For years CPOs and their colleagues have focused on squeezing costs out of their supply chains. But while the evolution of the physical supply chain has moved forward at a frightening pace, there remains one aspect that is relatively untouched: the financial supply chain.
For every physical order working its way up the supply chain, a financial transaction must go the other way. And while organisations have fought over knocking a few extra pounds, dollars or euros off purchase prices, the overall value to the company is determined just as much by the flow of funds as it is the movement of goods. “Given the fact that supply chains are becoming longer and companies are looking for very distant suppliers, the financial aspect is becoming predominant to the physical,” claims Enrico Camerinelli, chief analyst and European director at the Supply-Chain Council.
The aim for many global organisations now is to reduce their working capital – the amount of money locked up in the supply chain – by ensuring customers pay on time, keeping the amount of stock at just the required levels and, most significant of all, increasing payment terms with suppliers.
Research last year by REL Consulting found that 56 per cent of European companies decreased working capital through this tactic in 2005, compared with 47 per cent in 2004, and it appears this is a rising trend. According to a study by working capital technology and consulting company Demica in December 2006, 73 per cent of large European organisations planned to extend payment terms with suppliers in 2007. Similar research by Aberdeen Group found that 58 per cent of global companies were already using this tactic, and another 14 per cent planned to introduce such a policy during the next 18 months.
All of this creates something of a problem for CPOs. Increasing payment terms without offering anything in return could cause cracks in relationships that have been built up over many years while, in the long term, this is likely to lead to either increased costs or a drop in quality. In some cases, key suppliers could even fail altogether.
This is where the concept of third-party-funded supply chain finance programmes come in, as a variant on traditional factoring services. By establishing relationships with financial institutions or financial arms of logistics companies, purchasing organisations can offer suppliers access to cheaper finance based on the buyer’s credit rating rather than their own.
“Companies are starting to see that if they’re building partnerships with core suppliers, they may need to put something in place to support those suppliers with cash flow without compromising their own working capital cycle,” says Andrew Betts, global head of supply chain business at ABN Amro. “This is a practical example of where CPOs and CFOs can bring collaboration between buyers and suppliers.”
Under a supplier finance scheme, the supplier gets the vast majority of its money immediately while the buyer gets to extend its days payables outstanding (DPOs), as well as enhancing its credit rating, since suppliers have already been paid. “It fundamentally alters the adversarial approach to procurement and ultimately takes costs out of the supply chain rather than transferring them to those least suited to bear the risk,” says Fergus Groundwater, vice-president of procurement at Canadian material-handling company Advanced Dynamics, who is a major proponent of such schemes.
As well as big banks, other companies have also spotted the potential of financing suppliers to large organisations. Some software companies that provide the technology platforms linking suppliers, buyers and banks also offer supply chain finance solutions, although funds are normally put up by a finance partner. Spend management company Ariba, for example, announced in May that it was offering its customers access to Orbian’s third-party financing platform to “optimise their working capital and minimise risk”.
Take-up of third-party supply chain finance is currently most advanced in the US, but is now beginning to penetrate buying organisations in Europe too, as supply chains become longer and increasingly incorporate third-party providers. The growth of low-cost-country sourcing has also opened a whole new market. “As companies extend their sourcing activities into low-cost countries, they start to add complexity and risk to existing physical supply chains,” explains Betts. “Extending those supply chains can add days in terms of transit time, so you begin to see opportunities to optimise working capital within these large extended flows.”
Suppliers from countries such as India and China are likely to be major beneficiaries of this new method of invoice-based finance. According to Karl Alomar, chief executive of factoring company China Export Finance, the Chinese market is particularly suited as local banks prefer to lend against physical assets and are only likely to do so against invoices if accompanied by credit insurance, which can be costly. Yet if suppliers have to wait 60 or 90 days after delivery for payment, it could be 120 or even 150 days after they have incurred production costs that they finally receive funds, he says.
Friedrich Philipps, a director of supply chain finance solutions at Deutsche Bank in Frankfurt, believes this works best in parts of southern and central America and the Asia-Pacific region. He explains that the bank’s cut of the money owed to the supplier varies according to the length and amount of credit, the buyer’s credit rating and the countries involved, but could be as high as 3 per cent of the invoice value if local banks tend not to offer receivables financing or the cost of such borrowing is very high. “But if you’re dealing with a buyer who wants to negotiate low rates for its whole supply base then you have a very different proposition,” he adds.
Added incentives
There are other potential advantages for CPOs. One of the banks’ major selling points is that buyers can demand a share of the savings suppliers will gain from cheaper finance in the form of a price reduction. “Ninety-nine per cent of the time buyers need to see what’s in it for them,” says Philipps, “but there are times when buyers are prepared to help out suppliers. Even then they will be thinking that they might be able to reduce prices next year.”
Viktoriya Sadlovska, research analyst for supply chain finance and global supply chain at Aberdeen Group, gives the example of European fashion retailer AJT, which turned to supply chain financing after it discovered its Asian suppliers were losing up to 20 per cent of the invoice value to local factoring agents. “Suppliers were able to get finance at 5-15 per cent,” she says. “In return, AJT was able to negotiate a 5-10 per cent discount off the total unit cost.”
But, for Sadlovska, there is an even more compelling reason: the security that comes from knowing that, with a regular stream of funds coming in, your suppliers – and their suppliers – are less likely to fail. “It’s not just about cutting costs but also empowering suppliers and trying to make the whole supply chain less risky and more stable,” she says.
