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A not-so-new but still largely unexplored model of financing aims to lessen the tension between suppliers and manufacturers, creating greater flexibility on delivery and payment dates and infusing both sides with money instead of debt.
It's called supply chain finance, and it allows a seller (typically a supplier) to sell its invoices at a discount to a financial institution as soon as the invoices are approved by the buyer (usually a manufacturer or retailer).
Supply chain finance platforms let a buyer pay later and not tie up its cash, while a supplier can receive its money as soon as its obligations are met -- rather than waiting for a buyer to pay months later. Instead of hinging the transaction on the creditworthiness of the supplier, the financial institution (a bank or hedge fund) deals with the typically more fiscally sound buyer.
Aside from showing the promise of updating the traditional (and sometimes parochial) way of bankrolling the delivery of goods -- with the supplier desperate for cash as it waits for the manufacturer to pay -- supply chain finance could also strengthen relationships between manufacturers and their suppliers and improve how products are made.
"For any company, cash is oxygen, and if you run out of cash, you run out of oxygen," said Bill McBeath, chief research officer at ChainLink Research. "A reason why a manufacturer would be interested in this is, besides it being a better use of cash, it can also help a supply chain become healthier."
The need for supply chain finance
Supply chain finance upends the traditional means of bankrolling a supply chain in that it lets manufacturers and suppliers work together to pursue payment and delivery terms that consider both sides' unique roles.
For one, globalization has changed how products are manufactured. Parts arrive from suppliers spread across many countries, and a manufacturer's finished product often targets a global customer base. But manufacturers also typically need time to create a larger product and ship it -- more time than when a supplier expects payment. When a manufacturer pays a supplier faster than it can turn a profit on its own product, it is incurring debt and tying up cash flow.
As an example of this imbalance, Tom Roberts, a senior vice president of the supply chain finance platform PrimeRevenue, points to how a heavy equipment manufacturer sometimes can't turn around a product faster than the industry standard of 80 days payable outstanding. Meanwhile, a supplier will send a bill as soon as its product is received and expect payment within 30 days, meaning the manufacturer will, until it makes money on its product, provide the supplier with a loan for 50 days or more, he said. "It's not the best way to convert cash," Roberts added.
On the other end, suppliers typically don't want to accept longer payment terms to accommodate a manufacturer's longer production and sales schedule. Suppliers that agree to lengthy payment schedules will similarly feel the strain of cash and might resort to high-interest loans.
Supply chain finance aims to pay suppliers when they need to be paid, while taking manufacturers off the hook -- albeit temporarily -- from paying before they're ready. There are various forms of supply chain finance, but the one favored in manufacturing focuses on post-invoice transactions. Using a supply chain finance platform, a manufacturer and supplier come to terms and select a lender. After a manufacturer approves and submits the supplier's invoice to the lender, the lender pays the supplier on an agreed date or earlier, minus a small discount for the manufacturer. The manufacturer, meanwhile, has a longer window of time to pay the lender.
Roberts and others call the arrangement a "win-win" for both sides. A supplier can get paid within days, while a manufacturer can wait as long as 120 days -- sometimes longer -- before having to meet its financial obligation.
Fintech platforms aim to simplify financing particulars
Banks and even pension funds are acting as lenders and accelerating interest in supply chain finance, said Ganaka Herath, a partner at the consulting firm McKinsey & Company. With a relatively short financing period and with manufacturers serving as safer credit risks -- instead of suppliers that probably have less financial resources -- investors are slowly starting to see potential in supply chain finance, he said.
Supply chain finance started as a Citibank product in the 1990s and has "trudged along" with a "few big players" -- including Walmart and Mercedes-Benz -- now taking advantage of the ability to ensure suppliers are paid promptly, while they can keep debt off their books, Herath said. Still, a 2015 McKinsey report showed that only about one-tenth of a potential $20 billion global market for supply chain finance has been captured, and that lack of penetration holds true in 2017, Herath said.
PrimeRevenue is one of several fintech companies that offer cloud-based supply chain finance platforms and act as brokers, connecting manufacturers and suppliers with financial institutions. McBeath of ChainLink Research said the industry publication Trade Financing Matters (TFM) succinctly breaks down the offerings of supply chain finance platforms.
For example, TFM recommends Taulia for robust invoice automation and dynamic discounting. Ariba focuses on e-procurement, with e-invoicing and discounting capabilities, while Nipendo and Tradeshift are pioneering the platform-as-a-service model, combining cloud-based software for data and document management with apps. PrimeRevenue and Orbian are ones to consider for approved trade payable finance programs and wide selections of third-party funding providers. Manufacturers and suppliers can also consider offerings by traditional financial service firms, such as BNP Paribas, Citigroup, Deutsche Bank and HSBC.
Manufacturers can also contemplate using their own homegrown platform by connecting their accounting and invoicing technologies and working with financial institutions, Herath said, but that will probably be complicated.
Supply chain finance might not be a "win-win" for everyone, as Roberts and others suggest. Harvard Business Review notes that multibank fintech platforms, like PrimeRevenue, have increased the competition in financing to a point where lenders are seeing reduced profits. (Fintech platforms receive a small fee for administrating supply chain finance transactions.)
Preparing for supply chain finance platforms
A manufacturer shouldn't try supply chain finance without first having a financial goal in mind, Roberts recommends. Whether it's freeing up money for cash flow or funding an initiative, that goal must be clear and agreed upon by the CFO, chief procurement officer and all executives, he said. Manufacturers should also compare internal benchmarks against those of peers and competitors that use supply chain finance.
If a fear of complicated technology is holding back manufacturers and suppliers from supply chain finance, most platforms are simple to grasp and will show benefits if all parties are on the same page, Herath said. Once a manufacturer has chosen a platform, it should first focus on bringing in only the top 20% of its suppliers to keep things simple, he recommends. Then, carefully explain the concept of supply chain finance with each supplier, including a close review of negotiated terms and the overarching legal framework.
Ganaka Herathpartner, McKinsey & Company
The onboarding of suppliers is usually overlooked, and only months later do manufacturers realize that few of their suppliers are interested in using supply chain finance because they don't recognize its benefits, Herath said. He advises detailing the benefits of the financing process for suppliers but not forcing them to join. If suppliers are open to the concept, they will see that it goes deeper than finance. They'll recognize it also aligns both parties so they can jointly improve the supply chain, he said.
"A large supplier is not going to use supply chain finance just for a 10-day payable," Herath said. "They're going for larger intangibles: a stable supply chain where they don't run short of working capital. They understand better the flow of how supplies move forward, so that's why the strategic intangible of supply chain finance is even more important than the financial benefit."
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