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As new services come to market, finance executives are taking a second look at supply-chain finance.
Kate O'Sullivan, CFO Magazine
February 1, 2007
With thousands of suppliers shipping everything from furniture to toys to its 1,400 stores, Big Lots Inc. has long prided itself on its supply-chain management. But until recently, the closeout retailer had a few weak links in what might be called its financial supply chain — the flow of money that supports the movement of products. "We recognized quite a while ago that there were some inefficiencies in the financial supply chain, and that we were paying for those inefficiencies," says treasurer Jared Poff.
Many of the company's small and midsize suppliers were struggling to access capital to run their own businesses, says Poff. Frequently, they would factor their receivables to enhance their cash flow, often at a significant discount to the cash value of the receivables. That gave their competitors a big advantage, he says, because "if there were two vendors sending us the exact same product, but one had much easier access to capital and lower borrowing costs, it could potentially force the other out of the running." Consequently, the remaining vendor could charge a higher price for the product.
In addition, vendors' borrowing costs, which could be as high as 18 percent, typically ended up reflected in the price of the product, ultimately increasing the cost of goods for Big Lots. "We thought, 'There's got to be a way for us to let vendors compete on their ability to make the product and not on their ability to access financing,'" says Poff.
After reviewing multiple offerings from banks and other vendors that tackled only pieces of the problem, last December Big Lots settled on a Web-based service that Poff hopes will address suppliers' need for quick cash and lower the retailer's own cost of goods, or allow the retailer to secure longer payment terms. As soon as Big Lots approves a supplier's invoice, that invoice is posted on a system run by PrimeRevenue, a third-party service provider based in Atlanta. The supplier, which can see all of its approved invoices online, can choose either to wait for full payment or to sell the invoice to a bank or other financial institution that participates in the PrimeRevenue network and receive cash as soon as the next day.
What's more, the supplier's receivable will be discounted based on Big Lots's investment-grade credit rating. Because the invoice has already been approved, the financial institution considers the risk to lie with the buyer. "They know that their ability to get paid really depends on us," says Poff. PrimeRevenue then directs Big Lots to pay the bank. PrimeRevenue itself takes a percentage of the financing fee charged to the supplier.
In addition to providing cheaper access to capital, the system also removes uncertainty for suppliers, who often don't know that a payment will be late until a check fails to turn up, sending them scrambling for cash. "Not knowing when you're being paid, especially for a smaller supplier, can impact the ability to buy raw material or pay your own suppliers. It has a really intense domino effect," says Beth Enslow, supply chain practice leader with Aberdeen Group. The ability to see when invoices have been posted and approved enables suppliers to better plan for their own cash needs, which can benefit buyers because suppliers will have the flexibility to extend payment terms more readily. "Right now, they have to buffer themselves against uncertainty by holding on to cash and not extending payment terms," says Enslow.
A Slow Start
Big Lots has come relatively early to the supply-chain finance game. Just 13 percent of companies are actively employing supply-chain finance techniques, according to a recent Aberdeen study. While the concept has been discussed for years, buyers often approached it by pushing for longer payment terms, which many suppliers were unable to offer without putting their own finances at risk (and ultimately jeopardizing their ability to meet the buyer's needs).
"There is a disconnect between the actions of buyers and suppliers and their respective goals," says Viktoriya Sadlovska, supply-chain finance research analyst with Aberdeen. "The top pressure for buyers is to lower their cost of goods. And suppliers are resisting lowering costs."
Supply-chain finance vendors say their systems can reduce the friction between buyers and suppliers, but most companies haven't gotten the message yet. "The transformation of the physical supply chain has been fairly dramatic over the past 20 years as companies have moved to sourcing overseas, but finance solutions haven't changed at all," asserts PrimeRevenue CEO Joe Juliano. In contrast to "all of the work that companies have put into low-cost-country sourcing and optimizing manufacturing and putting in all the technology to forecast demand," most supply chains still rely on time-consuming and costly financing methods that can add up to 4 percent of the cost of goods, he says. For a supplier in China, the time between receiving an order and receiving payment for a finished product can be as long as five months, notes Juliano.
But finance may be poised to catch up. Technology has evolved to the point where both ends of the supply chain have greater visibility into the process. "In order to effectively extend a buyer's credit rating to suppliers, banks need to have supply-chain data about when goods are being shipped so that they can assess the risk. Thanks to more electronic commerce, now we have a lot more information," says Enslow. "I don't think companies could have done this effectively in the 1990s."
Like his counterpart at Big Lots, Richard Learmont, treasurer at UK grocery-chain Sainsbury's, says his company had been looking to improve its supply-chain finance techniques for some time and had evaluated numerous products. "We've been good at taking cost out of the supply chain in the physical sense, but there has always been this financial inefficiency. Our view and our suppliers' view of working capital have been at odds," says Learmont. "But none of the [vendors] that we saw really had anything credible in the market or had the technology to back up their ideas."
