Addressing the Weakest Link in Global Trade
A report from Harvard Business School
published last July tells us that US small businesses are facing a serious credit gap. Twenty years ago, small business lending accounted for about half of all bank loans; today that percentage has shrunk to 20%. Since the 2008 global financial crisis alone, bank lending to small businesses has decreased by 20%. Non-bank lenders are beginning to fill this gap, and they’re causing a stir by coming up with innovative ways to do it. What exactly is happening?
Big buyers in today’s global supply chains are funding their smaller suppliers by paying them early. For many industries, this marks a complete turnaround in how companies approach their suppliers.
Risking Your Own Supply Chain
For years, companies across manufacturing and retail used their size and position to get the most out of smaller suppliers. Every transaction was about shaving cents off each item to get the lowest possible cost, extending payment terms by 30 or 60 days to optimise cash, and demanding rapid turnaround and delivery. Many large players have recently come to realise the danger in such an approach.
Placing pressure on trading partners – whether by capital, cost, or tight demands – creates excess risk. Granted, there can be benefits to a manufacturer or retailer paying later to improve working capital instead of tying it up in inventory, but this comes at a cost.
If a manufacturer optimises working capital by stressing its small suppliers, then it is essentially strangling its own supply chain – forcing trading partners to either take a hit on margins or increase their prices. Thinking holistically about the supply chain and figuring out ways to better collaborate across all parties can pay major dividends in the long run.
Working With, Not Against Suppliers Assures Supply
Many large companies today are sitting on heavy piles of cash. Investing ‘on the sidelines’ in a money market fund (MMF) yields minimal returns. This is where big businesses are exploring the idea of stepping in to fill the gap in lending to small suppliers. The idea of offering early payments in exchange for invoice discounts has been around for several years in industries such as apparel and footwear. However, the trend is gathering steam across manufacturing industries, where large buyers see opportunity to essentially offer financing on their own payables at minimal risk. At the same time, their returns on investment can be anywhere from 3-5%.
Here’s how it typically works: capital costs for small suppliers – needed for factory space, materials and machinery – can be significant, particularly for those in emerging regions. When buyers provide payment to suppliers in seven days instead of 90, in exchange for a discount on the invoice, both parties win.
Instead of suppliers bearing all the credit risk, manufacturers and retailers would essentially take on their own risk – prepaying their own bills and in return getting invoice discounts and financing payments that provide significant return compared to the average MMF. Buyers with cash on hand get a better return while eliminating risk of delays. For suppliers, who are often overseas, the cost of capital can be as high as 10%. A 5% early payment programme funded by a buyer creates huge savings, while importers reduce the cost of goods sold thereby lowering duty fees. It’s a win-win-win scenario.
Paying Early with Someone Else’s Money
Another option for delivering early payment in exchange for invoice discount exists for large buyers who can’t pull from a large cash reserve. In this instance, a third party financer confirms the financial strength of the buyer and offers early payment to the supplier based on the buyer’s credit. The result is similar: the supplier gets the cash it needs to begin the order earlier, the financing rates are significantly lower and the overall cost of goods decreases because capital costs are reduced. Most importantly, there’s less risk to the supply chain.
The Next Wave of SCF Benefits Suppliers and Buyers
Supply chain finance (SCF) continues to evolve. While the term itself can mean different things to different people, a true SCF programme serves the best interests of all parties and is also flexible. Look for the ability to use events-based financing, where payments are triggered at various points across the transaction. This moves beyond early payment discount programmes into pre- and post- export finance.
Most importantly, an SCF programme invests in the health of the supplier by providing access to capital at lower costs through cash and order visibility. At this level, SCF cascades into supply collaboration. It becomes a tool for suppliers to have greater confidence and improve performance. The result is a win for all parties, derived from reduced purchasing and fulfillment risks; clear visibility into when payments are coming; and reduced costs.