Global supply chain: Treasurers battle to navigate a complex crisis
Experts discuss the nature of the supply chain shakeout, the challenges the crisis poses for treasurers, and strategies that can help corporates mitigate its impact
Experts discuss the nature of the supply chain shakeout, the challenges the crisis poses for treasurers, and strategies that can help corporates mitigate its impact
With hopes fading of any significant unclogging of the global supply chain any time soon many corporates are reviewing their supply management strategies and practices. But as they do so, one inescapable conclusion they will likely draw is that the greater the length of a supply chain, the higher the risk of disruption.
Heather Crowley, global head of supply chain finance at JP Morgan, however, says reconfiguring a complex global supply chain that has evolved over decades will neither be easy or quick, not least because of some deep structural challenges.
Specifically, she says, Western economies have become over-reliant on Asia, particularly China, thanks to its position as the only country to boast all 41 major industrial categories, 207 medium industrial categories, and 666 industrial subcategories, according to the UN’s industrial classification system.
“The pandemic revealed the acute risks of such a heavily concentrated supplier base, and the continued lockdowns [in China] are having rolling impacts. With rising geopolitical tension, we have already seen developed countries and multinationals move to mitigate risk and identify sources outside China,” says Crowley.
Emerging trade wars, followed by the pandemic and war in Ukraine, have further exposed the fragility of global supply chains. Furthermore, structural supply shortages in the commodity markets, especially energy, are going to make near-term inflation challenging. Inflationary impacts are already building rapidly downstream, as evidenced by producer price indices in developed economies growing at double digits over the first half of this year, according to Crowley.
The effect of supply chain disruption on corporates has been wide-ranging and severe. Procurement has been “acutely challenged,” says Crowley, with big box retailers notably overstocking to compensate. But without corresponding demand, corporates are being forced to reduce stock by sacrificing margins.
The opposite, however, has been the case in the commodity-linked market, such as oil and other hard commodities. In that space, there is an inability to source goods to meet end market demand across the markets which directly impacts sales.
“’Just in Time’ is now ‘Just in Case’ inventory management,” says Crowley. “Industries are being impacted by shortfalls in inventory, which in turn hits their bottom line. Retailers have recently issued profit warnings after seeing gross margins eroded by higher markdown rates, driven by inventory impairments and actions taken to address lower-than-expected sales, as well as costs related to freight, supply chain, and increased employee compensation.”
Corporate treasurers are at the heart of corporate efforts to mitigate supply chain disruption and in considering the challenges for them specifically, Crowley says the now heightened competition for sourcing means large companies should focus on the sustainability of their supply chain in the near term and diversification in the medium-term
“The days of stretching payables to harvest working capital will be muted until there is meaningful improvement in the demand-supply equilibrium for manufacturing. Rising borrowing costs will temper bond and bank new issuance, creating demand for liquidity sources generated via the sale of assets such as open account receivables. In some cases, corporates may look to alternative raw materials and adopt dual sourcing and longer-term contracts.”
With corporate debt still at or near record highs as rates head higher, Crowley says inventory finance solutions provide “a compelling opportunity” to benefit both suppliers and buyers looking to limit damage to balance sheets. Such solutions can also support corporates wanting to take inventory off-balance sheet to alleviate the drain on cash as they go about procuring additional inventory buffers.
Looking ahead, Crowley believes supply chain disruption will remain a major drag until at least 2023. In the meantime, corporates and governments will continue transforming their supply chains to minimise disruption and continue to focus on bringing production closer to customers.
She foresees corporates investing further in ‘Just in Case’ inventory solutions and diversification of suppliers and sourcing locations. This will be supported by the opening up of new trade corridors, such as the UK building up new trade routes to Europe, notably in the Netherlands, to cut dependencies on French ports.
Governments, meanwhile, will continue to provide stimulus to accelerate reshoring and expanding manufacturing. High profile examples to date include Japan’s $2.2bn financing plan to support manufacturing away from China, and the US government’s commitment to strengthening its medical equipment supply chain.
Drilling down further on the impact of global supply chain disruption on corporates and their treasurers, Sander van Tol, partner at Dutch treasury management consultant Zanders, says it differs considerably between industries and countries, and that even within industries there are often material differences. Factors influencing the nature of the impact include dependency on critical raw materials and/or suppliers, the effect of continued lockdowns in China, and warehouse and logistics capabilities.
As an example of the cascading impact of points failing in supply chains, Van Tol cites the sourcing of wire harnesses that are essential in the production of cars. Many German car manufacturers rely on Ukraine-based OEM suppliers like Fujikura, Nexans, and Leoni for this component but due to a lack of parts as a result of the Russian invasion of Ukraine, the total supply chains of car manufacturers have come to a halt, according to Van Tol.
“A minor disruption in the supply chain can lead to a big hit on corporate revenue and profitability,” he says. “To mitigate potential supply chain shortages, procurement teams are actively buying additional inventory and raw materials.
