Nick Martindale (NM): How many of you have given serious consideration to implementing supply chain finance schemes in the past couple of years and what are the motivations behind that?
Raees Lakhani (RL): We have been implementing one aspect of supply chain finance within a company that was low-cost resourcing. It was against a background of thumping the table and bringing the supplier prices down. We wanted to move this supplier relationship management forward to a different level by offering the supplier some incentive at the same time. One of the ways we did it was by helping the supplier to factor its invoices. The idea was that it would save a lot of time and effort in terms of paperwork and the supplier would get cash up front to maximise its working capital. It was an effective way of getting the supplier on board.
Stephen Wills (SW): Financial services is such a highly regulated sector, so when what is perceived as a slightly tricky or complicated financing arrangement is taken to one of our executive directors, there is a huge warning bell that sounds with them because of the Financial Services Authority and issues such as money laundering and the way in which financial services are regarded.
Eamonn Phillipson (EP): I would go along with that, certainly in my early days of trying to work out some of these conundrums. My last employer was an American company so it needed to be aware of Sarbanes-Oxley too. I see very much the situation of thinking “I’ve got a good idea” and then you go to the man at the top who says: “We don’t have a rule to cover that; how do we deal with that?”
Andrew Betts (AB): We’ve definitely seen increased demand for supply chain finance in recent months, and currently we’re running more than 200 active programmes in 30 countries. The issue of business continuity risk comes up much more now than it did perhaps 12 or 18 months ago. For example, a Chinese manufacturer with operations in Taiwan and Vietnam had a very strong investment with a European buyer, but was not in the best of financial health. Therefore it was in the interest of the buyer to look at how it could support the financing of one of its core strategic suppliers. That has happened for years, but the current economic situation means that it has become more high profile. Supply chain finance is a solution to a problem that exists now so it becomes a focus for market investment and innovation.
Ray Moore (RM): There is – or was – a lot of suspicion in the marketplace around supply chain finance schemes. It is not financial engineering in any way, shape or form; it is standard trade but on open account. I spend a lot of my time educating and giving consultancy to companies to get over this particular issue.
EP: Taking that semi-standard approach and moving it forward in today’s climate, what are the mechanisms that the finance community prefers to make risk assessment a reasonably fast and effective part of the process?
RM: Predominantly, supply chain finance schemes are based on the buyer’s financial strength. Ultimately, these schemes are put together on what we call a hell-or-high-water obligation from the buyer that says that once you have had your goods delivered and you have said that you will pay for them, you will pay for them.
From a governmental perspective, it cascades money back down the supply chain and assists the underlying supplier, which may be a strategic supplier to a company, from a working capital position. If a company is in financial discomfort through a lack of working capital provision caused by large buyers extending or having extended settlement terms, then how better to address this than through a structured supply chain finance scheme with a trusted financial partner sitting in the middle?
Ultimately there is a win-win-win here: the supplier wins because it gets an additional working capital line priced at a reasonable interest margin, the buyer wins because it may be able to, from a procurement perspective, potentially reduce its inbound cost on the back of the scheme – the credit arbitrage – and the bank wins because it is not taking “wholesale” supplier risk and has confirmation from the buyer that the goods delivered appear to be in good order and that it will pay for these goods on a specific day.
RL: The reality is that you would offer a service like this to your supplier only after vetting it and having a strong relationship. You’re not going to offer this to a supplier that you are not aware of.
EP: They may not be strategic in some senses, for example if you only require a certain product, a service or a project for a period of time or you have a strategic supplier that is taken over by a competitor. Then you need to work with those people because we have an exposure and may need to reverse out of that engagement, both for us as the customer and for you as the finance supplier.
David Loseby (DL): Having had the luxury of having worked on both sides of the fence, it is interesting to see it from the two perspectives. For me it is about doing the right level of due diligence, and not just being wholly reliant on a piece of paper that says: “I have insurance-backed asset finance.” It simply doesn’t work that way; it should be another instrument in the toolbox to be used at the appropriate point. Also it’s about being selective and using it in the right way, particularly where you have key commodities or products at risk.
