Regional and Industry Differences in Supply Chain Finance
Supply chain finance can be defined as ‘programmes allowing for the transaction-based financing of corporate business partners’, such as suppliers and distributors. These schemes are increasingly being proposed by international banks to corporate clients to effectively leverage stable business relationships, e.g. between large buying organisations and selected suppliers. Historically in international trade, such financing arrangements were mainly based on letters of credit (LCs) and drafts on a case-by-case basis. More recently, banks and non-banks have come up with smarter alternatives, reflecting the increasing trend among importers and exporters to forego traditional LC risk mitigation and to establish open account relationships with international trading partners.
A key aim of supply chain finance is to facilitate the integration and automation of financial interaction between buyers and suppliers, and thus help to ensure that the physical supply chain can operate as smoothly as possible. Regional and industry-specific differences add important dimensions that service providers must factor in as they tailor their offerings to suit different clients’ needs.
When putting in place supply chain finance schemes, a challenge for banks is that clients from different industrial sectors have different requirements. This is largely because the way that companies interact with their respective business partners can be very different from one industry to the next.
Take, for example, the automotive industry in Europe, where original equipment manufacturers (OEMs) have a high degree of technical integration with their Tier 1 suppliers, i.e. their most important business partners. Interestingly, this industry didn’t wait for an outside party to come up with integration solutions, but created these solutions themselves. Certainly in the automotive industry there exists a great deal of interaction – in terms of data links – between buyers and suppliers, which means a very high degree of automation and integration between the respective supply chains of those companies.
One example of an integration solution in this industry is a customer-managed inventory (CMI) arrangement, where a warehouse is situated very close to or within the OEM’s production facilities. When required, the OEM’s staff withdraw goods from this inventory zone, thus triggering a ‘self-billing’ process on behalf of the OEM. Initially driven by the working capital considerations of the OEMs, the relevant goods belong to the suppliers – and thus remain on supplier balance sheets – until the parts are used in production. CMI fits into highly integrated and very demanding collaborative environments which do not tolerate any disruptions in the physical supply chain, as any such disruption in the flow of parts might trigger a costly halt in production.
In a sector that is very modular or component-based, like the automotive industry, a company may source, say, 50,000 individual parts from numerous suppliers – many of which will be critical to the production of the vehicle. If a firm doesn’t ensure that its key suppliers are in good shape and can produce the right quality of goods at the right time, it might not be able to fulfil its customer orders. Consequently, buyers need to closely monitor their critical business partners to ensure that they are performing well.
Banks can play an important part in keeping the supply chain running smoothly by helping the OEM’s business partners with financing or settlement solutions. In this example, the number one priority for both the bank and its client is to integrate the solution into the existing technology infrastructure, especially in industries driven by just-in-time production logistics.
The automotive industry, as well as other well-integrated industries, certainly understands the need for the ‘collaborative financing’ of key business partners, since intensive collaboration among important business partners is already the norm. An OEM with a good credit rating can play a part in facilitating funding access for dealer distributors or suppliers, especially if the OEM’s business partners have difficulty accessing funding in some emerging markets, or if the OEM’s partners are subject to expensive funding costs due to poor credit standing.
Another example of a highly integrated sector with well-established buyer/supplier links is the chemical industry. One of Deutsche Bank client’s in this sector regularly sources specific raw materials that can be in short supply. The firm turned to Deutsche Bank for supply chain financing support because one of their strategic objectives is to help in the financing of their suppliers, which tend to be smaller companies from emerging markets. Such ‘added value’ delivered through financing helps the chemicals producer to distinguish itself from its competitors when fighting for the same scarce resources.
In some cases, collaborative supply chain finance works because the supplier endorses it; in other cases, the supplier simply has no need for such liquidity. Nevertheless, supply chain finance can still be used as an incentive to the supplier. For example, typically, the OEM’s purchasing department’s main job is to push the suppliers as hard as it can to produce the goods in a timelier fashion – at a better quality and for a cheaper price. With supply chain financing, the purchasing department has something additional to offer the supplier and can thus improve the relationship.