“However, the combination of higher inventory levels and production issues leads to increased working capital requirements in several sectors. To make things worse, supply chain disruption has fueled inflation concerns which also have a negative impact on economic growth and consumer spending and consequently future corporate revenue and profitability.”
Van Tol, who is also chairman of the advisory board of the Dutch Association of Corporate Treasurers (DACT), says CFOs and treasurers are seeing growing levels of accounts receivables and inventory on the one hand, but decreasing amounts of account payables on the other because suppliers are looking for prepayment before they even ship their goods.
“Under such a scenario, the cash conversion cycle explodes, exacerbated by lower revenue levels. This has an impact on the funding structure and leverage of corporations, especially for the more leveraged or distressed companies,” he says.
In such companies an increase in working capital can have a knock-on effect, as higher working capital requirements and lower EBITDA impact the leverage ratio which in turn leads to increased funding costs, even without considering rising interest rates and credit margin.
In considering the kind of advice Zanders is recommending to treasury clients looking to navigate the disruption, Van Tol says one key element focuses on capital and funding structure: “Our advice here is to create additional optionality in your funding mix. Examples include using accordion options in revolving credit facilities (RCFs) which can provide corporations with temporary additional funding.
“But we would also recommend treasurers investigate alternative sources of funding like supply chain finance instruments such as factoring, reverse factoring, and inventory financing. These instruments are designed to provide funding for corporations and their clients and suppliers to support the supply chain.”
Treasurers should also adopt a more risk-based approach for their cash flow forecasting processing. In this respect, technology-driven cash flow forecasting solutions employing AI and ML offer limited help as these are based on sets of historical data.
“Now is the time that the treasurer can earn their place at the table as a business partner with their skills in risk and liquidity-based thinking,” says Van Tol. “Treasurers should incorporate the concept of stress testing based on expert opinion into their cash flow forecasting approach. Collaboration between different functions – procurement, commercial, production, and treasury – is essential here.”
He also advises CFOs and treasurers to re-assess the actual financial strength of their supply chain by considering, for instance, whether the credit risk of critical suppliers and/or clients has increased because of supply chain disruption, and what their company can do to help mitigate this risk. Some corporations provide financing or even take an equity stake in key suppliers on which they are very dependent, he says.
As for the future path of supply chain disruption, Van Tol says this is difficult to call.
“The current tough period has affirmed we are operating in a highly specialised, integrated, and global economy. The risks we are facing now are a result of globalisation and outsourcing of production architecture in which the weakest link can easily break up entire supply chains.
“These weakest links are hard to predict. We have the example of one single vessel blocking the Suez channel for weeks or continued local lockdowns because of the Corona pandemic in some Chinese cities. These are unrelated events which all led to supply chain disruptions.”
While the roots of supply chain disruption and resulting turmoil in international trade stem from the pandemic, Paul Christensen, CEO of Previse, a working capital finance platform for small- and medium-sized businesses (SMBs), argues that many of the reasons for the inability of supply chains to cope with the shock and subsequent disruption pre-date the pandemic.
Principal amongst these reasons, argues Christensen, is “the chronic and ever-growing problem of securing sustainable working capital for SMEs, which is suffocating smaller suppliers of much-needed cash, hindering their ability to keep production going.”
Christensen, a former global co-head of Goldman Sachs’ strategic investments team, points to a study by Barclays and YouGov which shows that over a quarter (26%) of UK firms have reported a rise in late payments since the onset of the cost-of-living crisis, while lending to small businesses is also at a record low.
“This has serious knock-on effects on the rest of the trade cycle, preventing working capital from reaching all corners of the supply chain,” he says. “The result is that suppliers are left without the cash they need to adapt to rising costs, causing production to slow down and subsequent delays to their customers.”
According to a study by UK lender Aldermore published last month, over half of all UK SMEs have been impacted by the supply chain crisis in the last 12 months. Aldermore estimates that has put £3.9bn of earnings at risk as most SMEs have only a limited understanding of how their supply chain operates and the measures they need to take to help them navigate the challenge.
Based on a survey of almost 1,000 senior decision makers in UK SMEs, Aldermore found supply chain issues have led to increased costs (51% of respondents), delays in crucial projects (48%) and missed opportunities for growth (37%).
According to the study, the hardest hit sectors include technology (89%), manufacturing (88%) and construction (77%), all of which are particularly reliant on sourcing raw materials to maintain their activities.
Christensen, whose firm secured $18m in a Series B funding round in May to expand its working capital finance offering, urges firms to rethink their financing needs
“Forward-thinking suppliers can look at new forms of lending that have the potential to alleviate the pressure caused by these pain points. A technology-driven approach to financing can streamline access to cash, providing suppliers with the working capital they need to maintain production output against a backdrop of soaring bills.”