Having seen asset finance from the banking side, the component that was always missing was people with a trade insight and understanding of marketplaces. They were looking at it purely from a financial perspective. That has moved on over the past few years, but there is still a way to go in terms of putting that into a trading context and removing some of the layers of bureaucracy. I have seen organisations that have said: “That is way too complicated; I’ll just cut a deal that says I will give you a two per cent discount for advanced payment.” When some of the complexities of the arrangements are taken out it will become more attractive.
SW: Where I see a new opportunity is in vendor risk management. A lot of the deals we do are on behalf of the business. We don’t walk away from it – we put in governance checks where we do reviews with the suppliers – but it is largely owned by the business. Where we have a new opportunity is to move beyond doing the deal to make sure that the tools, the process and some expertise supports the business clearly on reviews, due diligence and vendors going out of business.
DL: When the financial crisis hit, I was working in manufacturing and the speed at which the credit risk insurance was pulled away was phenomenal. It’s a question of asking how you can integrate the totality of the deal with all the insurance, the financial, the rigour and the strength of the relationship that you have, not only with the first-tier suppliers but right the way down through to second and third-tier suppliers. Getting that closeness to the extended supply chain takes a lot of effort so you have to be really clear that this is a strategic piece of work which you are doing for the right reason and which is going to deliver some long-term benefit, not just a quick fix.
Tracy Stephens (TS): Being a sceptic is okay, because these are very complex situations. I would come back to what are the priorities of the organisation and the CPO in the nature of this relationship. Is it more risk management or compliance and how do you judge the time and complexity split, because you don’t want to get involved with helping financing vendors – even the strategic vendors – in principle?
EP: The key is to be able to make the evaluation, to know your supply network or your supply chain well enough. If you are not in tune with the entire process – the value-add process – then you won’t be in a position where you can rush off to finance.
RL: Shall we hear from Alex, as a sceptic? Where does that reluctance stem from?
Alex Mayfield (AM): I don’t see a clear view as to how a supply chain finance scheme is anything but a tool that is added at some point to the process. Technology makes it easier and gets rid of some of the administration and I can see some of the advantages. Dynamic discounting could be quite exciting because it allows you to make a decision depending on what you feel your cash position is and give a value to your cash versus somebody else’s. I remain a sceptic purely because funding someone else’s R&D has been around for years. Going and buying raw material because the supplier you want to use can’t afford to fund the working capital has been around for years. If you understand your supplier base, you understand where your critical suppliers are, you do your due diligence on those suppliers and then you ascertain whether or not you need to support them. The first principle is that you don’t. I just don’t see what I am looking at in terms of a panacea; I just see a tool and technique that is prevalent at the moment because of the financial situation.
RM: It really comes back to how complicated you want to make supply chain finance. To take away the risk you just alluded to, which is that you don’t want to be supporting a supplier’s R&D, you keep it very simple. You make sure you have the goods and you accept these goods and you may then want to extend days purchase outstanding or take some form of rebate in respect of a reduction. The key is that you have received the goods and are willing to pay for them on a pre-defined date.
Going back even further into the supply chain and putting structures in place to support suppliers on raw material sourcing can be done but these are typically more complicated and are really predicated on what the underlying supplier wants. Does it want stock off its balance sheet? If so, risk can be transferred to the financier, which will charge the companyfor this. The financier will also look to see where it can sell anyasset that the buyer may leave with it, which is usually seen ifdefault occurs.
AB: Another aspect is that banks are now working together more, because typically no one bank is willing to invest a billion dollars in an individual programme. We’re seeing club deals and syndicates come together because companies are asking for that level of credit to support their suppliers, and in cases when the risk of supply disruption or counterparty default is a serious business issue.
EP: Even in a cash-rich company, the CFO would still like to make a bit more on the bottom line from their cash, avert some risk in the supply chain or invest some of that cash to reduce the cost of the product that is coming through.
AB: Ultimately, there is a finite level of credit available to a business from each of the banks. Interestingly, the companies are also taking an increasingly rigorous approach to their suppliers, and are typically only rolling these programmes out to their top suppliers or those in immediate need.
In our experience, when we go to the suppliers and ask them to join the programme, they are more likely to engage if there is a relationship based on trust and a sense of genuine partnership with the buyer. Conversely, if the supplier is generally being pressured on payment terms and feels compromised on quality output, they are not going to sign up to a financing programme where the credit line can be withdrawn at any time.
