Supply Chain Finance and Moving Beyond the Payment Terms Debate

Looking Back and Forging Ahead. A distinctive view on Supply Chain Finance and the evolution of trade related financing which shaped this solution throughout history.

Agrarian Era

Of course it was all so much simpler in the days of early agrarian markets. You yoked your oxen, or 1^st born to the cart loaded with the bounty of your fields and made your way to the centre of town. There you laid out your stall and proceeded to barter and exchange between trading partners. The market provided easily discernible price discovery as exchanges of value occurred on the spot, visible to all and each participant adjusted their bid/ask position according to the immediacy of supply and demand and the velocity at which the exchange of value occurred. Most importantly you returned home with the proceeds from your days commerce tucked discreetly somewhere or securely strapped to the cart; a testament to the immediacy of settlement that underpinned the integrity of the marketplace.

Mercantilism Era

Population growth, global spice trade and the demand for more products and services ushered in the era of mercantilism. In this era specialized trading companies, the forerunners to commercial banks, provided trade liquidity, bills of exchange and early factoring models to provide some level of risk management for importers as well as exporters. It could be argued that the Industrial revolution was in fact a credit revolution as the mix of elements led to massive plant construction, market growth and education of consumers to consume – commonly known as Marketing in today’s world – all the while requiring providers of capital to underpin this activity with credit. Access to working capital and cash flow was the key driver for the global trade.

Industrial Military Complex

The rise of the Industrial Military Complex and its fostering of large scale manufacturing across multiple locations has had a significant impact on what we now call the supply chain. Whilst the processes it spawned drove economies of scale in manufacturing to hitherto unknown efficiency levels including the later development of manufacturing standards such as Just in Time, 24 hour replenishment and cost to serve modeling, it also drove the de-coupling of the consumer to the source of goods and the agrarian experience of consumer-supplier direct negotiation. The advent of marketing and advertising via catalogues, radio and television completed this separation and created what could be termed the “Era of designing the consumer experience.” The consumer intimacy with the end supplier was no longer as relevant. All goods were neatly packaged along with inspirational messaging as to why you needed this brand in preference to others and sourced from this preferred distributor. Who the manufacturer was or where they resided became less and less an important component of final selection. Companies relied on their distribution channel and the marketers to influence the consumer behavior.

Post War Era

For the nascent supply chains the major changes were just commencing. Large scale production capability to achieve and maintain a competitive offering was required, which in turn meant significant capital outlay that banks were only too happy to finance as economic circumstance flowed and asset growth and lending of capital became highly profitable industries in their own right. Throw in low cost country sourcing and the rise of more educated consumers globally plus the enmeshing of sophisticated financing options under the banner of ‘Global Trade Finance’ all to fuel the beast that today we know as the global economy. Apart from the regular economic cycles where suppliers re-learnt (and continue to do so), the harsh lessons of delayed cash flow and bad management of their receivables other irritants from a supply chain perspective began to surface in the form of heavily scrutinized balance sheets. Acronyms like DSO (Day Sales Outstanding) and DPO (Days Payable Outstanding) became part of the daily jargon of credit providers and the new overseer in town; the market analyst. Woe betide the CFO whose DPO or DSO were not matched to, or better than, accepted industry standards according to the latest equity analyst report. As a response, the era of squeezing the supply chain, especially so on payment terms began in earnest. The true value of minimizing the amount of capital you use in your business is calculable and the benefits clear to all none more so than those whose role is to apportion investment funds and deploy capital to businesses on behalf of the many millions of contributors to the localized savings, superannuation and 401k plans, in other words the savings of the very consumers driving economic demand. The stage we find ourselves today at is one of increased velocity and transparency of data as the boundaries between markets layers dissolve. What does this imply in terms of working capital and payment terms?

