Supply Chain Finance: Winners and Losers
Updated 25 January 2021
Supply Chain Finance (SCF) changes the standard terms of buyer-supplier arrangements, whatever these happen to be for the industry, commodity and country or legal environment.
This scope includes payment for goods or services, investment in non-current assets (tooling) or inventory and any other form where one party in the Supply Chain (SC) finances another party more cheaply than they can fund themselves.
Starting from this position, we can take the prime motivation of a better net financial deal for one or another, or hopefully all, parties along the chain. Below are some examples:
- For the buyer or seller, one of their biggest investments is in Working Capital which includes supplier payments and customer financing. If SCF lowers the cost of this investment or increases the flexibility of providing it, buyers and sellers can win.
- Operationally, companies can win with improved SC relationships. For suppliers to classify a buyer as a priority customer, and so deliver way beyond the contracted levels of service, their experience on how and when they are paid is an important consideration. At the other end of the scale, delay and uncertainty over when a supplier will receive payment can lead to poor service, delayed deliveries and even a supplier failure.
- Logistics providers can win by increasing their scope of service by offering inventory finance, injecting liquidity into the SC.
- Banks have become major providers of funds and platforms for SCF, some providing integrated finance and platform solutions, while others provide funds to the SCF platform providers.
- There is an emerging group of new entrants with alternative financial backing, sometimes built on non-bank funding models, such as peer lending and crowd funding. These are also often linked to or are part of a platform or hub offering.
- Governments and international institutions get involved, too:
- Shorten cash cycle times to encourage growth and investment
- Improve the financing of SMEs
- Encourage exports
- Support developing countries' economies
- SCF can mitigate long export payment terms while the physical product is shipped abroad. E.g. ‘The Export-Import Bank of the United States (Ex-Im Bank) today approved the first transaction under its new Supply-Chain Finance Guarantee Program...’.
- There is a particular focus on growth for less developed economies. International Finance Corporation (IFC) part of the World Bank ‘... established in 2010 the Global Trade Supplier Finance (GTSF) program ... short-term finance to emerging market suppliers and small- and medium-sized exporters, helping to address a huge shortfall in supply chain finance.’
So, there may be many winners.
Commentators generally focus on the seller having a Reverse Factoring arrangement imposed on them resulting in a charge for early, or even the same, payment terms. However, there are other implications where, for example, SCF can disguise the reality of an organization’s overall debt.
The counterparty loses when 'win-win' becomes 'win-lose'.
If SCF is implemented in a way that lowers the working capital or financing costs for one party - but increases either or both for the other party - then that party loses out, unless it is recompensed in some other way. In most cases, it's a seller - often smaller and less financially secure and so less able to deal with the result.
This is the thinking behind the European Commission’s Unfair Trading Practice (UTP) plans.
The instigator loses when their reputation suffers.
As enterprises alter payment terms for their suppliers, maybe to improve their Working Capital position and enhance their financial performance, this has often drawn widespread negative reaction from the media, impacting adversely on perceptions by stakeholders (e.g. investors, customers, partners and analysts) which has implications for organizational reputation, brand and shareholder value.
Who wants to be named in the UK Forum of Private Business “Hall of Shame”?
Banks lose when others lend to their customers via SCF.
Banks have traditionally financed individual organizations based on their credit risk, assets and so forth. This includes lending against invoices in the form of factoring and invoice discounting. However, these established banking relationships can be challenged by new SCF models where organizations are being financed by their customers’ or suppliers’ trading arrangements.
New entrants with alternative financial backing, sometimes built on non-bank funding models such as direct investment and even peer lending and crowdfunding are now well established. When integrated with a systems offering, they are often seen as ‘fintechs’. Lending against payment between established trading partners is relatively secure and so can be priced more keenly and undercut general bank financing.
Many of these alternative funding providers can also serve SMEs where traditional banks are less competitive given their overheads and risk models. “FinTech firm Previse has raised $11m in new funding” is an example.
Investors lose out when they underestimate the financial risks of a company.
Investors can be misled by hidden financing which distorts reported financial ratios. For example, Carillion. “The company’s (Carillion’s) liabilities to banks related to overdrafts and loans stood at £148mn on its 2016 balance sheet, whereas there was in fact a possible further £498mn owed to banks under the reverse factoring scheme, Moody’s said.”
To avoid some losing out, to encourage ‘win-win’, and to build better supply chain relationships SCF needs to be fair to all parties, clearly communicated and transparent.
Take a look at Financing the End-to-end Supply Chain. The book, updated this summer, provides a detailed introduction to supply chain finance, demonstrating the importance of the strategic relationship between the physical supply of goods and services and the associated financial flows.