Paul Kimber (PK): For us, it was both the severity and the speed of the change in the economic circumstances that really moved us from looking at this as something that was perhaps nice to do into something that we really had to do. It was suddenly very much top of the agenda in terms of the board. The relationship side was also another driver for us. We know that things will ultimately get better. One concern that we do have is that if our supply chain is on its knees and can’t finance its operations or get access to credit and capital, then when the orders start coming back, our supply chain could be weaker compared with our competitors’. The way we are doing this is not complicated; it is more on the payable side, but we see it as a lever that is appropriate now, whereas perhaps last year it was too hard to do.
In our case, we were really worried about the smaller guys. We have perhaps 80,000 items that we buy from companies around the world. They supply other affected sectors, such as automotive. It was not as though we were creating something that competitors could benefit from, but it was something positive we could do – using our creditworthiness – to protect the supply chain.
EP: I have certainly done things that my competitors could gain from and my job is to make sure that I gain more than them. The question was: what do you do with a small company and where does supply chain financing start in the order of company size?
PK: We buy from a number of small suppliers with turnovers around £5-10 million. They are reliant on overdrafts and short-term financing facilities. Suddenly, they found themselves with maybe only have three or four months of working capital and a potential black hole in their finances. There are other approaches that we have taken to manage the risk, but this is one thing we have been able to do on the positive side to help.
RM: The level of turnover we see supply chain finance working to can be low as £250,000. There are issues in respect of return at low levels of activity, of course. This is a key issue, because it does take time to put schemes in place but we are working with a number of retailers at the moment that are looking at widening their supply chain quite substantially. Some of these can be classified as just-in-time ordering mixed with a lot of produce coming from Asia or eastern Europe. One company has requested that we support, from a supply chain finance perspective, suppliers that are selling small batches of wares on a frequent basis. You can take it down to a pretty low turnover, as long as there is something in it for the provider. It has to be economic otherwise it doesn’t make sense.
EP: Obviously the proposals come to you from the top down. Do you ever have the route in where the supplier comes to you?
AB: Yes, that is a question we get asked regularly. Suppliers approach us with: “We are pretty confident you work with X high street name, which we think has a very strong credit rating, so we want you to advance us credit but we don’t want you to tell X.” That is difficult for banks to deal with as these types of programmes are not really suitable for undisclosed transactions, primarily because the credit available on a name is usually relatively limited. More importantly, in today’s environment, the corporate buyer will want to know exactly what its credit availability is and to manage it very precisely, pound by pound, dollar by dollar.
TS: The ultimate client is the one who is financially responsible for paying back the working capital loan. Does that make much difference to you if you are going to lend that supplier money based on its contracts?
AB: The best way to structure a transaction is to start from the strongest counterparty in the supply chain. That has an inherent challenge, however, because the strongest counterparty generally knows it is the strongest and is sometimes not prepared to have its credit dispersed throughout the supply chain. To be honest, banks are instructed by companies not to structure financing programmes two tiers down on their names because inevitably it undermines the credit rating of the strong company as a single entity, and that will in turn reduce the availability of its credit in the future.
NM: How important is working capital as a driver of supply chain finance?
DL: I was told very explicitly by the CEO of the business that I previously worked for that working capital was almost the number one priority now. The whole dynamics within the marketplace have shifted it right the way up the agenda. For me, it should always be a focus, in terms of understanding cash flow, irrespective of the market conditions.
PK: The agenda certainly has changed in terms of priorities. The pull from both the board and the owners of our company have broadened the scope of what historically we have been involved with. They want us to lead the initiative: to provide the strategy, to collaborate with finance and other parties within the business and provide a solution to some of these cash issues.
NM: The pressure to improve working capital is at odds with the supplier risk element. If you don’t have a solution along these lines, that is potentially going to cause a lot of problems with your supply chains.
PK: We were also attracted by the concept of supply chain finance for that reason. Rather than it being a war over cash between suppliers and customers, this is a way, to some extent, to take a bit of heat out of that battle and to provide a solution to some of our suppliers’ problems. But it is not a panacea.
NM: We have covered the theory and some of the more basic elements, so now I would like to move on to how things work in practice and what the issues are in terms of getting suppliers on board and talking with the banks. What are your experiences here?