A further, and largely unforeseen, benefit is the technology that comes with supply chain finance systems, giving buyers complete visibility over which goods have been dispatched, when money has been paid and received or when invoices are due for payment. “We were initially driven by good credit ratings and the arbitrage opportunities, but another opportunity was to link the bank systems and ERP systems of the client, integrating and streamlining the entire dataflow,” says Alexander Mutter, senior vice-president of supply chain business, transaction banking, at ABN Amro. “At the moment it’s the same level of importance for the client to have a streamlined process in place as it is the financial benefits.”
Sadlovska points out that while much of the physical supply chain is automated, the financial supply chain still often relies on manual processes, meaning that companies have no chance of taking advantage of early payment discounts even if they wanted to. But with a more transparent process buyers can pick and choose whether to go for extended payment terms or pay early to obtain discounts.
The biggest barrier to overcome is a lack of knowledge, cited by 60 per cent of respondents in Aberdeen Group’s survey (see figure 1, below). But this is exacerbated by poor internal relationships between CPOs and CFOs or group treasurers, which can often be strained or non-existent.
“The required dialogue has not happened enough so far,” says Bernhard Raschke, vice-president, Asia supply networks, at AT Kearney. “It’s only happening now because CFOs have started to take a much closer look at the realised benefits from procurement and understand that sometimes the product savings are more than offset by higher supply chain costs and inventory levels.”
Luc Volatier is a former CPO at Dutch baby-food and clinical nutrition company Numico who is currently undertaking a one-year sabbatical as an executive in residence at the European business school IMD. He believes CPOs must develop a more thorough understanding of the financial aspects and warns that those who concentrate solely on the price and ignore payment terms can actually have a negative effect on the company’s overall working capital. “If I want to increase my payment terms there is a risk that I will have to pay a bit more to my supplier or I might lose a discount I could get by paying earlier,” he explains. “So how do I know if I’m creating value?” He suggests the vast majority of procurement professionals are unwilling to consider anything that does not form part of the criteria on which their bonus is based.
The next step
Whereas financing suppliers to enable longer payment terms and potential price reductions has obvious benefits, some think that the true potential lies beyond this. Raschke believes many banks will offer factoring as a commodity service in the future but says the real benefits for banks lie in taking ownership of inventory and controlling the whole supply chain. Only a handful will be prepared to go this far in a big way, he suggests – which raises the question of whether it’s the banks that are best placed to offer this kind of service.
“Part of optimising your supply chain is to minimise inventory,” he says. “That’s the capability that transportation and logistics service providers, but typically not the banks, might offer. Banks need to collaborate with service providers and specialist inventory optimisation software companies so they can manage inventory-related risks. Unless the bank takes true inventory ownership, you as a company trying to improve your balance sheet will not see the impact.”
There has certainly been a blurring of the boundaries between the services offered by banks and logistics companies in recent years. Many banks have hired senior supply chain figures to head their own operations, while some logistics companies have created their own capital divisions to either work with partner banks or provide their own financial services to clients. One such company, UPS Capital, was set up in 1998 to bridge the gap between logistics providers and financial institutions. “There must be a ‘translator’,” says Andrew Dunbar, director of business development for global supply chain finance at UPS Capital, “an entity that understands both the physical and financial supply chains.”
Guy Dunkerley is supply chain director at Bristan Group, a UK bathroom supplier, and a former analyst with AMR Research. Having researched the concept of supply chain finance extensively during his time at AMR, he believes the organisations that manage inventory should be those with the best visibility of the whole chain, the best capabilities in terms of people or software and access to the lowest cost of capital. “If you could wave a magic wand, you’d create this mythical beast that has got end-to-end visibility and absolutely razor-sharp inventory management skills. And that is either a bank or very closely allied to a bank,” he says.
But it is Dunkerley’s stance as a supply chain director that perhaps illustrates better than anything the hurdles supply chain finance has still to overcome. “It’s marked under ‘a bit tricky for now’,” he says. “I would have to convince the CFO and the MD, get a bank in and if it’s not our current bank I’d probably get someone from head office on my back. It’s just got that ‘difficult’ aura around it. If it was that critical it would have already happened.”
CASE STUDY: BSH
Taking suppliers with you
When German electrical appliances manufacturer Bosch and Siemens Hausgeräte (BSH) realised in 2005 that its competitors enjoyed longer payment terms, it started looking into the concept of supply chain financing. The company also wanted to take some of its existing quality suppliers with it into new markets. “If we request our suppliers follow us to remote areas they need capital,” says Axel Fischer, head of purchasing for the laundry division at BSH.
After initial discussions with ABN Amro, it realised that what it was looking for – a highly automated platform that could be used on an industrial scale and would fit with the company’s existing IT infrastructure – didn’t exist. So it worked with the bank to develop a model that it now plans to roll out internationally after a successful pilot.
“You have to have a lot of functional know-how from book-keeping, profit-and-loss accounts and guarantee it to a certain extent with the banks,” says Fischer. “You also have to convince your suppliers.”
He admits that one of the original ideas was to use this as a means to get suppliers to reduce prices, but the company’s overall key performance indicators suggested that extending payment terms would be more beneficial. “If I take all the money away, how can I motivate them to contribute innovation or improve quality?” Fischer asks.
Nick Martindale (nick.martindale@cpoagenda.com) is deputy editor of CPO Agenda
