Hubris? Physician Heal Thyself

Every man takes the limits of his own field of vision for the limits of the world – Arthur Schopenhauer

The responses to the WSJ article on P&G’s effort to optimize working capital and payment terms has generated a lot of responses. Nearly all of them missed the key point, that P&G is collaborating with suppliers in their efforts to move to industry standard payment terms. By offering Supply Chain Finance, P&G can reach industry standards while at the same time improve supplier cash flow and reduce supplier costs. Typical of the responses is Bill Connerly’s article in Forbes. Bill describes P&G’s efforts as hurting both P&G and suppliers. ‰Procter & Gamble is about to lose money thanks to CFO hubris. Even after receiving a comment from P&G about their SCF program, he still feels it is detrimental for both P&G (in the long run) and their suppliers. Let’s go through the math and look at the example Bill used, a supplier with $100,000 of sales to P&G and a supplier borrowing cost of 4% APR.

• With SCF in place, the supplier can access funds based on P&G’s credit rating, not the suppliers. According to the original WSJ article the SCF rate to the supplier is 1.3% APR.
• According to the article, suppliers can use SCF to get paid on day 15 so let’s do the math from day 15. Prior to P&G’s term extension and SCF offer, the supplier with a 45 day term pays $333 to finance their receivable to day 15 ($100,000 / 360 * 30 days *4%). After P&G’s term extension the supplier pays only $217 ($100,000 / 360 * 60 days * 1.3%). So the supplier actually saves $116. Said another way, it’s cheaper for the supplier to finance 60 days of their receivable at the SCF rate of 1.3% than 30 days at the supplier’s own rate of 4%.

Bill also undervalues P&G’s benefit. In the example above, by extending payment terms 30 days, P&G will generate $8,219 in incremental operating cash flow, not debt. How do they value that cash flow? They can use that cash flow to invest in their business, buy back shares, pay dividends, etc. Let’s say they value that cash flow at a WACC of 6%. The value to P&G is then $493, far greater than the $8 Bill calculates by using P&G’s commercial paper rate of 0.10%. This isn’t short term cash or debt for P&G so it shouldn’t be valued at a short term debt rate such as their commercial paper rate. So, since P&G is making SCF available to suppliers, the reality of the example above is the supplier saves $116 and P&G makes several hundred dollars depending on how they value capital. With SCF in place this is an example of collaboration, not hubris. P&G has the opportunity to generate $2 Billion in operating cash flow simply by raising payment terms to industry standards. If I were a P&G shareholder, I’d be pretty upset with the management team if they didn’t capitalize on this opportunity, especially when SCF is available to actually improve supplier cash flow. Why should P&G, in effect, subsidize competitor’s longer payment terms and cash flow by paying sooner than industry standards?