SW: I wonder whether we have the capabilities for what we are talking about today in our teams and whether procurement training and education really equips buyers for what we are discussing. For me, it’s a bit of an inhibitor to navigating our way around some of the financial instruments that can help us, because the buyers that I recruit and I interview are probably more classical and traditional with their toolbox and their toolset and their capability. If we broaden that, we would see a lot better understanding of the debate and the suspicion that exists around it could be cleared.
DL: I can imagine that for people who have worked within either one sector or in one particular area of procurement for a substantive part of their career, to suddenly be presented with something like this is just a step too far and is putting risk into the whole decision-making process, frankly. The fundamentals for me are if you are going to do this then ensure you have the capability and if you haven’t then be very selective about how you might bring in that capability. Also key is how you transfer that knowledge, capabilities and skills into the organisation.
When I was working within the banking sector and talking to the sales and asset financing guys, you would hear them muttering under their breath that “these guys just haven’t a clue”. As
the process went on, you could see that their appetite for doing this just waned on a reverse exponential curve. There has to be a confidence within the financial sector that the people who they are going to trade and deal with know what they are doing. I would like to think that from a procurement professional standpoint we are in the right position to take the lead. My biggest fear is how we address what I call the skills and capability gap in bringing sufficient numbers of people through that have the understanding and experience to deliver. That is not about sending them on a course; it is much broader and wider than that.
RM: The best way to cut your teeth is to get in front of a supplier and understand the issues they are facing and then put in place a practical solution in conjunction with the buyer. We have done this with a retailer in Asia where a supply chain finance scheme is rolling out across four different jurisdictions at the moment. Who is driving this? It is the underlying buying organisation and the bank working in collaboration. The scheme works because we have sat down and said: “These are the issues, these are the solutions and this is how it works.” This message then needs to be relayed to the supplier whose core competence is not understanding the intricacies of supply chain finance but making garments to a specification. You get this message over by holding supplier conferences, producing factsheets and delivering these messages in the country of the supplier (Hong Kong, India, China and so on). It is an evolutionary educational process and you are not going to solve all issues faced on day one. It is again using the bank’s and the buyer’s expertise.
AM: The banks have a challenge to make it simple, in terms of explaining the value of the different items that they want to sell in. The thing that we, as a procurement profession, need to challenge is not necessarily getting all our guys qualified in the best finance schemes, but to get our core capability of innovative thinking as to: “Is this appropriate to my category? Can I extract some value? Is there a different way of doing it?” Dynamic discounting may have some real interest for us because it allows you to value your cash on an ongoing basis and potentially to change the value of that cash and allow your supply base to see its value as well. That is an interesting tool and technique that we might take forward. I am not convinced one size fits all. You have to be bespoke in terms of how you approach it and you have to take it as you would any other process of understanding your supply base, deciding which tool fits where and then using it to the best of your ability.
RL: At which end of the supply chain is there more exposure to the supply chain financing? If you take it from a buyer’s aspect of a procure-to-pay supply chain, is the supply chain financing more at the top, the upstream end or the downstream end?
AB: It is all the way through. There is a lot of activity on the receivables financing side, particularly following the breakdown of the asset securitisation markets. Whereas in the past, large organisations would take significant pools of receivables and move them into an asset securitisation structure, now that market has largely disappeared and we are instead seeing significant portfolios of trade receivables on business-to-business-type transactions coming to market. Distributor financing is another key aspect. Again, in previous years it was always “let’s look at risk transfer mitigation on to a bank”, but now companies are saying they will share that risk with the bank.
DL: Presumably you layer them in terms of saying this is how far down the supply chain you will go and therefore make that part of the deal more palatable? Beyond that, it is almost like saying “you’re still on your own”.
RM: Also focusing on the receivables side, a seller will look to sell all future risk and reward to a financial institution covering its book. Banks will take a view with the buyer that the risk is on the seller’s balance sheets – the buyer’s non-payment risk in the main – and it will not take on this risk without being adequately remunerated. This is usually a difficult discussion as the jurisdictions the companies will typically offer you are those where there is significant risk. Typically we might do one or two distinct lines where we know the company but will look at avoiding excessive risk.
DL: If you look at the wider agenda, you are far more likely to get into the right deal and to get a lot more out of it in terms of value add than you would by extending your credit line from 30 to 60 days. I would want to see a lot more things come out of it, whether that’s in terms of locking out competition or being able to rapidly ramp up production capability.
