For Atimi Software, this was a reasonably big deal. Kellogg, the cereal and snack food giant, had just hired Atimi to produce a mobile app for use in Kellogg’s marketing activities. The contract wasn’t unusually large, but it had the potential to lead to further business with a big customer.
Less exciting? Two years earlier, in 2014, Kellogg had lengthened payment terms to its suppliers to 120 days. For a smallish outfit like Atimi — the Vancouver-based company does about $10 million (Canadian) in annual sales — waiting that long for money could crimp its cash flow.
Fortunately, Kellogg also offered its suppliers an alternative. Rather than wait 120 days to collect in full, directly from Kellogg, they could get paid in a matter of days by a bank or other lender — if they were willing to accept a small haircut on their receivables, maybe a percent or so. Atimi took the haircut.
“It was a good idea,” says angel investor and business consultant Pieter Dorsman, who until early this year had been serving as Atimi’s CFO. “If we didn’t have that early-payment option, we might have had to take our accounts receivable to a factor, but they would have charged 3% or more. Going to a bank would have involved a lot more paperwork and been even more challenging.”
On the buyer’s side, extending payment terms to suppliers has always been a tricky business. Make suppliers wait too long and they eventually push back, perhaps offering less favorable pricing, perhaps terminating the relationship. Or they could be driven out of business.
But the payment alternative Kellogg offered Atimi and many other suppliers was designed to keep them financially viable and satisfied. Sometimes known generically as “reverse factoring,” because it is similar to traditional supplier-initiated factoring but is initiated instead by buyers, it is now called supply chain finance (SCF). Proponents argue that SCF not only solves most of the problems associated with extended payment terms, but also helps suppliers by offering them a cheaper source of financing than the other options — bank borrowing, simple discounting for early payment of invoices, or factoring.
In a typical SCF application, a company extending its payment terms contracts with a bank or third-party provider to connect to that provider’s SCF platform. The buyer then reaches out to its biggest suppliers to encourage their participation. Once suppliers are onboard, they begin submitting invoices through the platform.
When the buyer approves qualified invoices, usually within days, it triggers payment through the SCF provider on discounted terms. The size of the discount is negotiated between the provider and the supplier, but reflects the credit rating of the buyer, not the supplier. Later, the buyer pays the SCF provider the full amount of the invoice according to the buyer’s new standard payment terms.
Note that in the case of a bank-operated SCF program, the bank itself may fund the payments to suppliers. Alternatively, it may choose to sell the receivables to a third party in cases where it doesn’t want to keep the credit exposure on its own balance sheet. Or it might hedge the associated credit risk using credit default swaps. Third-party providers, by contrast, typically link banks and other lenders to their platforms to fund payments to suppliers.
Note, too, that while the company establishing an SCF program will want to know what kind of discounts its suppliers are being offered, it won’t know the actual terms. Otherwise, explains Enrico Camerinelli, a senior analyst with research firm Aite Group, the commercial liability represented by the company’s accounts payables would have to be reclassified as a financial debt to the banks, which could impact the company’s debt ratios and eat into its credit limits.
A Big Market
Supply chain finance took root in the auto industry in the 1980s. It gradually migrated into the retail sector, grew quietly for years, then exploded in popularity when the 2008 credit crisis left companies scrambling to conserve cash. Now that credit is again plentiful and big companies are awash in cash, SCF is touted not just as a way for buyers to improve their cash flow, but also for them to ensure their supply chains remain financially viable.
Management consulting firm McKinsey & Co. estimates there are $2 trillion in financeable, highly secure payables globally, representing a potential revenue pool of $20 billion; only $2 billion of that was being captured as recently as 2015. Revenue from such programs grew at 20% from 2010 to 2015, says McKinsey, and was expected to continuing growing at around 15% annually for three to five years thereafter.
Amy Fong, an associate principal with the Hackett Group and head of the firm’s purchase-to-pay advisory practice, says her firm’s latest study suggests that only about 23% of companies are using any kind of trade financing. Most users are large companies with investment-grade credit ratings.
A handful of large global banks, including JPMorgan Chase and Citibank, dominate the SCF market. But a growing slate of third-party providers — fintechs such as Orbian, PrimeRevenue, and Ariba, an SAP company — could help push SCF to smaller companies. That’s because the fintechs tend to work with a broader array of lenders.
When choosing between providers, companies may want to consider a bank if they already have a relationship with it. The bank will likely have in-depth knowledge of the company’s business and financing, says Hackett Group Associate Principal Veronica Wills, and so may be able to better understand the potential benefits of an SCF program to that company—and reflect that in its pricing. Banks also often absorb many of the upfront costs that companies incur to link to an SCF platform.
Fintechs are more likely to charge for connecting to their platform, says Fong, but also may have a broader product offering that includes more process improvement and automation solutions. They also will typically handle more of the heavy lifting associated with onboarding suppliers.