Both of these examples rely on a certain degree of dependency between business partners on the supplier side, but it could also work on the dealer/distribution side. For instance, in the technology industry, there may be only a limited number of dealers that can provide a firm with the ability to reach certain customers. In eastern Europe, for example, there are not many dealers that can sell a computer in the more remote provinces of the Ukraine, so a dependency on a few distributors will develop. The logic supporting a supply chain finance solution here is similar because the challenges are similar. Indeed, true supply chain finance experts do not ‘push’ their products, but tend to explore where and how value can be created from a business relationship perspective. And which business partners might be interested in such a solution.
Possibly with the exception of the high-end clothing market, the textile industry appears at the other end of the spectrum from well-integrated sectors such as automotives. In the middle and lower end of the market, companies swap suppliers frequently as they are permanently shopping for cheaper goods. Companies that buy in huge quantities and are keen to get bargain prices usually have no compulsion to stay with a supplier for much longer than one season’s contract. Although they might end up dealing with a core supplier for many years, there is no guarantee that they will remain loyal.
This type of behaviour, often seen at the low and mid-end of the retail industry, means that these firms often don’t see the need for supply chain finance collaboration because it is usually the big buyer telling the smaller partners how they want to do business. From a financial engineering perspective, the big retailer typically tells their business partners, suppliers, banks – or any other company that might be involved in a project – how they want it to be done. They decide around 90% to 95% of the solution and the others may have a say in about 5% or 10%.
For example, a huge international furniture producer was one of the first companies to set up a supplier portal that is accessible through the Internet. The company mandated that if a firm wants to do business with them, then the supplier must go through the portal. It doesn’t matter if the supplying firm is big or small – that is the way the furniture company does business. There are also certain services that are rendered through the portal; for example, an invoice can be tracked through the system and a firm may be able to ask for an early payment discount.
In this example, the very powerful buyer exclusively sets the rules, whereas in other sectors – such as the automotive and chemical industries – the dominant approach is much more collaborative, at least as far as relations between the top players are concerned.
The gamut of solutions that a bank can provide along a corporate’s supply chain can be examined from two perspectives: one is from the supply chain financing point of view, where business partners require financing; the other is the supply chain services point of view, where companies are looking for more efficient ways to exchange invoices, provide acceptances, settle disputes and make payments to each other. One area that has shown how companies can benefit from such supply chain services has been the health care sector in Singapore.
Taking a generic look at the relationship between a big health insurance company and a big hospital company, it is obvious that they depend on each other in many ways. For example, a health insurance company may cover 30% or 40% of a hospital’s patients at a hospital chain, which has 50 hospitals in a specific country. They are both important business partners and are therefore open to a more collaborative approach.
The health insurance company might seem like a low risk partner, but this changes if it decides to dispute the bill for whatever reason. Maybe 95% of payments are made without a problem within a relatively short timeframe, so there is very limited need for financial intervention as the hospital group knows that it will receive the payment after three or four months. But what happens with the other 5%, particularly since it is not known in advance which transactions are going to be disputed? This process of clearing the payment and checking the invoices on the side of the health insurance company is a very specific process, which cannot be compared to checking invoices in other sectors, such as automotive manufacturing.
Deutsche Bank has made inroads in the health industry, particularly in Singapore, over the past three years purely from a process optimisation perspective. The bank links hospitals with their business partners – insurance companies – to help them to reduce the time it takes them to check those invoices. This is done through a process where the bank converts the invoices from a paper trail to an electronic trail so that the hospitals and their partners can exchange and process invoice related information more efficiently.
Now Deutsche Bank also plans to look at the health industry from a financing perspective. Within the healthcare industry, this is a very detailed task as it goes beyond sector specifics into individual customers to the point of dissecting their business profiles, their business processes and the relationships that they have with their key business partners. Some of those business partners may be important enough to them that they will want to improve their relationships to the point of helping to improve the partner’s financial wellbeing.
Asia has increasingly become the manufacturer of the world. Many firms receive raw materials and commodities from Asia, but are now also basing their factories and production in the region.
In Asia, there are two broad categories of supply chain finance deals, each with different structuring requirements. One is a local situation where the supply chain is entirely domestic. It could, for example, be an Indian subsidiary of a large European corporate, which has an onshore manufacturing subsidiary and sources locally from many Indian suppliers. Technically, it’s a European client, but the buying entity is its Indian subsidiary. This is a growing trend because there are many European and American companies who have manufacturing entities in Asia and, therefore, they procure domestically.