Often some of these companies will not have the capability to ramp up production. The next barrier is “okay, we have increased production by 20 per cent, but now we need to invest in new equipment and new lines” and then you get into the next round of issues. For me it is looking at trying to do some modelling and scenarios in respect of different aspects of how you can make this deal work; not only the financing piece. Finance is only one element.
RM: We’re working with a buying company at the moment and it is constantly looking at the insurance marketplace about the cover it provides. Unfortunately there is little credit cover available on this particular buyer although it is in pretty good shape from a credit perspective.
The CFO has looked at this as it is stopping his business expanding. We contacted him and said: “Insurance market, supply chain finance; why not compare the two? Both provide a similar function and that is taking out the payment risk of the buyer. Given this, why not put in place a local supply chain finance scheme to replace or supplement the insurance cover the suppliers have in place.” And that is exactly what it is in the process of doing.
DL: Where companies have gone for extended payment terms, officially or unofficially, suppliers know that when their time comes they will bite back just at the point when you really need them to be there to help you expand your business and seize opportunities in the marketplace. You won’t be in a position to do it, because the first-tier and second-tier suppliers that you have used will not play ball with you.
EP: That is one of the best reasons why your suggested approach is the only approach: don’t only focus on whether you can trust the bankers or not, look for opportunities to take advantage of today’s situation because it isn’t only about today.
NM: Just picking up on the return on investment, Alex, as you mentioned the dynamic discounting, does this become a bit more appealing from a procurement perspective, if not perhaps now in years to come?
AM: We are not looking at it from that point of view. Our aim is to reduce the total cost of supply, but it is more about the broader supply chain side. We have historically been involved in the physical flow of materials, increasing the information flowing downstream in terms of supply chain, but this financial flow is just helping to bring the whole thing together as well in terms of total cost of supply. To some extent, it is moving our procurement focus away from levers and opportunities in terms of us versus the suppliers; they are just trying to look at the broader picture to take costs out of the supply chain.
TS: From a procurement standpoint, you have to have an economic advantage or you are trying to reduce your risk. There is no other reason why, from a procurement/supply chain perspective, you should do anything in this business besides one of those two. From a US perspective, the word “finance” and the word “scheme” don’t go well together in the same sentence right now. You have to be careful about what is the reasoning for getting into this area of the business and it has to be for reduction of risk or for a competitive, economic advantage.
AB: I agree that you have to be cautious in how you approach supply chain finance programmes. Banks have to maintain a distance between ourselves, the company and the suppliers, and the facility needs to be maintained as a trade payable. If not, you run a risk of this being reclassified as bank debt. There is an accounting treatment issue for these type of programmes as well, which is quite demanding, particularly in the US. You need to bear in mind that this is an underlying trade transaction and that we are operating in that way. It is not a loan to the company that is then being paid to a group of key suppliers.
NM: Rachael, is this an area you have looked at in your research and has it shot up the agenda?
Rachael Stormonth: Without doubt, particularly in the US, in high tech and some areas of industrial. Finance schemes can be used as a tool that provides potential opportunities to make procurement add value to the business. At that stage, and only at that stage, will the procurement function ever merit a seat on the board. I think the recession gives us that opportunity.
DL: It does. For me it is almost like shaking off the old coat of simply being a purchasing or buying function and becoming a commercial business partner. Once you have achieved that status and earned your respect at the relevant tables and are seen to be a commercial business partner, you tend to get the invite to the board as opposed to just banging on the door without hearing what is going on on the other side.
EP: What interests me, having worked for some companies that have seen the light or have been shown the light and some that have not, is that every company that I have worked for as a director on the board recognises that whether it is boom, recession or business as usual, they are all opportunities. If procurement is not aware of where we are on the economic cycle and how to play the best on that game, long term, then we only have ourselves to blame.
TS: The seat at the table has to be earned by taking responsibility, being a leader and making results happen, whatever the results or the priorities of the organisation. Where CPOs are getting a seat at that table, procurement is not merely a department but a function that goes typically across every area of an organisation, educating the business about where it needs to be and then executing the results – then you come to the table.
This debate took place in London in September, in association with Resources Global Professionals. For more CPO Agenda Executive Debates, visit www.cpoagenda.com/debates
