How Can E-Payment Improve the Supply Chain Process?
In the last 20 years, companies have spent millions of dollars improving the ways in which they source and distribute goods and services. Manufacturing companies, in particular, are scouring the world for materials that will be shipped thousands of miles away to be manufactured and distributed to sales sites in all four corners of the globe. Complex supply chain systems allow large companies to manage this process cost-effectively. In fact, according to Professor Warren H. Hausman from the Department of Management Science and Engineering at Stanford University, a company’s success is shaped as much by the performance of its supply chain as by the end product it manufactures.1
The Internet has further transformed the supply chain process. The term “e-business” is commonly used to describe the “planning and execution of front-end and back-end operations in a supply chain using the Internet”.2 From grocery stores to computer manufacturers, the Internet allows information to be integrated across the entire organization. This integration allows companies to monitor and forecast demand more accurately and allocate assets more productively, while improving customer service with a more responsive and consistent user experience.
Many leading companies are harnessing the Internet to improve their procurement processes. For example, a large US-based technology company has implemented web-based software that allows it to compare contract terms with purchase order (PO) information to identify inconsistencies. If the PO is above the contract amount, the system alerts the buyer. If the PO amount is lower than the negotiated figure, the software alerts commodity managers to possible savings opportunities.3
Despite the efficiencies gained from investments in supply chain management, these improvements stop just short of resolving manual payment processes. As a result, business-to-business payment has not seen a corresponding increase in efficiency in the last 10 years, despite the availability of automated payment programs from organisations such as Visa. Most companies have not integrated payment into their supply chain management systems, resulting in inefficient financial processes. This is a curious anomaly since, as will be discussed later, automating payment can benefit not only the payment process but the supply chain as a whole.
What do we mean by “inefficient financial processes”? Most companies manage their financial flows manually, using paper-based invoicing and payment systems. Initiating, tracking and reconciling these paper-based invoices and payments can be a significant part of a company’s treasury costs. In his white paper on supply chain efficiencies, Professor Hausman uses the example of a European car manufacturer that has 385,000 purchases a year, with a value of €33m from 6,500 different suppliers. A Datamonitor survey found that paper-based procurement transactions cost approximately €77.50, often more than the goods purchased. Given the scale of these financial flows, it is surprising that payment remains such a low priority for most organisations. Payment routed through each party’s bank should be considered an integral part of the supply chain process.
Manual processes – When all of the companies along the supply chain use paper-based payment systems, it is extremely difficult to track accounts payable (A/P) and accounts receivable (A/R) efficiently. For example, a tea distributor in the UK might buy £2m in tea from a supplier in Asia each quarter. This figure may correspond to six different invoices generated by the supplier. Nevertheless, the tea company may consolidate all these invoices into one payment which, with exchange rate fluctuations, may be difficult for the supplier to reconcile against the various invoices it has outstanding with the tea company. The tea company faces similar challenges with reconciling its own A/R. In most cases, companies will make an effort to match remittances with invoices for their suppliers, but this requires a commitment in time and resources.
Lack of timely information – For many companies, financial flows do not include enough information about SKU numbers, item quantities and PO numbers. This burdens companies with the extra responsibility and cost of manually tracking this detailed information.
Lack of compliance and spending controls – Because spending in many companies is done on an ad hoc basis, it is almost impossible to monitor and enforce compliance with corporate spending policies. Companies that do attempt to enforce compliance without an automated process often find themselves in a lose-lose situation, with compliance escalating the cost of low-value purchases.
Delays in invoice reconciliation – Companies today face challenges reconciling invoices, POs and shipping receipts. This leads to significant delays in invoice reconciliation, resulting in payment delays and an increased need for working capital.
One of the unfortunate by-products of financial inefficiency is an increase in working capital requirements. Companies need working capital in order to deal with variable financial inflows and outflows. Tying up working capital is a serious problem for companies, as it prevents them from investing these funds in areas that will help grow their business.
An increasing number of companies are looking to streamline financial flows as part of their efforts to improve supply chain efficiencies, thereby reducing processing costs, which increases profit margins. The good news for companies is that transaction processes can be improved relatively easily using existing payment platforms and technology.
Electronic purchasing cards allow companies to make procurement easier and more cost-effective. Purchasing cards can be used to buy anything from office supplies to capital equipment. They provide companies’ treasury departments with aggregated data on all procurement spending across the company. This allows companies to empower employees to make purchasing decisions while maintaining centralised control of spending and compliance.
RPMG Research estimates that using purchasing cards results in a 74 per cent reduction in the procurement cycle time. The same programs can also help companies reduce petty cash accounts by 57 per cent and reduce the number of suppliers in the MRO supplier base by 42 per cent. The RPMG report also concluded that US companies using purchasing cards saved US$23bn in 2002.
A European car manufacturer implemented a purchasing card program for indirect materials. The company managed to reduce its processing costs by 50 per cent and processing time by 56-80 per cent. These savings allowed the company to reduce its inventory by 22 per cent and save 5-12 per cent in purchasing costs due to more efficient sourcing of materials.
