The current global economic unpredictability, highlighted by Greece’s precariousness within the eurozone, and the resulting tightening of credit is impacting trade flows and extending financial pressure on a growing number of global suppliers. The result is an increase in the risk that corporates need to proactively manage. In this context, financial supply chain (FSC) programmes are becoming more and more popular as a way for large buying entities to protect strategic components of their supply chain.
However, many corporates are not yet fully focused on the risk implications that the global economic uncertainty may have on their supply chains. During a recent webinar attended by a large number of corporates from various industries, Deutsche Bank conducted a straw poll which revealed that close to 80% of participants felt that their awareness of the financial health of their suppliers was low to medium, while 36% had experienced a significant negative event with some of their strategic suppliers over the past 12 months. This feedback suggests that most respondents are still not sufficiently aware of the risk associated with their FSC, which is supported by the fact that so many have had a negative experience in the past 12 months. A well-planned and executed FSC programme can help address financial weaknesses in parts of the supply chain.
The same survey found that over 70% of the respondents said that they were in the early stages of a FSC initiative, which proves that such a programme is in demand. The initial focus for most companies is on working capital, as firms need a tool to improve their working capital management and financial position, but risk management is quickly coming to the fore as a reason behind a FSC initiative.
FSC: The Supplier Benefit
Traditionally, the main marketing focus of a FSC initiative has been to highlight the benefits for the buyer. However, in order for a FSC programme to achieve success, a detailed value proposition for suppliers must be put forward to encourage their buy-in.
In advance of the webinar, Deutsche Bank posed the question to participants: “How successful do you think that you’d be in extending payment terms, or days payable outstanding (DPO), with your suppliers?” The majority of respondents said that their success rate would be less than 10%.
The webinar then explained how a company could present the value proposition to its suppliers, and also the importance of understanding the service and support components of a FSC offering.
After the webinar when those same participants were asked “How successful do you think that you’d be in extending the DPO for your suppliers using a FSC programme?”, the response went from a success probability of less than 10% to roughly 50%. The response leads to the conclusion that many buyers have previously been focused on why FSC programmes are good for them, rather than how to make them attractive to their strategic suppliers. As a result, they probably would not have been able to articulate a value proposition that would drive adoption and, ultimately, give the buyers the desired payment terms.
Corporates need to understand how to drive better penetration of FSC programmes by delivering clear messages associated with improved working capital and risk mitigation on the supplier side and, quite simply, financial calculations.
Take, for example, the situation for many small and medium-sized enterprises (SMEs): pre-crisis, they had benefited from the comparatively low cost of financing – money was cheap and readily available; however, after the crisis the SMEs were badly hit, as their financing costs rocketed, while collateral requirements increased and loan limits decreased. Even if they had access to credit, that capacity was most probably cut, and suddenly they found themselves fully pledged, with their borrowing lines fully utilised.
The proposition of a well-positioned anchor entity – which can offer access to credit capacity at a competitive rate in order to allow the supplier to then sell the receivable with no contingent risk, collateral requirement, borrowings, or pledging – suddenly becomes a compelling argument.
However, some buyers make the mistake of indiscriminately launching massive FSC programmes because they don’t fully appreciate the impact that such programmes can have on their own credit capacity. In today’s environment, credit is a scare and valuable resource, and a company should focus that capacity to the suppliers that will give it the best commercial advantage.
For example, they should focus on strategic suppliers, because if a buyer loses these suppliers then it may have serious production issues. Also, if a buyer puts too much financial pressure on its key suppliers, then it runs the risk of impairing their profitability and, as a result, could trigger a reduction in quality, which will have downstream effects on the business. Ultimately, the buyer has to understand how to deploy a FSC solution in a way that gets it the most bang for its buck.
FSC Programmes: Different Core Value Propositions
Corporates also need to distinguish between the core value propositions of different FSC programmes. If a company presents a value proposition based on payment automation, such as moving from paper to electronic invoices, then it will promote a different strategy for supplier adoption than if it is pushing a programme where the fundamental driver is optimising working capital through utilising its credit capacity. For the latter, a company needs to stress that it has this scarce resource and wants to allocate it accordingly to create the greatest benefit for all, thereby improving the buyer/supplier relationship.
