Getting Supply Chain Finance Right
The credit crunch has increased the pressure on corporate treasurers who have to grapple with less liquidity than existed 12 months ago. Yet from somewhere, somehow the business needs to be financed. For a treasurer, this means attempting to decrease the days sales outstanding (DSO), increase the days payables outstanding (DPO) and decrease the days inventory hold (DIH). It is all about effective working capital management and exploiting financial opportunities that are embedded in the relationship between buyer and supplier. Improving links between buyers, suppliers and banks in the supply chain increases visibility, improves process efficiency and enables the transfer of mutual advantages, such as trading sustainable funding opportunities, at an attractive cost against extended payment terms.
For example, let’s examine a typical supply chain with a pre-supplier, a supplier and an original equipment manufacturer (OEM). Each firm has its own bank relationship, so the usual scenario is that the different banks involved look solely at the needs of their direct clients. Because each bank will traditionally work on the credit facility of its own client, there is little consideration about the overall needs within the total supply chain. Therefore, the credit assessment and credit appetite might be limited to the client situation without considering the necessities in the chain overall. Without an overview of the complete financial supply chain, it is difficult to remove the overlap and inefficiencies of providing credit across different parties. It creates the situation where a corporate may not necessarily have access to the required amount of liquidity in the right location and/or at the right time. This, in turn, would lead to the provision of more credit facilities than the actual underlying necessities on a net basis require, which is an overpaid credit process and liquidity expense.
So, how to improve the situation and keep buyers, suppliers as well as bankers happy along the supply chain? The success or failure often relates to co-ordination within the corporate’s organisation and between corporate and banks. All related parties in the supply chain need to be brought together and aligned in order to improve financing efficiencies. The following aspects are vital:
There are many benefits to be gained in supply chain finance by banks collaborating with other industry players, such as system vendors and commercial data integrators. Banks need to connect to commercial data, for example, as well as logistic providers who support the corporate supply chain, in order to access the data needed to provide cost-efficient trade finance services. The quality and level of integration between these providers will be critical in testing the success of these solutions.
E-invoicing providers are a good example of industry collaboration – they need to talk to each other to be able to exchange data in order to support their clients and really consider the strengths of each provider in their field.
Collaboration is also happening in the supplier finance arena where there are some technology providers working together with banks to provide certain capabilities. This occurs between banks and logistic providers, as well as data integrators. Plus, no single technology provider has the global solution for every corporate’s needs, as most vendors are focused on a particular industry or region. Therefore, banks should embrace a three-fold strategy of partnering with vendors, supporting industry initiatives and proprietary solution development.
Some banks are promoting an open system model, where different parties can connect, so it’s effectively a collaborative system that is not restricted to only one party and counterparty, or bilateral system. Bilateral systems are part of yesterday’s world – the new world talks about collaboration.
Not only is it important to review existing processes within the corporate, but also those linking the corporate to its service and finance suppliers. Whereas the management of the physical supply chain is very much confined to the areas of procurement and logistics, the management of the financial supply chain is, by and large, fragmented across procurement, sales and treasury. Consequently, senior management focus tends to be weaker on the financial aspects of the supply chain. Indeed, in many cases it is not even understood as being an integral part of the supply chain. Naturally, key performance indicators (KPI) and performance measurement might not be aligned, or sometimes even collide.
For example, the treasurer has the target to expand payable terms from 60 to 90 days to improve net working capital and the procurement officer is measured against rebates he can squeeze from suppliers. How can these targets go hand in hand if the supplier does not agree to accept longer terms to see cash or to further rebates?
To successfully link the physical and financial supply chain it is therefore necessary to chart the single process steps in all related departments, to consider departmental targets and priorities, and to examine value in each component of the supply chain. From there, potential changes and adjustments can be analysed. Value gaps create opportunities which, in most cases, can only be materialised in projects which have senior management focus, look at mutual benefits along the whole supply chain and help to re-adjust target setting and performance measurement.
In the example above, one of the possible solutions could be that the procurement officer gets access from treasury to offer straight funding to suppliers when discussing term extensions. Treasury, in turn, then sets up supply chain related funding structures that are available in today’s markets.
