The Bankruptcy Risk: Heeding the Distress Signals

The Bankruptcy Risk: Heeding the Distress Signals

The bankruptcy of Hanjin Shipping line serves as a reminder that companies can monitor markets for this type of risk.
The bankruptcy of Hanjin Shipping serves as a reminder that companies can monitor markets for this type of risk.

Hanjin Shipping filed for bankruptcy on August 31, 2016, creating the largest ever container shipping bankruptcy according to the Journal of Commerce. Aside from this unenviable world record, the sinking of the South Korean shipping line is notable for the scale of the fall out and the lessons we can learn about risk management.

In world shipping terms Hanjin was a sizeable player. The Wall Street Journal estimates that Hanjin ships carried some 25, 000 containers across the Pacific Ocean every day.  The line handled approximately 7% of U.S.-Asia cargo, and was a member of the influential CKYHE alliance of leading ocean carriers.

The disappearance of such a player was bound to ripple through global chains, but the extent of the repercussions took many enterprises by surprise.

Retailers were thrown into a panic because when the line’s troubles became clear, billions of dollars of merchandize were stranded on Hanjin ships during the crucial run up to the peak holiday end-of-year season. The legal status of these ships – assets of a bankrupted company – suddenly became ambiguous, and there were reports of vessels being seized or stranded and ports turning away the stricken line’s ships.

Merchant ships are at the center of an international web of suppliers, service providers, distributors, and retailers. But the vendors that served Hanjin found themselves in a particularly difficult position when the line declared bankruptcy. Many, including longshoremen and drayage companies, refused to handle the shipping line’s containers due to concerns that the carrier would not be able to pay them. The warehouses that store the product offloaded from Hanjin fleets, and the trucking companies that transport it, are caught up in the uncertainty, as are factories that make the products destined for Hanjin ships.

All this is taking place against a backdrop of industry instability. World container shipping is in a precarious state. There is rampant overcapacity, and shipping rates are too low to support the asset-heavy business. Hanjin’s exit requires the CKYHE alliance to re-group, and freight rates will be affected in the short term by the loss of the line’s carrying capacity.

Industry insiders are familiar with these repercussions, but watching the drama play out is still a sobering experience. People outside of the industry might be surprised as to how far the interconnectedness of world trade has progressed, and how far such a crisis can spread across globe-spanning supply chains.

Companies have invested much in programs to help them eliminate or mitigate the risk of supply chain disruptions. As the Hanjin affair underlines, anticipating bankruptcies – especially where key suppliers are concerned – is an important part of supply chain risk management.

I cover this type of risk in my latest book, The Power of Resilience: How the Best Companies Manage the Unexpected (MIT Press, October 2015). There are a number of telltale signs that indicate a company is in trouble. Here are three types of warning signs that companies can look out for.

  1. Financial
  • Failure to prepare timely financial reports.
  • Multiple adjustments to annual reports.
  • Frequent negotiations of banking covenants.
  • Deteriorating working capital ratios.
  • Lengthening accounts payable.

When monitoring these financial signs, companies should be aware that these tend to be lagging indicators; financial data may be infrequently collected and can reflect figures for suppliers’ sales, profits and debts for the previous quarter or year. One way to collect more timely, in-depth financial data, if to write contracts that mandate supplier cooperation with audits and timely reporting of key financial metrics.

  1. Tactical Issues
  • High employee turnover in key positions.
  • Failed projects/failed acquisitions.
  • Operating loss.
  • Lack of capital investment.
  1. Operational (supply chain management) Issues
  • Late/missed deliveries.
  • Quality problems.
  • Billing and invoicing errors.
  • Carrier selection errors.

The two tactical and operational categories are symptomatic of cutting corners, and indicate that management is distracted from providing good customer service.

An article on the Hanjin bankruptcy published by The Economist this month reported: “Of the 12 biggest shipping companies that published results for the past quarter, 11 have announced huge losses. Several weaker outfits are teetering on the edge of bankruptcy.”

Given the parlous state of container shipping, it is not easy to pick which lines will actually go under and which ones will weather the storm. But paying heed to warning signs like the ones listed above is a good start.

This advice applies to any company. Another option is to monitor news aggregation services such as Lexis-Nexis for indicators of business health. For example, two years prior to the bankruptcy of Kodak, Lexis-Nexis reported 15,000 news items about the company with terms such as “insolvency.” Six months before the bankruptcy the number of stories shot up exponentially.

At the time of writing Hanjin had begun efforts to restructure, with the likely outcome being either liquidation or the emergence of a much smaller shipping company. The countless companies that did business with the debt-ridden carrier continue to navigate a way out of the mess.

This post was written by Yossi Sheffi, Elisha Gray II Professor of Engineering Systems at MIT, and Director of the MIT Center for Transportation & Logistics. His latest book is The Power of Resilience (MIT Press, 2015).

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