The second broad category of deals and opportunities in Asia is a cross-border or cross-regional deal where the multinational company (MNC), whether European or American, doesn’t have a manufacturing or procurement subsidy in Asia. This means the MNC will be buying directly from Asian suppliers.
To service these supply chains, banks need to distinguish between the offering and implementation strategies that they would execute for a completely domestic deal and for one that is cross-regional. There are a large number of cross-regional supply chains where, for example, a buyer in Germany has 10 suppliers in China, six suppliers in Hong Kong and four suppliers in Thailand. While those deals tend to be larger in terms of size and revenue potential, they are obviously much more complex from an implementation point of view as they involve multiple levels of decision making and contact points for a bank within the client organisations. For example, a large European retailer client of Deutsche Bank is currently in the process of negotiating a global supplier finance solution that may potentially require a large amount of customisation.
The domestic scenario is much easier to implement because the buyer and suppliers are in the same country and the decision-making process tends to be localised. From a logistics point of view, it’s simpler because the currency, legal jurisdiction and, probably, IT interfacing requirements are the same. For example, a large Dutch food client recently implemented a domestic solution for their Indonesian subsidiary – for its local currency purchasers – which it took directly off the shelf and didn’t require any customisation. A domestic solution will also often be easier to implement thanks to the decision-making that tends to be localised.
There are two aspects of supply chain finance: a pure financing component and a platform component. European and US-centred deals tend to be focused more on the platform than the financing solution. This is because they’re not just looking at how much finance a bank can provide to its suppliers and at what price, but also place the financing platform on an equal level of importance, if not higher.
In Asia, buyers place a higher importance on the extent of financing and at what stage the financing can be applied, i.e. how early in the supply chain process can the bank step in and provide financing. They aren’t as concerned about whether the financing platform is technologically superior. Indeed, their questions often revolve around several issues: is the bank able to provide financing to the extent that they need for their suppliers? Is the bank able to come in much earlier in the value chain, such as at the purchase order or invoice stage, and provide financing for their suppliers? These issues seem to be more relevant for the Asian supply chain finance buyers as compared to the platform-related issues seen in Europe or the US.
Banks or other service providers in Europe and US began using technology as the leading enabler for supply chain financial services, so they built the technology first and then fitted the financing products around it. In Asia, it evolved the other way around. Here, banks first developed their financing programmes by looking at the supply chain cycle to see what form of financing could be provided at each stage. Once they had the financing programmes and the credit parameters lined up and tested, they then looked to provide it through a technology platform.
Certainly, Europe has taken the lead on the platform side while Asia has led with the financing, maybe because Asian corporates are more supplier-facing. In Europe, which is a buyer-centric market, banks are developing solutions with large buyers, so accounting and platform sophistication is at the forefront. In Asia, the large supplier market needs the flexibility and types of financing at the forefront of development because this is what worries these suppliers the most.
The other key factor is cost. There are certain steps and activities – both on the client side and the bank side – that are often much cheaper to do semi-manually in Asia compared to, for example, in Europe. This means that the level of automation is a key cost saver in Europe, but not necessarily in Asia.
Certainly, the ability to understand and accommodate these types of differences will be a key requirement for a provider offering solutions across sectors and regions. Indeed, one of Deutsche Bank’s strengths in this area is that it is able to combine the on-the-ground expertise of locally hired and sector-specific staff with the reach of a truly global bank.
Supply chain finance is all about keeping the supply chain running smoothly by helping to ensure an uninterrupted flow of goods through financing or settlement solutions. Yet banks that are developing supply chain finance solutions face industry-specific and regional challenges.
Highly collaborative and automated industries look to banks to increase their reach up the supply chain by providing financing solutions to their suppliers, who may not be able to get cost effective financing themselves due to their credit record – or maybe because they are based in emerging markets. While less integrated industries may not see the need for collaborative financing, some may look to improving their supply chain services, where companies are looking for better ways to exchange invoices, provide acceptances, settle disputes and make payments to each other.
Service providers also have to address regional differences. In Asia, the manufacturing centre of the world, the needs of domestic corporates – that conduct most of their business locally – and large MNCs sourcing materials directly from Asia vary considerably. Banks need to distinguish between the offering and implementation strategy they would use for a completely domestic deal and one that is cross-regional.
Banks must understand and address the differences in supply chain finance strategy needed for different corporates – tailoring their offerings to suit different clients’ needs.