Is supply chain financing one of COVID-19’s few winners?
Liquidity is one of the big themes of the last few weeks; cash has once again become king. The importance of cash, and the gathering of it has seen many organizations deciding daily who to pay and who not to pay. A practice that has been much more prevalent than one might imagine from the isolated stories that have made the headlines. However, it can also be argued that those who elected not to pay on time are not by default the bad guys; survival may be a legitimate business tactic in a crisis.
Whether there is blame or not to be applied is not the focus of this blog; the focus is that payments are another core business process that, for many, lacked transparency and reverted to spreadsheets, human decision making, and button pressing. There was confusion in Procurement and Finance Functions up and down supply chains all across the land.
One lesson? The hitherto slow to innovate payments market is due for a radical overhaul and multiple forces will accelerate its transformation;
- The supply market is already awash with legacy banks, platforms, and disrupters hastily balancing the introduction of innovation with protecting legacy revenue streams.
- There is now a steady stream of business customers burnt by the pandemic who will seek faster, more transparent, and flexible tools.
- For SME’s particularly, the government will most likely look to put in place regulation to ensure prompt payment, something already on many corporate agendas.
A time for change?
Working capital has long since been one of the Finances Function’s favorite levers. The trouble for them is that some of the processes and tools available have left them wanting; a fancy system and contracted payment terms were often no guarantee of on-time payment.
A famous story in Proxima folklore was the running of a work capital extension program (essentially extending payment terms). The client had run the numbers on contracted payment terms, around 30 days, and calculated the benefit of moving to 60 days. The trouble was, on further investigation, actual payment terms achieved were already more than 60 days, and so what should have been a cash flow boost was having the opposite effect!
So what can be done now?
Futurists will look to Blockchain as the answer, and it probably is; a transparent and real-time business ledger. But is it not here now, for everyone. There are also undoubtedly gains to be had by running better systems and processes until the market presents us with the solution. The trouble with this? The more complicated you make the rules around payments, the harder it is to manage in any system that is not fully integrated and automated; mistakes happen.
Furthermore, standardizing terms take away a key negotiation lever for procurement teams. However, it must be asked how many Procurement and Finance Teams really understand the real value of cash and how important prompt payment is to a supplier. Suppliers have bills to pay, be that staff costs or costs to other suppliers.
Imagine that a supplier’s outgoings are on 30 days. Their receivables are on 90 days, which presents a ludicrous situation whereby a suppliers can suffer as much through winning business as they can through losing business. For smaller suppliers, this might create an even more seemingly ludicrous situation. They need to take credit to adhere to payment terms from above, typically coming down from a large organization at the top of a chain. An SME is essentially bankrolling a multinational…? In this day and age, and with all that means commercially and reputationally, it doesn’t feel right.
And that is where Supply Chain Financing (SCF) comes in…
COVID continues to show up some of the deficiencies B2B payment practices, and it also accentuates the need for corporates to support SMEs, something that often makes sense both commercially and reputationally. With this in mind, supply chain financing could be one of the big winners in 2020/21.
Supply chain financing is essentially the practice of putting an intermediary (usually a bank or other supply chain financing provider) into the payment process between buyer and supplier. The intermediary then offers “reverse factoring” as a service; this allows buyers and suppliers to have different payment terms. Typically the buyer will opt to pay to longer terms, and the seller chooses to get paid on shorter terms. The intermediary then has to figure out how to make a profit in the middle, but that ceases to be the buyer or supplier’s problem, in a perfect world, everyone is happy.
But the solution does not stop there. Most supply chain financing providers go beyond simply organizing payments. They offer other “value-added services” like “dynamic discounting” for example, this allows suppliers to be even more flexible in making decisions about when to get paid. These schemes enable suppliers to manage their own payments in exchange for more or less favorable terms, like early payment for a fee, for example.
It sounds excellent, doesn’t it? But the practice is not yet as widespread as you might think for something which seems so logical on paper. supply chain financing is usually focussed on managing payments across a large number of suppliers. Delivering working capital and efficiency benefits to the buyer, but this means it can be complicated and time-consuming to implement. So perhaps while it looks like a good business case, it may not historically have been the best business case facing the CFO as they worked through their pre-COVID priorities.
Further supply chain financing is often used to streamline payments to the thousands of smaller or non-strategic suppliers that an organization may have, but sometimes take up is lower amongst these suppliers than expected. Why? supply chain financing is not without its challenges for SMEs.
In a world without a standard supply chain financing solution, suppliers can be requested to sign up to multiple schemes. This can take time and add internal complexity, as well as meaning that the supplier can lose some control of cash management practices. In such cases, suppliers may opt to put their own financing solution in place rather than take the supply chain financing.
But supply chain financing is getting a lot of coverage, and clear leaders are starting to emerge in the solution sphere; a space is ripe for competition over the next few years; it should be exciting and fun to watch. For buyers, the message has to be that it is a two-way street, there are different reasons for adopting supply chain financing as a strategy, and different approaches to pursue.
For a scheme to succeed, the benefits cannot be one way only, and it is essential to let the desired outcome select the solution, not the other way around. (NOTE UPDATE: The UK Government has only recently been reported to have canceled work on an SCF scheme for UK SME’s due to a perceived mismatch in the benefits planned vs. predicted).
A lot of the talk is around working with smaller, more innovative companies and supporting SMEs, and for these businesses, cash always has been king. Despite its complexities, supply chain financing can be an exciting tool as part of a well-managed working capital program. And a smart working capital program is going to think about “what’s in it for everyone.”
For more information about how Proxima could help you, please get in touch.