Supply chain finance (SCF), de-facto, is recognised as the provisioning of financial instruments that ease the working capital of a company’s supplier base. This goes along with the notion that supply chain management relates to the management of goods and information exchanged with a company’s suppliers.
Nothing, in my opinion, is more misleading.
My long-lasting experience, first as a practitioner and then as the European director of the Supply Chain Council, suggests that supply chain management should be defined as ‘a disciplined blend of practices, organisation and technologies that support users in the design, plan, source, make, deliver, and return of goods and information relative to products and services delivered to end users in the global market’.
In other words, supply chain management oversees the flows of goods and information across the entire source-to-pay and order-to-cash (O2C) processes – not to mention the parallel worlds of new product introduction and after-sales. This should be the premise of SCF – to reduce finance costs not only of one part of the supply chain, i.e. the suppliers, but rather the entire supply chain.
The typical processes of sourcing are, indeed, part of the supply chain manager’s duty. Yet there are additional activities, such as:
- Network planning.
- Production planning.
- Scheduling of supplier deliveries.
- Forecasting customer demand.
- New product introduction.
- Inventory management.
- Distribution planning.
- Managing returns.
These processes all expand the reach of the supply chain manager’s responsibilities, and all trigger equivalent processes in the financial chain. For instance, ‘distribution planning’ demands the ability to manage letters of credit (LCs), get International Commercial (INCO) terms financing, or plan for foreign exchange (FX) transactions. ‘Forecasting customer demand’ triggers a cash forecast capability, while ‘production planning’ looks at investment and asset based lending services as the natural counterpart from the financial value chain world.
I feel compelled to say that the term SCF is used rather inappropriately. The previous few, yet punctual, examples introduce the notion that SCF must extend its reach way beyond where it is currently (and mistakenly) positioned. That is, again, a mere buyer-centric perspective.
If, as strongly asserted by various sources, SCF relates only to the buyer supplier (i.e. buyer-centric) relationship, then how should the customer-centric relationship be called? Some say that this is a ‘demand chain’; and, therefore, the correspondent financial services should be tagged as ‘demand chain finance’. Next, comes the need to finance internal manufacturing operations and inventory. Those would then be referred as an ‘operations chain’ financed by an ‘operations chain finance’? The story could go on endlessly.
Can you see the point? It’s not only for reasons of semantics that I suggest using a single term to cover the entire spectrum of these processes. The point is important because the more terms used to indicate the various corporate processes financed, the more barriers are created rather than being removed. Numerous terms translate into more silos, and each silo will be served by a discrete set of niche products.
Each group of offerings – be it trade finance, payments and cash management, securities service, structured finance, or insurance and risk management – is still managed by a separate unit within the bank. The corporate client interfaces with multiple relationship managers, each responsible for their own product line. The nomenclature, itself, is a proven evidence of such a siloed approach: while corporate users ask for solutions, banks come forward with products.
Banks and Financial Product Management Dilemma: Package or Keep Separate?
One of the frequent topics debated in transaction banking (and, in particular, in SCF) today relates to whether banks can remain profitable once they start offering solutions in the form of integrated packages rather than keep on selling separate, or vertical, product lines, e.g. cash management, trade finance, open accounting, etc.
The greatest fear suffered by banks is that they might start losing revenue and cannibalise product lines. The approach I always recommend is to learn from the successful practices of industries that have had similar experiences in the past. There’s no need for banks to reinvent the wheel if they can learn best practices from others, even if these examples come from completely different sectors.
One valuable source of good practices is IT. This is a sector in constant evolution, a buyer’s market heavily exposed to customer demands and standards compliance – not so dissimilar from the banking world, after all.
I found the paradigm of IT extremely helpful to illustrate how banks can take inspiration from software vendors when deciding how to best deploy a business plan strategy to build and install electronic platforms for global transaction services.1
To achieve similar inspiration, I refer to my preferred area of corporate IT: the market of enterprise systems. During the late 1970s, application software vendors had to decide whether they’d stay with a portfolio of separate software applications product lines (e.g. production planning and execution, warehouse management, logistics, parts purchasing, inventory control, product distribution, and order tracking) or merge them into an integrated multimodule software system.
The industry chose the latter option, which eventually launched the era of the materials requirement planning (MRP) systems. MRP, in turn, evolved in the late 1980s into enterprise resource planning (ERP) systems. Players such as SAP, Oracle, JD Edwards, Baan and Peoplesoft expanded the footprint of the MRP and moved from co-ordination of manufacturing processes to the integration of enterprise-wide backend financial applications and human resources processes (e.g. finance, accounting, payables, receivables, and HR) to provide a complete solution to a company for managing their inventory, cash and people resources.
The decision criteria used to opt for MRP first and subsequently ERP weighted the risks of operating in a competitive market and offering a piecemeal of separate software ‘verticals’.
These risks would entail:
- Commoditisation, as a consequence of stiff competition on functionally restricted software applications.
- Loss of market share, due to the presence of ‘best-of-breed’ providers with more functionally rich, performing and ‘mission critical’ applications.
- Higher total cost of ownership (TCO) for the client, due to the subsequent (and inevitable) need to integrate the various originally separate software modules.
ERP vendors also learned that they might have lost some revenue by blurring the lines between rewarding vertical product lines, but they gained in profitability because they were able to attach lucrative (and more scalable) added-value services to the selling of the ERP product, such as post implementation maintenance, system integration, consulting, and training.
