Supply Chain Red Flags: How to Determine When the Risks of a Manufacturer Are Too Great

When conceptualizing supply chain risks, many of us focus on headline-grabbing events like the COVID-19 pandemic, maritime attacks by Houthi rebels, or natural disasters that disrupt entire industries. While these large-scale disruptions do pose serious threats to supply chains, many risks come from more subtle sources, specifically suppliers and sub-tier manufacturers. These less visible vulnerabilities can still cause significant issues, leading to component shortages, compliance failures, data breaches, and reputational damage.

The risks embedded in suppliers are not always immediately apparent, as manufacturers strive to present themselves as stable partners. However, businesses can look for key red flags that signal underlying risks. Some indicators are obvious, while others require deeper investigation, but they offer valuable insights into a supplier’s operations, security practices, and adherence to international standards.

In this article we look at four signs a supplier poses a potential risk to your business.

1. Lack of Transparency 

The level of information manufacturers are expected to track, maintain, and share has increased exponentially over the past decade. As the Harvard Business Review explained in a 2019 article, 

“Companies are under pressure from governments, consumers, NGOs, and other stakeholders to divulge more information about their supply chains, and the reputational cost of failing to meet these demands can be high.” Depending on the industry and the regulations and public scrutiny surrounding it, organizations may now face pressure to disclose data about energy use, carbon emissions, fair pay, adherence to labor laws, and the ethical practices of their supply chain partners. 

For many businesses, meeting these new expectations for supply chain reporting is not something they can effectively carry out on their own. Suffice it to say, much of their ability to report on ESG, sustainability, and other categories of growing importance hinges on how transparent and forthcoming their suppliers are. Working with manufacturers that demonstrate a characteristic lack of transparency can make these responsibilities significantly more difficult to execute. Further, engaging in such partnerships can give rise to serious material issues in the longer-term, including regulatory problems, shortfalls in supply chain due diligence efforts, and tarnished public perception. These consequences are all but certain to loom even larger in the years to come, too, as governments and international bodies continue imposing new reporting requirements on organizations across the globe. 

But the failure to procure critical supply chain information for regulatory agencies and the public more broadly isn’t the only negative consequence associated with opaque manufacturers. Suppliers who don’t respond to requests for data or appear unwilling to turn over key documentation may be deliberately concealing issues whose seriousness surpasses general due diligence measures. Such secretive, surreptitious businesses may be covering up precarious financials; relationships with disreputable or even sanctioned lower-tier suppliers; or human rights issues either within their operations or further along the supply chain. 

In any case, a lack of transparency is, at best, a logistical inconvenience for companies. At worst, it could be a sign of deeper problems—issues with the potential to threaten not only their own operational stability and regulatory adherence, but those of their customers, too. 

What a Lack of Transparency Could Signal 

• Poor or substandard supply chain due diligence.
• Regulatory issues.
• Weak record-keeping practices.
• Deliberate obfuscation of their own suppliers.
• Potential human rights concerns.

2. No Publicly Available ESG Data

A wealth of current figures and statistics persuasively demonstrate how more and more manufacturers and other businesses are now reporting on ESG’s environmental, social, and governance pillars. A 2023 report carried out by the International Federation of Accountants found that 95% of large global businesses are now disclosing ESG information on an annual basis. Nearly two-thirds of those firms, meanwhile, are obtaining third-party assurance for at least some of that information. 

For now, these corporate ESG disclosures are largely voluntary. But an impending wave of global sustainability regulations will soon make many of the reporting categories legally required for in-scope businesses. Frameworks like the Corporate Sustainability Due Diligence Directive (CSDDD), the Corporate Sustainability Reporting Directive (CSRD), and the Security and Exchange Commission’s climate disclosure requirements—all of which are either in the early stages of implementation or pending final approval—are poised to institutionalize sustainability reporting for many larger businesses. As the decade progresses and the scopes of these directives expand, meanwhile, many smaller businesses will eventually face similar due diligence requirements. 

For companies working to continuously expand their ESG reporting and eventually comply with these imminent government regulations, suppliers who don’t publicly disclose any sustainability data present a significant obstacle. Many reporting categories—including supply chain due diligence, forced labor probitions, and scope 3 emissions calculations—require companies to obtain information from their manufacturers. Suppliers that aren’t currently disclosing any ESG information are far less likely to be tracking it internally, thus creating a potentially large reporting gap for their customers. Organizations that choose to work with manufacturers with no public ESG record are positioning themselves unfavorably for a rapidly materializing near-future, one where sustainability reporting is obligatory for a large swath of companies. 

