EVALUATING SOURCES OF SUPPLY

Evaluating sources of supply may be more critical than evaluating what’s being supplied. After all, the best equipment or service on the planet is greatly diminished in value if it can’t be depended on. Repair, replacement parts, and upgrades are important life cycle extenders. The latest gadget has diminished value if your organization gets sued for patent infringement by the supplier’s competitor and the entity the gadget was purchased from isn’t around, or doesn’t have the resources to defend itself and its customers in such an action. No matter who is right, the outcome is less than satisfactory.

If your organization uses a purchase order process (i.e., limits the power to commit funds to be paid in exchange for goods and services using a purchase order form) then it’s likely the individuals authorized to issue POs can conduct supplier due diligence. Initial or preliminary due diligence is general in nature and does not require any technical subject matter expertise beyond a qualified purchasing representative’s knowledge of buying what the acquiring organization needs for its business. As project planning proceeds and technical concerns arise, subject matter expertise will be needed to complete the due diligence process.

Evaluating sources of supply is a process whereby accounting, contractual, legal, and technical subject matter expertise investigate and quantify potential risks of doing business with an unknown third party. It involves an examination of the entity’s financial health, ability to produce deliverables in the level and amounts required, and its ability and reputation for post-deliverable support of whatever type is required by the acquiring organization.

Evaluating the financial health and stability of a potential supplier can be accomplished by examining a set of audited financial statements covering a period of time in the past. Publicly traded entities that are potential suppliers are required by law to file quarterly and annual financial statements. If the potential supplier is not a publicly traded company, then there may be other sources of financial information such as Dunn & Bradstreet. D&B is a credit rating organization, providing credit history and assessment. As such they have access to information on most any entity that wishes to do business on credit. They also collect information about how the subject pays their bills. 

For example, do they pay on time, or according to agreed on terms, or are they occasionally or perpetually behind? These same agencies also monitor and report on lawsuits and extraordinary events that may have an impact on the company. Considerations or concerns about the potential suppliers intellectual property rights may be found in simple searches that can turn up patent or copyrights granted.

The overall concern amounts to the ability of the supplier to produce and support the required quantity of equipment, software, or facilities and services for the time required, typically ranging from 2 or 3 years to longer than 10 years. The ability to conduct due diligence isn’t rocket science; it’s mostly a matter of common business knowledge. You and your peers in accounting that deal with purchasing, contracting, and paying bills can undertake and complete it with a reasonable amount of time and effort.

EVALUATING EQUIPMENT AND SERVICES

Evaluating equipment and services is usually within the context of feasibility assessment, or project planning. Risk is minimal and limited to the amount of time and perhaps travel expense invested in this type of activity. As projects grow and commitments are made, risk grows. What we are concerned about is risking capital, and if the opportunity is real, risking the loss of not just the invested capital, but also some or all of the promised return. The worst of all possible nightmares is a scenario where the project causes a problem outside the scope of the project as envisioned, requiring an unplanned, unbudgeted expenditure.

Not only should equipment and services be evaluated, but their source of supply as well. Conducting due diligence on one or more suppliers varies by level of effort depending on several factors such as how long the prospective supplier has been in business, their size, and their capability to produce and deliver the products and services required by the project at hand. A new supplier that’s been actively supplying products or services in the marketplace for several years will require less effort than a start-up. A start-up with an innovative, new product may require more effort; certainly it’s likely the effort will be different. Well-known or start-up, any situation involving claims of significant new technology should be taken with a grain of salt until all potential material risks have been uncovered, examined, evaluated, and quantified.

Due diligence is most effective and efficient when it is conducted in a way that it becomes a benchmark for acceptance of equipment and services. Conducted properly, there should be no surprises for buyer and seller. If function, form, and performance are not as expected, then there has been a misunderstanding in the past, or something about the hardware, software, or services needs troubleshooting and fixing. Ideally, the due diligence process takes into account the requirements and specifications, and compares capabilities and performance of equipment, facilities, and services of one or more sources of supply. The process should begin with a simple paper-based evaluation. Once everything looks okay on paper, more extensive evaluation can be undertaken.

There are two basic approaches to conducting evaluations. A general evaluation can be undertaken whereby the supplier provides a set of information about the capabilities and performance characteristics of the equipment. The evaluator takes that information and proceeds to determine if the equipment or services are capable of performing as claimed in the information provided. This may or may not determine if the equipment and services meet the business requirements of the buyer. The other approach to evaluating equipment and services takes a specific requirement or set of requirements and then proceeds to determine if the equipment and services meet some or all the details in the requirements established by the buyer.

Once a direction is established, then the process can be sequenced into three or fewer logical steps. Step one can be what’s referred to as a paper-based exercise. Simple expert analysis of the information provided by potential suppliers can be analyzed to determine if it meets or exceeds the requirements established by the potential buyer. The next step after paper evaluation requires examination and testing of one or more working samples. Depending on the size and complexity of the project and the potential risks/returns at stake, scalability may be an issue. If scalability is a concern, then the structure of the initial working samples and their evaluation criteria should be staged and structured so as to be extensible to greater scale. Another way to view this issue is to structure the paper evaluation and the initial working sample evaluation so it is representative of the full scope of the network or system as known at a given time.