The recession taught some major corporations that, if they wanted to secure their supply chains, they needed to ensure that suppliers could finance their operations. Sam Tulip looks at the challenges of modern supply chain finance…
The need for short term finance in the supply chain probably emerged very soon after the first farmer planted a crop and realised it would be six months before he could sell it. By the Middle Ages proto-banks such as Monte dei Paschi (still, just, with us) had developed early forms of factoring and invoice discounting, but it could be argued that there has been little development since.
However, in the past decade or two, new attitudes of buyers towards their suppliers, new ways of looking at supply chain risk, and developments in IT have enabled a sea change in supply chain financing.
Although factoring and discounting have kept the wheels of commerce spinning for centuries, they have a number of inherent disadvantages. A smaller supplier’s receivables book will typically include many customers with little in the way of credit history. Lenders must therefore carry out checks which are both expensive and would take far too long, or raise their discount rates to cover the unknown risk, sometimes to almost punitive levels. Globalisation has exacerbated the problem – suppliers may be owed money by firms around the globe, but themselves be based in developing countries with few alternative sources of finance.
Availability is also an issue: it is quite common for the finance house to refuse to accept some or all invoices apparently on a whim; bank policies can change sharply due to new regulatory requirements.
Furthermore, discounting counts as a loan, secured on the invoices. This can make the supplier look still less credit-worthy. While factoring involves a sale of the receivables book, often this is ‘with recourse’ – if the factor is unable to collect on the invoice, they can demand their money back from the supplier. (In international trade, forfaiting is a form of factoring, normally ‘without recourse’ but therefore with quite high discount rates). Certainty is missing, and firms that use factors or discounters are often seen to be weak or desperate.
Longer distances between supplier and customer inevitably increase the time between the supplier manufacturing (and having to pay their staff, suppliers and other bills) and the customer selling the goods and being able to pay the supplier. Equally, a retailer may be building up stock prior to a launch, months hence, in a new market, or a construction firm may need to buy materials, hire plant and pay subcontractors long before even staged payments on the project are made. World events may also create a need: if industry is to take advantage of post-Brexit export opportunities, the relevant supply chains will need more working capital.
Not surprisingly, small businesses regularly fail, even with full order books, because the cash has run out and as supply chains have grown more complex and global, and as economies recover from recession, the need for financing has grown. Tom Roberts, head of global marketing for PrimeRevenue, says: “Cash is your best friend – absence of cash is a real danger”.
Buyers have some responsibility to ensuring their suppliers’ access to working capital, and that is precisely the approach that modern SCF techniques take. As Boris Felgendreher, senior director of marketing at the platform provider GT Nexus, puts it “It is not in the interests of the big brands for their suppliers to have cash flow problems. They have an ecosystem of suppliers. There used to be the allegation that the brands didn’t care, but that is changing. Companies that ‘get it’ have the health of their supply ecosystem in mind, and have an interest in suppliers having healthy cash flow situations”.
Instead of the financiers providing capital to the supplier in the form of a loan secured on the invoice, they fund the buyer to enable the latter to pay the invoice on time. The lender is looking at the creditworthiness of a single relatively large company rather than a host of unknown firms – the risk is much better understood and the premiums accordingly much, much lower.
The buying company can thus offer all, or a select part, of its supply base a predictable and controllable source of finance. Using cloud-based systems, the supplier can see (through a simple web portal) as soon as the buyer has approved an invoice for payment. If the supplier is in no urgent need, he can wait for the invoice to be paid in full in the normal course of events. If however cash flow is tight, they can call off that invoice for immediate payment, at a discount certainly, but at a much more favourable rate than through conventional financing.
It is possible to be even more sophisticated. Felgendreher says: “Finance has been provided after the goods have been produced and invoiced for. Now the platform can recognise ‘milestones’ against which funding can be offered much earlier in the process”. For example, if the supplier has a contract with a heavy upfront commitment in materials, they could call off part-payment against proof that the materials have been purchased, or against other production milestones.
