Managing the Financial Supply Chain During the Downturn
The financial supply chain management agenda is changing substantially as the economic slowdown impacts business flows globally. The issues of tightened liquidity and insolvencies have a cross-industry and cross-regional impact.
During the last couple of months, the corporate business agenda has been impacted by changes in the economic environment. Clients’ sales business has become negatively influenced and many industries have passed the following phases:
At the beginning of the credit crisis and the economic slowdown, many firms looked towards the emerging markets to compensate for disappearing regular business flows. However, after a short period of time, these began to be hit just as hard financially. In regions like central and eastern Europe (CEE), manufacturing has been heavily impacted by volatility in raw material prices and currency fluctuations, affecting both the stability and profitability of these markets. These market conditions have had significant effects on both domestic and outsourcing industries.
The CEE manufacturing industries are already facing a massive reduction in orders, which has had a substantial economic impact on the region. For example, Slovakia’s car industry, called ‘the Detroit of the East’, showed an annual output decline of 51.6% in April, the steepest fall since the current data series started in 1999, according to Forbes.
In fact, the corporate agenda faces similar challenges across all the markets, whether CEE, western Europe, US or Asia – nowhere has continued to trade as if it is business as usual. Senior management, particularly in finance units, is facing an ‘emergency agenda’ across the world. ‘Cash is king’ and, therefore, the identification of blocked assets, risk elements and efficiencies in the financial value chain provides a new area of enhancement.
Decentralised organisation and decision structures may be destructive because of their complexity and difficulty reacting to given circumstances and changes. To navigate the company successfully through the economic slowdown, a cross-linked neural system is essential to enable a corporate to react to a rapidly changing environment. In this context, the perceptual mapping of the physical and financial supply chains is critical.
On the procurement side, many companies are facing a significant number of insolvencies in their supplier portfolio. For example, in the auto industry a number of suppliers are on the verge of bankruptcy due to the fall in car demand globally. Failures by those supplier companies would shut down the flow of vital parts to the entire industry and grind the production of new vehicles to a halt.
Such an example illustrates how the credit crisis has impacted the supply chain, both physical and financial. Previously, corporate clients were looking for opportunities to improve profitability within different business divisions involved in the respective cycles separated in the physical and financial supply chains. Obviously, detailed forecasting and cost efficiency was a crucial part of companies’ agendas, but in many cases managed separately in physical and financial business division silos.
Beneficial competitive market positions and situations are used to reduce pricing and improve profitability. Alternatively, or in combination, payment terms have been extended by the arbitrage employed by the different credit standing between buyers and suppliers. Additionally, customised financial supply chain solutions have been seen as tools to enhance balance sheet ratios.
Today, however, the emphasis is more on speed and flexibility to react to new circumstances and protecting one’s business. Buying entities, for example, are concerned about core supplier portfolios, specifically how the economic downturn will affect their suppliers’ credit standing. They are also concerned about the ultimate performance of their suppliers and the rebound impact that has on buying entities as a consequence. In such volatile market environment, the turn-around time of adjustments is vital.
The uncertainty in the market stems from many different concerns, such as:
These have all contributed to a climate of fear, but currently treasurers and finance directors are expressing greater concern about even more fundamental issues such as substantially reduced orders, which can affect the viability and success of their core business.
Although many governments have requested that banks – particularly in the case of the newly state-owned banks – support the local industry and be prepared to allocate sufficient financing to local corporates, the question still stands as to how effective this influx of liquidity will be.
Corporates are also experiencing significant challenges with their credit insurance agencies, which are trying to rescue their risk by offering limited credit insurance mitigation to support business operations. Overall, a proper change management programme is vital in the current business environment and unpredictable outlook. The ability to readily manage required changes flexibly is making a significant difference for many market players’ business strategy.
In response to the challenges, most industry and financial institutions are becoming more innovative in financing the physical supply chain and finding new ways to inject needed liquidity. Solutions are being developed through the customisation of financing based on the available assets, but also on the counterparty risk that corporates face both on the procurement and sales sides.
For example, on the procurement side, banks are helping to elaborate and expand information on credit and ultimate performance risk. Banks are advising procurement centres as to how to analyse and rate suppliers. There is a greater amount of in-depth financial analysis done now than in the past, when the focus was on performance-driven analysis only.
Today, most corporates find that it is increasingly important to go deeper into financial information and their bank(s) needs to be able to provide the tools to do this. Banks have to be able to explain to their corporate clients the different methodologies they can use to identify the full range of risks. The overall objective of this partnership is to:
On the other side of the corporate/bank equation, corporate treasurers are starting to look at the concept of stable financing from a different angle, mainly because they are forced to due to the economic climate. What they want is to ensure that they have a stable and attractive financing solution, which includes the terms and conditions required by their suppliers. Many corporates see a lot of benefits in directly involving important business partners in the supply chain finance strategy. The end-to-end liquidity and financial planning are more often a firm part of the bilateral negotiation between buyers and sellers with the objective of eliminating any avoidable cost and risk impacts. The strategic partnership ties business partners closer to them and ensures enhanced information management, improved forecasting, reduced risk mitigation as well as financing cost. These hard and soft values can build a win-win partnership between the parties involved in the supply chain. (For more information, see Regional and Industry Differences in Supply Chain Finance.)
