The Importance of Assessing your Vendor’s Financial Health

3rd May 2016 (Last Updated July 18th, 2018 10:30)

Henry Kerali outlines the importance for sponsors to vet their vendor’s financial health

The Importance of Assessing your Vendor’s Financial Health

Picture this scenario: You're a sponsor company whose clinical trial has just been given the go-ahead. You're ready to get the trial underway, but you haven't selected your CRO. You've narrowed down your list to two eligible providers, and yet you still can't find a deal breaker. There's a lot that goes into vetting the prospects of a preferred provider. Chief among them is the vendors' financial health. It's a key aspect of CRO selection that can be the difference between a sponsor picking Company A over Company B.

So why should sponsors analyze their vendors' financial health? The aftermath of the global economic crisis that occurred in the late 2000s continues to plague some of the world's largest markets, areas in which sponsors and vendors alike do business.

With the biotech sector in the midst of a bear market, sponsors, large and small, face intense scrutiny over their drug pricing. Meanwhile, an increasingly-complex drug development landscape is causing an imprint on the industry's productivity and profit.

R&D budgets - a significant source of costs - are now reaching into the billions for many firms and sponsors are becoming increasingly reliant on outsourcing to stretch them. The vendors that depend on the business from sponsors are contending with the industry consolidation that is still manifesting its effects on the supply chain.

These factors, among others, are impacting the financial performance of many companies that rely on the industry, leading some to fail. This is why it's important to assess prospective vendors and their financial health. When vendors are underperforming to the point where you have to sever ties, these failures can result in cost overruns, quality issues, product development delays, and lost revenues.

Experts say it is advantageous for sponsors to employ in-house tools to assess their vendors. While there are benefits to using an in-house system over third-party tools, significant differences do exist. To start with, sponsors see vendors as collaborators, rather than investments and therefore judge their eligibility on different, more relevant criteria. Furthermore, turning to finance professionals who work within your company enables them to focus solely on your projects, a benefit you might not receive from third party vendors.

Once you've decided to adopt an in-house tool to assess a prospective vendor, decide what kind of data you want to gather. Develop eligibility requirements to help focus assessment efforts, and to that end, there are multiple aspects you need to consider. Examine the company's financials from several different perspectives. Use metrics to assess its liquidity (to what extent is the vendor able to meet short-term cash outflows?). While no metric is perfect - each has its limitations and idiosyncrasies - bear in mind multiple indicators lend greater weight to conclusions.

Be sure to examine the company's profitability, analysing how well the company finances its operations?. Assess its interest coverage, determine how much profit is used up by interest payments, and look at the company's customer concentration. Ultimately, avoid basing your appraisal on a historical snapshot of the company. Instead, adopt a forward-looking approach to better gauge the level of risk in partnering with your vendor (how susceptible is the company to becoming bankrupt?).

After analysing your vendors' credentials, involve key stakeholders in the process, drawing support from top management, while emphasising their role as an additional decision-making tool. The process your Finance team utilised to assess the vendors should be explained to upper management to avoid misinterpretation and misunderstanding.

Ultimately, when partnering with a vendor, the sponsor must do due dilligence in assessing their strengths and weaknesses. By having a solid vetting structure in place, you safeguard the integrity of your trial.

 

References:

Matthew Eckman, Head of Vendor Financial Risk, Genentech, How to Create an In-House Tool for Assessing Vendors' Financial Health (Presentation)