
• Pressure from buyers - buyers will always be looking to get a better price from you and their leverage in negotiations is the threat to take the order elsewhere. Don’t forget they want your product and there may be a significant cost to switching to an alternative supplier. Make sure you expect this your best way to handle it is to mitigate the risks above so you are able to negotiate knowing that loosing the order will not put the business in jeopardy. As you where expecting this risk you should have also been taking steps to mitigate it throughout the first year by looking for costs savings (through efficiency not reduction in quality), by adding value to the product or by making it more desirable by marketing it thereby giving you a stronger position from which to negotiate.
• Opportunity cost - When taking on any significant deal, especially when making an investment you should be assessing the opportunity cost. For example assuming the new big customer wants to place an order for £1 million pounds and the price you agree on gives you a 10% gross profit margin. You’ll have to spend £900,000 on materials and manufacturing to make £100,000 profit. In comparrision your direct to market sales channel (mail order/e-commerce perhaps) may have a 50% gross profit margin meaning that to make your £100,000 profit you’ll only have to make sales of £200,000. To achieve sales of £200,00 you would only have had to invest £100,000 in materials and manufacturing costs. As cashflow problems are the biggest killer of small businesses this significantly reduces your risk. Things get further complicated if your £1 Million pound order requires you to make a capital investment funded by borrowing, which will further reduce your net profit. Whereas if you invested the £900,000 via your direct channel (perhaps increasing advertising costs) you may make significantly more profit.
• Supplier risk - this is a risk you should be continually managing anyway, but it becomes even more crucial to review your mitigation strategy as volume increase and margins are squeezed. You should consider what effect it will have on you if your suppliers raise their prices (possibly due to new legislation or industry wide increases in the cost of raw materials). What if a supplier goes out of business? How will you be affected if the supplier is late delivering?

While this is not a comprehensive list I hope it will give readers something to think about. The reality is that running a business does involve taking risk and it’s rarely possible to mitigate all the risks.

The impact of many of these risks can be modeled. The development and analysis of these models (known as Quantitative Analysis) is a skill learned by students on an MBA course. If you’re facing these kind of decisions it might would be worth looking to hire someone with an MBA or if money is tight seek an MBA student who will be probably be cheaper. Alternatively consider hiring a business consultant with the relevant expertise.

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