In the financial supply chain business, corporates are looking for strong commitments from their relationship bank to support their suppliers during this tough economic climate. Even when suppliers are becoming insolvent, buying entities are trying to help them to survive economically because letting them go under may damage the buyers’ business, too. In most manufacturing industries, the replacement of a core supplier takes more than 12 months.
Banks are developing financing solutions customised to their clients’ need embedded in their value chain. This innovation needs to be expanded because a stable finance solution is a tool that helps to financially serve the supply chain across industries and borders. Most industrial sectors and international corporate banks have recognised the advantages in supporting the supplier and buyer infrastructure in a more effective way.
Particularly on the procurement side, there is increased demand from buying entities for financial support to be extended to core suppliers to ensure they will survive the economic downturn. The objective is to have a more detailed understanding of the underlying business case and its dynamics. The correct selection of suppliers, based on in-depth financial analysis, is a crucial aspect of this process, just like the support of core suppliers is vital for the entire business. Today, there are fast and continuous changes in the rating of suppliers, and buying entities need to constantly review and assess their evaluation methods as well as policies and strategies. The extended co-operation between business partners supports the improved and updated information exchange to speed up the process of managing changes and challenges.
Traditional financing is still very important and certainly has not disappeared, but banks and corporates need to be more creative in providing increased liquidity and credit to the different layers of companies. Bank relationships need to be extended to partnerships with a combined agenda covering physical and financial supply chain topics. Providing that the end-to-end business case and its dynamics are well understood, more innovative and comprehensive solutions can be delivered. For example, Deutsche Bank is active in a number of middle market initiatives to expand its role in this area, particularly in terms of providing liquidity and risk mitigation services to this segment. This situation opens up the opportunity to help market segments in ways that haven’t been standard practice before, but also to support new clients in different market segments.
Today, it is necessary that banks understand how companies can become more efficient and, importantly, where they can get access to additional liquidity and mitigate the risk exposure even in mid-sized international companies. Banks need to explore the commercial, technical, legal and accounting structure along the supply chain of each company – is it still decentralised, or if not, is it possible that it could be more centralised? In many scenarios, funds may be blocked, but where they aren’t, companies need access to these accounts so that they can streamline their cash flows within the company. Additionally, adjustment of the processes, terms and conditions provide underestimated potential to add additional value to the company’s business.
Banks should also adjust the credit model to the underlying business case and the commercial terms and conditions. From a treasury perspective, of course, the overarching objective is try to generate more liquidity within the company’s own network, but treasury must also reduce the risk exposure and asset exposure at the cash site. In this respect, the client’s value chain needs to be analysed from end-to-end. It includes procurement, manufacturing, warehousing and sales cycles.
Corporate treasurers can use state-of-the-art electronic systems and web-based solutions to link their treasury systems with their banks’ systems in a more efficient way. Also, they can improve other processes at all stages along the supply chain by implementing e-solutions on the billing side, for example. On the order hand, they can link their existing enterprise resource planning (ERP) and IT systems with third-party systems to get greater visibility of their cash flows and physical work flows. Electronic platforms and digitalised data exchange and management tools are also used to support sales and to manage accounts receivable finance programmes. Such portals and services are helping to leverage efficiencies and to force process changes across the financial supply chain. Furthermore, they lay the future foundations for extended co-operation with service providers and keep the focus on core business.
How banks fare during this crisis will play a key role in how corporates move forward with their banking relationships. In terms of a corporate’s strategy of working with one bank or a number of banks, it depends on the client’s profile, how the client is positioned with regards to their financing structure, and how the landscape looks from the client’s corporate activities. It is vital to embed the international business in a stable and broad servicing network of banks supporting the overall value chain end-to-end.
To become more efficient, a corporate has to be focussed on its bank relationships and understand what they want to get out of those relationships. If the corporate operates internationally, then there is a greater dependency on the banks’ network and global systems capabilities available to get access to information across borders. In order to mitigate risk, a corporate has to get the complete information at the right time in the right spot. Also, if it requires local services, the corporate must understand what kind of network a bank service provider can deliver to directly connect to services where its business is. Many business cases require a global strategy to be executed locally. Therefore, it is crucial to involve all stakeholders and business partners in the end-to-end and day-to-day process.
Companies can use the economic crisis as an opportunity to re-think their business strategy and focus on a comprehensive operational model and management system. The breakdown of existing business unit silos, as well as co-operation with strategic business partners, is vital to be able to react appropriately given current challenges.
There is a strong strategic dialogue happening between corporates and their counterparties as to how to make their business relationship more efficient – strategic partnerships, rather than buying relationships. Effectively, there will be a change in behaviour and more integrated co-operation – not only what has already happened in the physical flow of goods but also combined with managing the financial supply chain. When we talk about efficiency, this is a huge untouched area where there is a positive momentum to develop more integrated physical and financial solutions between counterparties.
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