Ken Roche, chief executive at Orbian, another third-party supply-chain-finance-system provider, says his company has been developing its platform, which is based on SAP, for years. The company started as a joint venture between SAP and Citibank and has since spun out on its own, touting its ease of integration with SAP as a key differentiator. Roche acknowledges that "the education process has been slow. People haven't really been aware of these kinds of products, because the focus has been on other areas of efficiency."
Gaining an Edge
Roche sees more companies catching on, however. "Last year at a conference, I was the only one presenting on [supply-chain finance]," he says. "This year there were five different presentations on the same topic." Other providers aiming for a piece of the evolving market include TradeCard, a New York–based company that works mainly with retailers; boutique banks, such as SCF Capital in London; and branches of various large financial institutions, such as HSBC and ABN AMRO.
Sainsbury's eventually chose the PrimeRevenue system to allow suppliers access to their approved invoices for trade. "Enabling them to get access to sources of funds potentially using our borrowing rate rather than the rate they might be used to using is very, very attractive," says Darren Shapland, Sainsbury's finance chief.
Helping its suppliers will ultimately benefit the grocer as well. "We have one overarching objective in rolling out this program," says Learmont, "which is to make the terms and commercial relationship we can offer our suppliers as attractive as possible, to make sure we obtain the best products on the best terms from them."
The company pushed to be the first in its industry in the United Kingdom to roll out such a system, in hopes of gaining an edge with suppliers and strengthening its supply chain overall. Other companies may look at improved supply-chain finance practices as a carrot to offer suppliers to encourage them to tackle a big, expensive project, such as adopting radio frequency identification technology.
From a supplier's perspective, even for a company with an investment-grade credit rating, the simple ability to monitor invoice status provides a strong incentive to participate when a customer rolls out a new supply-chain finance system. "You know if an invoice is blocked for payment or if it hasn't been entered for some reason," says Stephanie Bice, accounts-receivable manager at Air Liquide Electronics U.S., a supplier to the semiconductor industry that was an early user of the PrimeRevenue system after its largest customer rolled out the service in 2004. "A lot of times as a supplier you're not sure whether an invoice was received or whether a customer will pay within terms."
The willingness of suppliers like Air Liquide to participate will be critical to the success of any supply-chain finance system. Third-party providers have taken that into account, considering the potential technology limitations of vendors, especially in less-developed countries. Because the new systems are Web-based, suppliers will simply need an Internet connection to access them. "All they need is a Web browser," says Orbian's Roche. "There's no integration."
However, getting suppliers around the world to voluntarily adopt new supply-chain finance practices will require a significant communications effort. Both Big Lots and Sainsbury's have supplier-education plans in place. Sainsbury's discussed the new system at its supplier meeting last November and is now preparing a team to meet with suppliers on an individual basis to explain the concept in more detail. Big Lots sent mailings to targeted vendors and followed up with phone calls from the merchandising department, vendors' most frequent point of contact at the company. The callers then encouraged those who expressed an interest to contact Poff or PrimeRevenue, which has a vendor-education department. "We want to make sure vendors understand what we're offering and why it's a benefit to them," says Poff.
If buyers can gain better terms and a more stable vendor base, and suppliers can improve their cash flow and financial stability, the new supply-chain finance offerings may start to catch on more quickly. "It's really about looking at how they can work together to take costs out of the supply chain," says Sadlovska, "not just one party benefiting at the cost of the other party."
Kate O'Sullivan is staff writer at CFO.
Many companies are thinking about supply-chain-finance techniques, but few have firm processes or plans in place.
13%: Actively using SCF techniques
15%: Have firm plans to enhance SCF practices
41%: Investigating options
31%: No action taken
Source: Aberdeen Group
Many buyers and suppliers are still a long way from agreeing on how they can improve their supply-chain financing. As of last September, these were the top actions each side planned to take in the next 18 months to improve the financing of its supply chain.
|51% — Negotiate price reductions with suppliers for early payment||67% — Implement a program that enables both streamlined transaction processing and access to financing|
|41% — Implement a scorecard system to track supplier performance||49% — Find a cheaper financing source|
|40% — Implement new technology for better automation and visibility||44% — Implement new technology for better automation and visibility|
|39% — Extend payment terms||37% — Obtain additional financing from a financial institution|
|32% — Implement a program that enables both streamlined transaction processing and access to financing||26% — Use purchase-order performance milestones to trigger buyer payment or export finance|
|Source: Aberdeen Group|
Ahead of the Curve
Some of the techniques employed by companies that are actively managing their supply-chain finance:
Source: Aberdeen Group