Maximising the Financial Supply Chain in Support of Trade Flows
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In the early 19th century, economist David Ricardo outlined his theory of commerce to demonstrate that everyone would benefit if nations conducted international trade with one another. This is based on the fact that one country will always be more efficient at producing a particular product (e.g. wheat) than another country with which it may wish to trade. If the second country focused its efforts on any goods other than wheat, then there would be mutual benefits to be gained if both goods were traded.
Now, 200 years later, the ability to increase efficiency in international trade to the benefit of all concerned is just as crucial. Players in the international trading arena, from buyers to raw material producers, and the service providers who support flows of merchandise – banks, shippers, customs agents, to mention a few – are all striving to make the processes easier, faster and cheaper.
Over the past 30 years, there have been significant developments in making the processes involved in taking goods from the raw materials stage, through production to the ultimate delivery to the end-consumer, more efficient. These improvements have been a result of:
While there have been initiatives to speed up this physical supply chain, the financial services industry has been criticised for its inability to develop at the same pace. This is the case for supply chains that are buyer-driven (as in automotive and other large manufacturers) and those that are producer-driven (retail and textile industries). However, as the latter tends to be more fragmented and decentralised, there is greater room for improving the financial support to all players in the supply chain.
Making the financial supply chain more efficient means reducing manufacturing costs, business process costs and costs related to logistics. But this can only be achieved with a set of financial solutions that are designed around the whole supply chain.
A financial institution can truly assist in creating value for a corporate entity by understanding the entire supply chain and by working in collaboration with other members of that chain, sharing the same vision and dedication to quality and technology. This atmosphere of trust creates a desire to offer banking and other financial services to the supply chain.
If banks and other financial institutions are to be successful in supporting complex supply chains, there is a very important piece to this puzzle that demands the attention of all participants. This is the data elements that are required to cut across the physical and financial supply chains to enable participants to make informed decisions, reduce duplication of effort and enable a bank or other provider of services to add value to the process.
IT developments over the past 10 years have provided global trading communities with massive opportunities to realise their potential and gain an edge over their competitors. The key to unlocking these benefits is the efficient management of data that is created and used by all parties in what should be a simple process of moving goods from “A” to “B”; or manufacturer to consumer. IT does this by:
However, it is becoming apparent to many corporate entities that good supply-chain management is not merely about being efficient and reducing costs, it is also the framework that companies must study as part of a more strategic goal: that of maximising shareholder value.
Chief financial officers (CFOs) around the world are starting to recognise that they have a vested interest in changing the way their corporate entities procure or sell merchandise. There is no better way to translate supply chain efficiencies into cash than streamlining (i.e. making cheaper) the financial needs of all players in the chain. Burdensome costs for a raw material supplier downstream will be transmitted all the way across the supply chain to the ultimate consumer.
Recent research in the American Business Review1 shows that there is greater correlation between the price-earnings (P/E) ratio and operating income than there is between P/E and more traditional methods of measuring corporate profitability (e.g. net income etc.). There should be more focus on top-line operating income than there has been in the past. CFOs should also drill down into the supply chain as this has an important bearing on the operating returns of the business.
The increased use of air transportation has also had a dramatic impact on the way goods are shipped to the consumers. Today, 50 per cent of goods by value are shipped by air, yet they represent only 2 per cent of international trade by volume. (Many believe this is due to the fact that it is not worth paying the extra cost of airfreight for items that are of lesser value and have a high volume-to-price ratio.)
There is a recognition among buyers that they cannot afford to have high-value goods tied up in transit as this carries a cost in inventory that is neither sustainable nor acceptable. This translates into increased current assets, slows the inventory turns and results in higher financing requirements. At a time when the cost of borrowing is certainly going to increase and when the debt ratios of corporations are under more scrutiny, these issues become of paramount importance to companies.
Further, it is not just about getting the finished goods to market as fast as possible; it is also about the overall efficient management of stocks and the way in which goods are housed. Research has shown that it is possible for a company to achieve significant savings by reducing the number of stockholding centres. If a supply chain reduces the number of warehouses from 20 to five through consolidation, the savings for inventory-holding costs can fall by up to 50 per cent as supply-chain processes become more efficient. Evidence of the above considerations is apparent from the inventory-carrying cost as a percentage of the gross domestic product of the US, which fell from some 8 per cent in 1980 to a little under 4 per cent by 2000, as a result of more efficient processes, which freed up capital and cash to invest in other ventures.
Recognising the need for an all-encompassing approach to a supply chain, many large sophisticated companies no longer accept the provision of banking services on an individual product-basis. Those banks able to accommodate cross-functional demands will increase their share-of-wallet from such corporations. Banks that fail to provide an holistic approach to the supply chain will put any existing payments, cash management, trade finance, foreign exchange and other services provided to supply-chain members at severe risk.
This does not mean that banks merely have to provide a fully integrated web-based system for corporate use, or merge their international trade, payments and cash management departments: it requires a much more fundamental change. Banks have to get much closer to the supply chains of their customers and provide many non-traditional services that may include:
Finally, there is one very important area that remains to be addressed, and that is to ensure that a collaborative approach is taken by all parties to a supply chain so that the data obtained throughout the process can be stored, re-used and passed on to bring about even greater efficiencies.
Collaboration is the key if there is to be a common vision and development. Without it, there will continue to be fragmented services and the potential benefits that can be derived from the straight-through processing of information and services will not be realised.
The future of commercial trade is very much dependent upon the ability of all the parties involved in supply chains to agree on the development of common standards and rules to support the transmission of, or access to data, so that value-added financial services can be offered cheaply, in a timely fashion and with reduced risk attached.
The financial supply chain has to be driven by corporate bank initiatives such as the SWIFTNet Trade Services Utility (TSU) where banks share a matching and rules-based engine, which compares and associates data elements from corporate documents. This, coupled with various industry verticals (such as RosettaNet3), is where banks can truly add value for their customers and their own stakeholders.
It is not only the immediacy that must be understood when discussing the supply chain, but also the need for a visionary approach to determine how players will interact in the years to come. This is fundamental, because if we all seek near-term results without considering the longer-term implications of unilateral or bilateral actions, there is little chance of the trading community benefiting from common standards and rules through which all parties can communicate effectively.
1 “The Profitability of Earnings-Price Trading Rules Based on Operating Income”, Prof. Tony Kang, American Business Review, June 2003.
2 XML: Extensible Markup Language.
3 RosettaNet is a consortium working to establish an industry-wide e-business process standards and language for use between supply-chain partners.