The enterprise software vendors also evolved their products into ERP systems because they had to follow their corporate clients who were also evolving: modern companies started to integrate their various internal functions. The manufacturing sector, particularly automotive, was the first to experience this trend thanks to the influence of Japanese ‘just-in-time’ and ‘total quality management’ practices, which revolutionised the work organisation structures still centred around Taylor and Ford rules (i.e. mass production, segregated duties, quality at the end of the line, “Any colour the customer wants as long as it’s black”). In summary, the lessons learned from the ERP vendors are:
- Vertical solutions generate revenue, but integrated (i.e. packaged) solutions (e.g. ERP) ensure profitability.
- Vertical products are not scalable in terms of added-value services and add ons. ERP solutions are.
- The integration of IT applications followed the integration of duties at corporate organisations.
Turning back to banks and to the theme of staying on separate product lines or offering packaged solutions, an overview of the major business imperatives pressuring the banking industry can help:
- Most banks today claim they wants to sell solutions, not just products.
- The banking industry has become a buyer’s market, where corporate treasurers carefully select their bank relationship partners and demand more added-value services
- Corporate treasurers are accountable for enterprise-wide visibility of cash and are integrating functions once separate (e.g. cash, trade, payments, FX, etc).
- Banks are claiming they are really serious in putting the customer at the centre.
If there’s only one thing we should take from the ERP lessons is that the key heart of an ERP lay in its ability to improve the performance of the internal business processes of a company. The
magic word is ‘processes’.
This for banks means:
- Putting the customer at the centre means putting their processes at the centre of gravity of any future offering. A corporate treasurer has the need to finance its company’s working capital regardless of the product name of the financial instruments offered by the bank to accomplish the result. Whether it’s a LC, an open account trade, an invoice- or purchase order-based financing does not matter as long as it fulfils the expectations of solving the problem and responding to the treasurer’s TCO prospect.
- Corporate treasurers are accountable for the processes in the financial value chain. As these cross end-to-end the functions of the entire organisation, integration is the only means to secure visibility and control.
- Integrated financial value chain processes require integrated financial instruments.
- There’s no risk for a bank to lose profit if it sells integrated product lines. That’s what the customer wants.
In summary, it is economically advisable to reduce the silos and the discrete sets of well separated niche products that support SCF.
The Way to B2B Finance
The importance to agree on a common set of definitions and products for SCF is also highlighted by the works on the topic held by international associations that deserve attention.
- In December 2010, the Bankers’ Association for Finance and Trade International Financial Services Association (BAFT-IFSA) published the document ‘Product Definitions for Open Account Trade Processing and Open Account Trade Finance’
- In September 2009, the Bank of England (BoE) asked UK stakeholders to form a working group, chaired by the Association of Corporate Treasurers (ACT), to review the SCF market. In July 2010 the working group published ‘Supply Chain Finance – Report of the Supply Chain Finance Working Group’.
- The International Chamber of Commerce (ICC) and SWIFT are working on a series of common financial product definitions adopted by corporations in their trade operations and supported by the technology of SWIFT’s Trade Service Utility (TSU). The bank payment obligation (BPO) is one of these products.
Yet, the definitions of SCF given by the three groups differ in two main categories:
- BAFT-IFSA and ICC-SWIFT consider SCF as related only to open account transactions.
- BoE-ACT extends further the concept and includes the processes that go beyond the limits of the buyer-supplier relationship.
- On one thing all agree: SCF is used to finance the processes that cross the borders of corporations and integrate businesses.
We can start from this perspective of a common business ‘ecosystem’ to build the foundations of a ‘new’ SCF.
If we again use the IT industry as the leading ‘fil rouge’, we see that such an ecosystem of collaborative and integrated buyers, suppliers, and partners was successfully defined as business-to-business (B2B). B2B describes commerce transactions between businesses, such as between a manufacturer and a wholesaler, or between a wholesaler and a retailer. I repeat, the three international associations all agree that SCF supports financially the processes that cross the borders of integrated businesses and corporations. Since we have just seen that there is a general agreement to define the processes that cross the borders of integrated corporations and businesses as B2B processes, why not rethink of SCF as ‘B2B finance’?
There is a possibility that, eventually, B2B finance could become the new paradigm upon which banks, corporations, solution and service vendors may start building a constructive and finally clear dialogue.
My definition of SCF is that it is the set of financial approaches and instruments that optimise the transactions, working capital and costs of the extended, or end to- end, supply chains. You can easily replace ‘SCF’ with ‘B2B finance’ and the sense of the definition would not change. As stated at the very beginning, it is too late to try and change the use of a term (i.e. SCF), as it is so engrained in the current perception that is uniquely related to the buyer-supplier relation. ‘Perception is reality’, and there is no point in trying to change this status quo. The objective of this article is to highlight that as long as financial institutions (and trailing software vendors) continue to focus on SCF as a set of invoice-based and post-shipment (i.e. buyer-centric) financial instruments, they will not properly serve the corporate community, which is clearly demanding for a portfolio of cash-to-cash chain solutions, from payables to receivables, to inventory, rather than a set of transaction-based discrete products.
That is, a set of financial approaches and instruments which optimise the transactions, working capital and costs between businesses. In two words, B2B finance.
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