Charting New Territory in Working Capital Management
For most companies, there is major room for improvement in working capital management. Advances hinge upon automation and integration of the financial supply chain. The financial supply chain at most companies is fraught with inefficiencies that cut across multiple subsidiaries, departments, and financial institutions. The order-to-cash process consumes significant time and resources: 30 days is typically a minimum, while 120 days is common if there is a dispute. Most companies have, at best, automated only fragments of the financial supply chain, and only the largest corporations have established buyer-supplier connectivity via electronic data interchange (EDI). Consequently, companies are saddled with excess working capital generating little or no return.
Companies are gradually realizing that their current financial supply chain practices are not sustainable. They must eventually move from the manual quagmire to the electronic realm. Most, however, will not move quickly for want of resources. While the drivers that motivate change vary, the list is short: cost containment, competitive pressure, working capital pressures and compliance issues.
At most companies, an integrated and fully automated financial supply chain is unknown territory. Few have figured out how to tackle connecting disparate billing, accounting/enterprise resource planning (ERP), and payment systems across subsidiaries and geographies and banks.
But there are companies that have begun mapping the e-financial supply chain landscape. Celent estimates that 38 per cent of Fortune 1000 companies have implemented either electronic invoice presentment and payment (seller side) and/or an order-to-payables solution (buyer side). For mid-size companies, the share is likely to be around 25 per cent, according to IOMA AP Department Benchmarks and Analysis 2005. The adoption curve, however, is still relatively shallow, with few companies moving beyond piecemeal transaction level improvements to process level improvements.
At the transaction level, the migration to electronic payments is still in its nascent stage. From a purely economic perspective, the continued use of checks in business-to-business payments is baffling: they are far more expensive (often 10 times ACH) and they add days to the cycle time. From a business process standpoint, however, the reason for companies’ steadfast use of checks comes to light. First, the process, though grossly inefficient, is not unusable. Second, the process upstream of the payment is typically manual. Hence, companies face a chicken-and-egg syndrome: do they migrate upstream processes to the electronic realm first or migrate the end-of-the-chain payments to ACH?
The only way to completely map this unchartered area is through cooperation and collaboration between companies, third-party technology providers and banks. Orchestration across systems and standards development must take place for the entire financial supply chain to be integrated. Companies must press their suppliers to build electronic bridges and participate in developing and implementing standards. Financial institutions must be willing to invest based on long-run benefits instead of focusing on questionable short-run gains. Technology providers must implement application programming interfaces (APIs) and adopt standards in order to remain at the forefront.
The elegance of the concept of end-to-end financial supply chain automation is hard to deny. The providers of EIPP and order-to-e-payable solutions want to slay the paper dragon in one sweep. They are finding, however, that the one sweep elegance gets mired in multiple departments and business processes. Moreover, different economic arguments resonate with each stakeholder. For example, procurement may care relatively little about discount capture because historically only a small percentage of their suppliers have offered it and because they are accustomed to being rewarded via rebates from purchasing card usage. Accounts receivable may be taking heat from sales and customers for an antiquated billing/invoicing system and want to focus solely on that pain point. Treasurers are increasingly interested in the big picture (end-to-end automation) because the resulting transaction visibility and cycle time reduction facilitate their cash flow forecasting.
Companies are beginning to speak out: they want easier systems integration, more automation, and fewer bank partners. Although they are not a majority, treasury innovators are found not only in the global corporations but also among an increasing number of midsize companies. Many companies with foreign operations are aggressively reducing the number of their bank providers. A common approach is to retrench based on currency instead of geography. The euro is facilitating the process with only the fittest of European providers left standing to serve multi-national companies.
Banks risk being marginalized or ostracized if they do not improve their electronic bridges to treasury services customers. Early mover companies have proven that they will build if their banks do not, and they will enlist other third parties. These companies, including Lucent Technologies and Ericsson, have already led the charge in building in-house banks and payment factories, sending a strong message to banks. Companies that are implementing third party treasury systems are relying on their treasury system for working capital related information, placing their bank at the back end instead of the front end.
Fortunately for banks, regardless of how much a company achieves internally, it still relies on them for payment clearing and settlement. Moreover, companies are finding that they can raise their STP rates by partnering with banks. To the degree that a shared service centre has to sell itself internally to the lines of business to justify its existence, it has to constantly be seeking and realizing efficiencies. Consequently, banks still can play a critical partnership role.
To date, banks have played a relatively small role, compared to ERP vendors and point solution providers, in mapping the e-financial supply chain landscape. However, their potential role is nearly boundary-less, and expansion is no longer merely a choice but an imperative.
Treasury services is essentially a price times volume business whose profits are caught in a vice: rising commoditization of transaction services, attendant fee erosion, and increasing infrastructure costs compounded by slow growth in select products. Most banks estimate that around a third of mid-size and large companies are either in the quest to lower their bank fees and/or reduce the number of banks they use. These initiatives translate into heightened competition and an imperative to improve a bank’s value propositions.
Fee pressure is being felt by most banks and across a majority of their wholesale payment-related products. Companies ranked reduction in bank fees as a relatively high priority in a Federal Reserve Bank of New York survey. As a result, they are increasingly scrutinizing their bank fees and demanding greater discounts. Compounding banks’ situation is the cost albatross of their payment infrastructure. Most banks grapple with multiple payment systems, many of which are proprietary and use different formats. Global banks manage a web of domestic and international cross-border systems. Consequently, payment processing tends to consume a greater proportion of operating costs than its share of revenues, resulting in below average margins.
These pressures have led numerous banks to examine their payment-related businesses and take a defensive posture, rationalizing those that generate low or no profits and/or are subscale. For example, many banks have chosen to exit certain businesses completely, such as retail lockbox and trade finance, and offer them through a white label provider. Leading treasury banks have also taken an offensive posture, undertaking massive IT restructuring projects and exploring new business opportunities along the financial supply chain.
As a result of these pressures and trends, the competitive landscape and infrastructure will shift. Today, large companies deal with over five banks, which have been selected based more on geography than best of breed and which often require the company to implement proprietary connectivity and formats. In the next 10 years, companies will deal with less than five banks selected on ease of systems integration, cycle time reduction, and least cost routing. Banks will have to be responsive to companies’ needs and demands even if that translates into cannibalizing traditional businesses in order to build a future in a growing business.
The gradual electronification of the financial supply chain is certain. Companies will turn to non-bank providers if banks are unable or unwilling to help them navigate the integration and automation rapids. Unless banks build bridges to customers’ archipelago of systems they will be relegated to the low-margin custody, clearing, and settlement business while others win in high-margin, integration, and information-related businesses. Only by venturing along the financial supply chain and adding value through system integration, business intelligence, and electronic payments can banks stem the erosion of revenues and margins and secure a position in the new world of working capital management.