The informed consumer and the end of the traditional receivable

Remember the agrarian market model described at the beginning of our journey? Well it’s back courtesy of the Internet as well as the mobility, immediacy and transparency of data. And the era of the ‘marketing to the designed consumer’ is over. The observed is now the observer. Via internet, smart phones and big data availability, consumers are driving what I term the ‘individualization of the buying experience’. Price comparison, real time data and multiple choice distribution channels put the consumer in charge of and having influence over many aspects of the buying experience and the supply chain. This includes: price discovery, comparison, optioning and customization of products, real time feedback, etc. The informed consumer demands for authentic and up to date information is endless and growing and may include questions such as: Is it fair trade, was child labour involved in the production, what is your carbon footprint, etc. All these demands are changing the nature of consumption reflecting a consumer in charge of the process and consequently acting as a direct participant in today’s global supply chain; similar in some respect to the market experiences our agrarian forebears experienced. Such changes reshape how the supply chain is managed; and reshaping always involves capital investment. In amongst this what role the financial markets and what new models might transpire? In terms of financial markets we are familiar with highly sophisticated systems matching buyers and suppliers with immediate settlement terms globally across an array of commodities. Such market making and risk management activities on the macro level are already filtering down to the consumer level in real time and through highly efficient channels, which in turn will further impact global supply chains and access to on demand working capital. Coming back to the title of this article, how then is this related to Supply Chain Finance and the debate on payment terms? In today’s market the informed consumer is firmly in charge and more arrive with confidence to the market than ever before. The diversity and individualization of the buying experience has markedly increased the velocity on the consumer side of the transaction and the settlement of that value exchange. This is also true at the macro level where value exchange and settlement activities such as $100M of oil contracts for delivery settled at the speed of light. Isn’t it therefore somewhat archaic for the supply chain to wait for 30-60-90 or even more days for payment of goods and services already delivered? Sadly such settlement velocity on the macro level has yet to permeate into supply chain payments. However when looking at a company’s position with respect to the buyer’s DPO and supplier’s DSO the conversation is still stuck in the old arm wrestle of my payment terms versus your payment terms. One way or another one side invariably loses or at best comes off in reasonable shape. One party’s working capital will be adversely affected. Maybe more surprisingly, it is not always the case that the supplier that is negatively impacted. For example early payment discounts may not be always in the buyer’s best interest depending on the Return On Capital Employed (ROCE) hurdle rates they set or their ability to accurately manage their working capital and make efficient use of their cash.

Supply Chain Finance

The time has come to move the conversation to a point where the debate is not about 90 days versus 30 days and I don’t trivialize the difference here, but rather centered on the ability of the supplier to access the buyer’s initiated on-demand financing and accessible through the sale of the supplier’s receivables in order to improve their working capital and accelerate cash flows to fund commitments, innovation and profitably grow their business. After all the reality is that the supply chain is increasingly exposed to the disruptive, yet opportunity-creating behaviour generated by the end consumer. Therefore, why should the supplier not have access to the same payment and settlement velocity enjoyed in other market layers previously mentioned? Supply chain finance has become a key solution for leading organization allowing them to shorten their payment and settlement time at a considerable level in order to remain competitive. Gone are the days where an organization could just look at its own DSO and DPO to improve its working capital without considering the other constituents in its supply chain. Today’s new supply chain finance models provide a holistic approach allowing both side of the trading equation to improve their financial strength and remain competitive. Such solutions managed by highly efficient processing platforms offer suppliers payment on an earlier date rather than the actual, later maturity date-in most cases reducing their payment terms by over 80%. On the other side the buyer has the opportunity to improve its working capital by optimizing its payment terms. The difference of time between collection date by the supplier and repayment by the buyer is bridged by a third-part funder providing financing based on the buyers’ credit rating. This creates a win-win solution with the ability for the buyer to standardize payable terms, while giving the option to the suppliers to get paid in just a few days instead of 60 or 90 days.

Looking Back and Forging Ahead

Every business model during the different eras has either reshaped itself to exploit or withstand prevailing conditions, or has been reshaped by those prevailing conditions. Companies who accept that the only protection against oblivion is a constant willingness to innovate and move away from processes that no longer serve them or their supplier’s best interests will grow and profit from that change. Throughout history one constant has remained and will continue to be front and centre. Access to efficient working capital and cash is a fundamental component in the ability of buyers and suppliers to cooperate and exploit the market conditions in front of them. Supply Chain Finance has become a critical element in the ability for supply chains to keep pace with the expectations of today dynamic consumer driven markets.