There are a variety of programmes that can be categorised as FSC products, such as receivables finance, payables finance, etc, and some are popular in certain industry sectors. For example, the retail industry has historically accessed working capital through the factoring market. However, the credit crisis resulted in the collapse of a certain large factoring companies and the scaling back of other players, which severely limited access to that type of financing.
Another type of financing product, a confirmed payables solution, needs an ‘anchor client’ that has a reasonable credit capacity in the market (see case study in Financial Supply Chain Solutions: Key Issues for Corporates). However, if a company is in difficulty, it becomes more challenging to put together a programme where a service provider takes on the troubled company’s exposure.
Supplier Onboarding Challenges
Sometimes a larger corporate’s demand for credit to support a programme, such as a confirmed payables programme, will often exceed the capacity of any one bank or even a few big banks put together. In many cases, large corporates look to a few banks to put together FSC programmes because they want an assurance of capacity to support their business.
Banks are often willing to work collaboratively because the market opportunity is so great. This works because normally it is not a single FSC programme with many bank participants – although there are technology vendors in the market that sell a system and then a number of banks provide the liquidity. In most cases, the client enters into multiple agreements with their banks, and then suppliers are onboarded by one or another bank, not multiple banks. One bank may onboard suppliers, for example one, three, five, seven and 14, for a given client and the next bank has a different set, etc. That diversification in the bank group reduces volatility which benefits both the corporate and the supplier. The bank’s focus will be to ensure that the customer understands how to target its suppliers so that everyone gets maximum value out of a FSC initiative.
For this to work smoothly, the onboarding process must be as easy and streamlined as possible (see Client Onboarding: Improving the Customer Experience). In confirmed payables, the value flows from being able to onboard suppliers – if a company builds the programme but then doesn’t make it easy for suppliers to participate, or deliver the value proposition message properly, then suppliers will not join and the FSC programme will not get off the ground.
If the corporate and bank work in partnership to collectively determine the tone of the message and plan the approach, then adoption rates skyrocket and client satisfaction with the process is significantly higher. As the adoption rate improves, it becomes easier for the buyer to leverage the liquidity they are providing through the system to achieve other objectives, such as extending payment terms.
Ultimately, whether a supplier participates in a FSC programme or not is principally driven by four factors:
- How focused are they on raising liquidity: what is the alternative cost of capital?
- Is this a good rate?
For example, a well-performing company may suddenly look at its receivables and realise that it has concentration risk with one particular supplier. It normally can fund that at LIBOR plus one, or it can participate in this programme at LIBOR plus two. Is there another alternative? It could insure the receivables and pay a premium, but then it doesn’t gain liquidity. It could then sell those receivables outright and that will meet a risk management or portfolio balancing objective, rather than a pure DPO or cost containment objective.
Additionally, some companies that wouldn’t be expected to participate at a given rate will choose to do so opportunistically. For example, they may have a large bond payment or are building up cash for an acquisition. There are many kinds of corporate finance initiatives that might drive them to look beyond just the comparative funding cost.
As global economies continue to squeeze suppliers and their access to liquidity, their risk profile may deteriorate significantly. Corporates should be increasingly proactive in looking at the risks associated with their supply chain and consider strategies to help mitigate some of those risks. FSC programmes may be a great way to provide strategic suppliers a liquidity ‘lifeline’ that can then be leveraged to enhance the relationship or to achieve other benefits such extending payment terms or negotiating price reductions. Understanding the value proposition of a FSC programme and communicating this to your strategic suppliers is essential to driving adoption, just as picking a partner that can help formulate and deliver the value message is an essential component to launching a successful initiative.
One successful US-based retail client of Deutsche Bank looked at a targeted pool of suppliers and calculated the cost of carrying a receivable for 100 days at the supplier’s imputed cost of funding. Based on the lower cost provided through a FSC programme, the retailer was able to show these suppliers that, by participating in the programme, the standard payment terms could be extended to 167 days and remain cost-neutral to the supplier. For the retailer, this terms extension represented an improvement of 67% in DPO, while suppliers were able discount their receivables with Deutsche Bank well in advance of the former 100 day mark, effectively reducing days sales outstanding (DSO), reducing carrying costs, and without borrowing or pledging collateral. The programme is a huge success because the retailer took the time to identify the appropriate supplier pool to target and delivered a clear, compelling, and fact-based message on the economic benefits.
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