When German industrial giant Siemens AG launched a supply chain finance program some years ago, it didn’t go with a big bank. The goal, says Mark Schiffers, now a managing director at SCF provider Orbian but then a Siemens finance executive in charge of the program, was to improve Siemens’ own working capital performance while at the same time making sure it “worked in a fair way with its suppliers, so that it wasn’t overpowering them.”
Siemens initially hoped to enroll 1,000 suppliers, but the banks it approached were willing to take on only about 50 to 100, Schiffers recalls. Not only was Siemens unwilling to accept those constraints, it also worried that if a bank changed its strategy and exited the business, Siemens’ suppliers would lose their liquidity source. Furthermore, Siemens didn’t like the idea that a bank might sell its trade receivables in the secondary market or use credit default swaps to hedge the bank’s credit risk with Siemens.
In search of alternatives, Siemens turned to Orbian, which works with multiple banks and other institutional investors to fund its programs. Orbian was open to operating on the scale Siemens wanted. Today, Schiffers says, the program has more than 2,500 Siemens suppliers participating.
Many of the direct costs to buyers for setting up an SCF program are relatively minor for very large companies, especially if they work with a bank. According to the 2014 Aite Group study, buyer expenses can include time spent by IT teams connecting to the SCF platform, and by legal teams revising or establishing commercial contracts with suppliers and service contracts with platform providers.
More substantial costs revolve around gaining access to an SCF platform if not working with a bank. Buying software directly from a platform provider can cost on the order of $600,000, Aite Group reports. Alternatively, a buyer can pay a per-use license fee in which costs might run as little as $2,000 for an annual spend of $1 million to as much as $600,000 for an annual spend of $10 million.
Companies also can incur ongoing costs for staff to manage relationships with participating suppliers, onboard new suppliers, provide legal review of onboarding procedures, and manage the overall SCF program.
For suppliers, the direct costs are negligible. There may be some training required to use the SCF platform and to analyze the benefits of participation, but otherwise the principal cost is the discount agreed upon in exchange for early payment.
“In many cases, we can show suppliers there is more economic value to them post-implementation than pre-implementation,” says Geoff Brady, head of the global trade and loan products business in North America for JPMorgan Chase.
For buyers, the benefits can be significant. In April 2013, Procter & Gamble announced that it was implementing an SCF program in conjunction with an extension of its payment terms to 75 days from an average of about 45 days. The Wall Street Journal reported that the program was expected to free up as much as $2 billion in cash. Kellogg has reported that its supplier financing program generated about $330 million in extra cash in one year.
Adopting an SCF program can be a smart move for buyers who know they can’t otherwise continue to extend their payment terms, says Camerinelli. Wills is generally OK with the idea, too, but argues that it should be one of the last in a series of payment-practice improvements. “There are many internal efficiencies that can be realized before moving to offer discounts to a supplier base,” she says.
Introducing an SCF program isn’t without risk, either. Wills warns of a “significant public relations element” in which the buyer could be seen as “the big bad guy squeezing suppliers.” Companies that establish programs with their relationship bank also need to be careful that it doesn’t prompt the bank to reduce other lines of credit.
For suppliers, the key determinant in whether to participate in an SCF program is to calculate whether taking a discount for early payment is the least costly source of capital. In other words, does getting paid, say, 99% of an invoice total in 7 days cost less than getting paid 100% in 90 days? And is it less than borrowing from a bank or going to a factor? For many, it is.
Randy Myers is a freelance writer based in Dover, Pennsylvania.
Supply chain finance programs can be enticing, but they don’t suit every company.
Before and after a company decides to launch a supply chain finance program, there are a number of things it can do to improve the odds of success, say experts.
• Get payment processes and technology in order. “Where we see good, sustainable results,” says banker Geoff Brady of JPMorgan Chase, “is where buyers have very efficient payment processing technology. If it takes them 30 days to get an invoice through the system and approved, there’s not as much time to discount it, which means there’s not as much value for them, the supplier, or us.”
• Create a cross-discipline SCF project team. “The most successful programs have a dedicated team that can make sure everyone is on the same page,” says Brady. The team should include not just finance personnel, says Enrico Camerinelli of Aite Group, but also representatives from procurement and logistics. They can be instrumental in the program’s success and help identify which suppliers should be involved.
• Look to the biggest suppliers first. Even if the ultimate goal is to onboard as many suppliers as possible, it only makes sense to first target the largest, as their participation will have the biggest impact on cash flow. By the same token, if top suppliers indicate they won’t participate, the company may consider forgoing a program.
• Expand the program to as many suppliers as possible after launch. “This is volume-based business,” says Camerinelli.
• Keep payment terms within or near industry norms. Payment terms under an SCF program can vary dramatically, but Brady encourages buyers to be sensitive to the norms in their industry, or risk alienating suppliers. “You don’t want to be an outlier,” he says. —R.M.