It’s crucial to remember that it’s not just about the disclosure requirements that exist today—or even those entering into force in six or 12 months. Firms need to start cultivating the access and facility with their supply chain for the more rigorous, all-encompassing regulations that are all but guaranteed to emerge during the latter half of this decade and beyond. 

What N0 ESG Reporting Could Signal 

• Lack of internal sustainability accounting.
• Poor ESG performance.
• Lack of investment in necessary accounting and reporting tools.
• Indifference to environmental and social considerations, including greenhouse gas emissions (GHG), decarbonization, and ethical treatment of workers. 
• Potential issues with executive leadership.

3. Absence of Key Industry Certifications

Independent, third-party certifications are a way for companies to demonstrate their bona fides within their industry. Certifications from large, recognizable certifying bodies exhibit a commitment to adhering to the highest industry standards, a desire to make continuous operational improvements, and a willingness to stand behind the quality of a business’s products and services. There are a handful of crucial certifications in the electronics industry, many of which are developed and administered by the International Organization for Standardization (ISO). 

• ISO 9001
• ISO 14001
• ISO 27001
• AS9120 (quality management system standards developed by the Society for Automotive Engineers specifically for the aerospace industry). 

Just as the presence of these certifications illustrates an organization’s diligence and eagerness to set themselves against their industry’s benchmarks for performance and quality management, the absence of them can be equally revealing. Manufacturers that have not invested the time, money, and effort to earn fundamental certifications from ISO, SAE, and other key professional associations are indicating to potential customers a lack of seriousness about adhering to their sector’s best practices. 

The absence of critical certifications may evince more than just a lackadaisical attitude toward industry standards, too. Companies that forego these emblems of professionalism and quality assurance may not want to expose themselves to a third-party audit because they know—or at least strongly suspect—that their operations don’t meet the standards established by their field. 

Whatever the motivation behind it, suppliers that decline to obtain critical certifications should almost always be perceived as inherently risky entities. 

What Failure to Obtain Industry Certifications Could Signal 

• Noncompliance with industry standards and best practices.
• Lack of financial resources and/or personnel.
• Questionable or unreliable internal practices.
• Potential absence of any overarching quality management system.

4. Ongoing Regulatory Issues and Legal Challenges

Businesses that fail to comply with environmental regulations or trade restrictions—or otherwise run afoul of the law—risk exposing themselves to serious consequences. These include fees, fines, and other financial penalties, litigation, and civil liabilities. Violating regulations and cutting legal corners can also damage a firm’s credibility, tainting their reputation among customers and the public at large. 

For businesses that rely on a large number of manufacturers across their supply chain, understanding the full implications and potential fallout if those manufacturers violate the law is critical. For one, suppliers that have failed to adhere to one regulation pose a significantly higher risk of failing to comply with others, too. This type of serial noncompliance could 

leave a supplier’s customers unwittingly purchasing components, subassemblies, or other goods that are out of regulatory compliance. Further, manufacturers embroiled in lengthy and complicated legal battles are vulnerable to bankruptcy and other financial problems, circumstances that can have a significant impact on businesses’ ability to reliably source from them. 

While it’s not always clear what the full spectrum of outcomes is for a supplier navigating compliance issues or legal proceedings, what’s far less ambiguous—and all but indisputable—is the fact that they introduce significant risk to any potential business partners. 

What Legal Problems and Compliance Issues Could Signal 

• Other illegal or noncompliant activities yet to be discovered.
• Poor internal standards and quality management.
• A lack of corporate governance and internal compliance. 
• Financial vulnerability. 
• Unethical business practices.

How Supply Chain Visibility Can Help Businesses Identify Red Flags and Effectively Manage Risk

When it comes to selecting suppliers and entering into supply chain relationships, organizations always have the ability to carry out comprehensive risk assessments and the due diligence measures that come with them. But while companies don’t always have the tools, visibility, or technological prowess to obtain full transparency into potential suppliers, they can learn to carefully glean important signs about a company’s broader risk profile. 

For some companies, though, relying on these “risk proxies” may not be enough. Firms determined to delve deeper into the slew of risk factors posed by potential suppliers—including financials, compliance statuses, ESG performance, and cybersecurity infrastructure—can gain substantial value from a supply chain risk management (SCRM) platform. 

Z2Data, one of the leading SCRM tools for manufacturers and other firms that source from the electronics supply chain, provides exhaustive profiles on over 150,000 suppliers, manufacturers, and other businesses. These profiles include proprietary risk scorecards that meticulously evaluate companies based on a broad range of key criteria, including geopolitical risk, vulnerability to bankruptcy, trade compliance, and ESG performance, among other factors.

To learn more about Z2Data and the wealth of actionable supplier insights the tool provides to customers, schedule a free demo with one of our product experts.