Distribution accounts can be used by distributors and wholesalers to automate the A/R process. Companies provide distribution cards to their retailers, thereby shifting the burden of chasing invoices to their bank. This compresses the A/R process and allows companies to transfer sales proceeds into working capital more quickly. When a shipment is delivered to the retailer, it pays for the goods using the card. The distributor authorises the transaction centrally and its bank settles the funds and reconciles the transaction data. This provides a financial tool to finance small buyers, while eliminating cash transactions and reducing risk. These functions help to increase sales and at the same time reduce the costs of transactions and processing.
Integrating electronic invoice presentment and payment (EIPP) systems with supply chain management saves companies time and money. EIPP tools allow companies to view detailed invoice-level information and remittance details. This eliminates the errors common in the manual processes mentioned earlier.
Many best-practice companies have harnessed the power of the Internet to consolidate and access financial flow information. For example, companies can use the Internet to provide their suppliers with online access to the status of their invoices. This can reduce the cost of maintaining call centres to handle supplier inquiries.
Electronic payment platforms from organisations such as Visa allow companies to manage payment information using Web-based tools. This enables treasury departments to access line-item details on all of their invoices and expenditures, including travel and entertainment expenses, procurement, and large-value transactions.
General Electric saved as much as 12 per cent of its accounts payable, or US$1.8bn, when it introduced an EIPP system in 1999. GE recorded a 61 per cent drop in paper invoices, a 50 per cent decrease in accounts payable staff and the elimination of an accounts payable call centre in the first year the EIPP system was operational. GE also managed to capture 90 per cent of allowable discounts worth US$100m that year.
Product supply chain management can be measured against three key performance indicators (KPIs)4:
Efficient financial flows can directly and positively impact customer service by ensuring the smooth delivery of goods ordered. Equally, improvements in supply chain design and operation may reduce inventory levels, thereby improving C2C. Also, innovative payment systems, including distribution cards and EIPP, can reduce A/P and A/R for companies, resulting in less working capital requirements. Finally, financial flow efficiencies can influence a company’s inventory. If a company has unexpected delays in cash receipts it may force them to delay ordering new materials due to working capital constraints.
Supply chain management is an integral part of today’s business world and the catalyst for the growth of global sourcing, manufacturing and distribution. However, most companies have not prioritised the automation of payment processes with the same degree of urgency. Fixing the supply of material goods without considering payment is the business equivalent of stopping the race without crossing the finishing line. Best practice companies are going the extra mile by integrating financial flows as part of their overall supply chain management systems. In quantitative terms, companies that embrace existing electronic payment solutions could save almost US$10m annually per US$1bn in revenue5 (see figure below).
The good news for companies is that payment solutions exist today that can add significant advantages in terms of saving time, reducing cost and increasing visibility. What’s more, these solutions have been designed to integrate seamlessly with companies’ existing supply chain infrastructure. The net results are measurable benefits for suppliers, manufacturers, retailers and consumers.
1 Financial Flows and Supply Chain Efficiency – A Visa Commercial White Paper – 17 January 2005.
2 E-Business and Supply Chain Integration – Hau L. Lee and Seungjin Whang, Stanford University – November 2001.
3 Supply Chain Performance Managements – Hau L. Lee, Stanford University and Jason Amaral, See Commerce – October 2002.
4 Hausman, Warren H., ‘Supply Chain Performance Metrics’, Chapter 5 in The Practice of Supply Chain Management,edited by Corey Billington, Terry Harrison, Hau Lee and John Lee; Kluwer, 2003.
5 Process improvements and cost savings for accounts payable (A/P) and accounts receivable (A/R) have created 30 to 70 per cent reductions in these costs. Assuming these costs represent 0.5 per cent of revenue, then the savings for a $1bn company would be approximately $5m annually.
A typical $1bn company has $148m invested in working capital: working capital ($1bn Co.) = (54/365) * $1bn = $148m. Increased visibility to A/R and A/P flows could reduce uncertainty in financial flows and thereby reduce WC needs by 10 to 20 per cent. A 15 per cent reduction represents $22.2m for a $1bn company: 15 per cent working capital reduction = .15 * $148m = $22.2m. The annual savings is calculated by applying a company’s weighted average cost of capital to this value. Suppose a company’s WACC = 15 per cent/year; then the annual savings from reduced WC would be $3.3m: annual savings from working capital reduction = .15 * $22.2m = $3.3m.
For a $1bn company, the value of a four-day reduction in DSO is nearly $11m (USD): value of reduced DSO = $1bn x (4/365) = $10.96m. If the company’s weighted average cost of capital (WACC) is 15 per cent/year, then the annual savings is $1.6m: annual savings of reduced DSO = 0.15 ($10.96m) = $1.6m. Total annual savings = $5.0 + $3.3 + $1.6 = $9.9m.