Some 3PLs (Damco for example) run production milestone tracking in the supplier base on behalf of clients – this of course is aimed at physical control of the supply chain but there is no reason why the same milestone reports should not form the basis of an SCF programme. Indeed, Mark Coxhead, chief executive of Woodsford TradeBridge, says: “Milestones are quite a driver in the sector and firms like us are actively looking at how we can inject finance earlier in the process”.
Paradoxically, just because supplier finance is now predictable and available, it is often possible for buyers to negotiate either lower prices, or extended standard payment terms, or both. Says Coxhead: “People often forget to ask ‘If I pay you in just a week, what discount can I get?’ But if suppliers have available and flexible finance, buyers can often get these discounts”. It is important, he says, to educate procurement people in the opportunities that SCF open up.
There are further possibilities: PUMA, the sports company has a programme, financed by IFC (part of World Bank) and using a GT Nexus cloud platform to offer SCF to suppliers in emerging markets. The twist here is that the pricing of capital is tiered, with the best rates offered to suppliers that score highly in PUMA’s audits of social and environmental standards. Felgendreher comments “These ways of supporting suppliers financially allow them to be held to higher standards, and enable suppliers to do the right thing. As with milestone financing, we can use technology to deliver traceable proof of achievement on our platform and thus allow the release of funding”.
This approach to SCF is eminently scalable. At one end there are companies such as PrimeRevenue which focuses principally on major multi-national corporates such as Michelin or the brewers SAB Miller, and in supporting SCF schemes run by finance houses such as AIG or Barclays. At the other end are more boutique operators such as Sancus Finance or Woodsford TradeBridge, targeting mainly SME supply chains (with funding requirements of say £250,000 upwards). More varied and less traditional sources of funding, says Caroline Langron, managing director of Sancus Finance, “allows us to be more flexible and lighter of foot – funders like the opportunities, which are easy to understand and give good returns”. Both styles of operation are converging on the middle ground, and there is a healthy level of competition between SCF providers, something that has hitherto often been absent in traditional financing arrangements.
It should also be mentioned that in some cases buying companies themselves may finance or co-finance their SCF schemes. This can arise when companies have large cash piles, earning negligible interest on deposit, but where in uncertain times long term investment is unattractive. By financing their supply chains they can obtain a better return, plus the advantages of a happier, better funded and inherently less risky supply base as outlined above. But alone, says Sancus Finance’s Langron, “they haven’t got the IT: a big vendor programme isn’t about the cash, it’s about administering 2,500 suppliers”. Tom Roberts of PrimeRevenue, agrees that for major brands the attraction may not be primarily financial, but in the advantages of simplifying and removing conflict from the payment process with literally thousands of suppliers worldwide. “We have programmes that have been running over a decade and buyers are still onboarding suppliers at the rate of 200 plus each year”.
But for smaller firms, cash is definitely key. Woodsford TradeBridge provides SCF for many companies in areas including logistics, and construction. In the latter case, says Coxhead: “There is an acute shortage of skilled sub-contractors, and they won’t work for you unless they get paid on time. Our clients are often the ‘meat’ in this sort of sandwich, and we provide a liquidity solution that keeps both contractor and ‘subby’ happy”.
So it’s ‘win-win-win’, for financiers, buyers and suppliers. Isn’t that just a little too good to be true? Langron concedes that “We do hear that, and education is a challenge. Funders get the model and love it, but the challenge is to get the message through to buyers and suppliers. Understanding is developing – we are getting more people ringing us directly saying ‘I’ve been a supplier that has benefitted but I’d like to get more of my buyers doing this, or be able to do this for my own suppliers”.
Taking the supply chain as a whole, the cost of doing business, and the risk attached, is lowered – often dramatically. Modern supply chain financing is a 21st century solution to an age-old problem.