When determining the best way to reorganise processes and workflows it is equally important to consider whether parts of the financial and documentary chain – and if so which parts – should be outsourced to partners that can manage it more efficiently and cost effectively. Banks and third-party vendors do offer such services. Choosing how, where and with who to best integrate is a time consuming, but ultimately rewarding, task.
Integration of Funding Concepts in the Supply Chain
There are three areas of financial services that should be examined in order to address issues around the financial supply chain:
One useful supply chain finance product is supplier finance. This is the direct finance of suppliers based on a web-based collaborative platform. The buyer uploads accepted invoices, suppliers can see accepted invoices and the bank can offer to discount such invoices at the suppliers’ online request. Technically this is just a click away whereby the supplier has the choice to either ask for discounting or wait until maturity.
There are other supply chain finance products available at various trigger points along the supply chain to buyers as well as sellers. In that respect, according to the stage in the value chain, these supply chain finance products can be used for commodity and raw material purchases, during the production space, as specific transit finance, and/or as post-shipment finance. They are usually directly linked to a single transaction and rely on such data, but can also be used in conjunction with the documentary credit business.
A second area to look into is (financial) supply chain services. This offers tools to make the trade processing more efficient. For example, in global trade management a number of medium-sized and larger corporates might say that they can’t afford to stay on top of the knowledge related to documentary credit and that they do not want to employ specifically trained people to do it because the unit cost of processing internally would be too high. In such cases they consider outsourcing. Another example related to supply chain services is the use of the SWIFTNet Trade Services Utility (TSU) function, which helps to match purchase order and invoice related data from buyers and suppliers. This inter-bank services provided by SWIFT allows banks to support, for example, the global sourcing process for clients through conditional open account payments, as well as linking into attractive financing solutions to buyers and sellers. The TSU solution adds to the data quality, which is not only essential for the corporate supply chain process, but also for the bank finance proposition.
Reporting, or information management, is one of the most important areas for financial supply chain management. It should not only allow monitoring of DSOs and DPOs and provide information on transactional costs, payment flows and financed transactions, but also feed the risk management of the client in order to manage related country risk, liquidity risk, commodity risk, interest risk and foreign exchange risk.
In essence, supply chain services provide many additional options designed to make a corporate’s life easier and more efficient.
In order to intermediate themselves back into the supply chain, some banks have established themselves as a one-stop shop providing systems, applications and, of course, financing. This offers an advantage over technology vendors who cannot provide the financing piece of the supply chain. Traditional non-bank vendors basically offer a system, invite people to use the system, and are then dependent on banking partners to provide the financing services as well as funding markets. The latter proved unreliable during the credit crunch with quite a number of asset-backed securities (ABS) driven financing vehicles currently becoming defunct.
Banks can additionally provide risk management services and offer risk mitigation in the area of country risk, liquidity risk, commodity risk, interest risk and foreign exchange. Such an integrated approach from banks is advantageous for corporates because it is a combination of advising on how to improve efficiencies in the production and related risk management cycles, as well as determining funding in the most attractive way. Products and services can therefore be employed effectively.
Select large corporations might prefer a vendor’s offering for two reasons. First, neutrality, i.e. they are not bound to one single system or bank. And second, they like a vendor that provides the system that can be integrated into the corporate’s own suite of systems and nothing else. A bank can offer its own system and it could have multi-banking capability, but it will be that bank’s system and other banks might not easily be able tojoin. This can be acceptable if combined with a corporate’s wish to retain a larger number of banks to secure ample funding resources. In fact, through a bank’s proprietary platform syndications can be embedded more easily.
In the end, a corporate will want to know what value can be created with any new product or service and will be less interested in how that product works as long as it works reliably. The most important questions for a bank to answer are: What pain points might the customer have? What services and solutions could eliminate these pain points? How can the bank integrate into the client’s workflow processes and not vice versa? And crucially, can the bank prove the sustainability of the product or service? Ultimately, corporates will always prefer to talk about this with a partner who can really address their business problems, understand them and then offer services that suit them. Solution-driven banks are in the ideal position to perform this role.