Supply Chain

SupplierPay: Cynicism, Optimism and Reality

Is the government's initiative to help small suppliers a bag of wind or a bona fide hope?
Scott PezzaJuly 31, 2014
SupplierPay: Cynicism, Optimism and Reality

Three weeks ago, the White House announced that 26 companies had signed onto the SupplierPay Pledge, expressing their intent to help their small suppliers by either paying them faster or facilitating their access to lower-cost sources of working capital. The announcement was greeted with a mix of cynicism and optimism.

Small suppliers surely provided much of this food, waiting in a warehouse for distribution to grocers.

Small suppliers surely provided much of this food, waiting in a warehouse for distribution to grocers.

I agree wholeheartedly that small businesses are in a precarious position and that they can get the short end of the stick when it comes to larger enterprises’ working-capital decisions. My struggle is with whether this news should provide a ray of hope that things may turn in their favor. There are aspects of the pledge hat provide support for both positions.

If this initiative takes hold, everyone wins: small businesses get some working-capital relief; large businesses strengthen their supply chains; and the vendors who facilitate dynamic discounting and supply-chain finance see an uptick in adoption. Folks like Ariba, GT Nexus, PrimeRevenue, Taulia, Tungsten Network and others offering buyer-funded, bank-specific and multi-bank solutions should certainly have their interest piqued. But that’s getting a bit ahead of ourselves. There are a few things to discuss before kicking off the celebrations.

Drive Business Strategy and Growth

Drive Business Strategy and Growth

Learn how NetSuite Financial Management allows you to quickly and easily model what-if scenarios and generate reports.

The Cynic
First and foremost, the pledge isn’t a binding contract — these companies didn’t actually promise to do anything, and they didn’t receive anything in exchange. Moving past that, the pledge itself is short on detail, aside from aspirational statements that sound a lot like what large companies are already doing when it comes to supply chain finance (i.e., offering smaller suppliers access to alternative capital sources at good rates). The basic framework is made up of three parts: (1) speeding payment or offering competitive financing; (2) sharing best practices; and (3) accomplishing point number one without extending payment terms as part of the deal.

I won’t harp on the negative, but there are a few nuggets in the existing text for cynics to latch onto. First, the promise isn’t to get small suppliers access to low-cost capital. It is couched as making capital available at a “lower cost,” but “lower” is relative. Lower than what? Being charitable, that would mean lower than the small business’s own borrowing cost, which could be quite high. That said, if larger suppliers weren’t extending terms (or paying later than already agreed-upon), there wouldn’t be the need for a financing cost above 0%.

There’s similar nitpicking to be done about the pledge leaving it up to buyers to define what “small supplier means” (i.e., they can define it around the subset of companies they already intended to work with). The prohibition on using the pledge as part of a program to also extend terms applies only to current suppliers as well, so it may provide more of an incentive to seek out new suppliers than to stick with existing ones.

Alternatively, these large buyers may have already extended terms with their small suppliers, so this would only prevent them (if they choose to be prevented, that is) from doing so further. If nothing else, that maintains the status quo with their existing base and may even provide a silver lining if the original extension did not go hand-in-hand with a supply-chain finance offer.

The Optimist
With the negativity out of the way, the last sentence of the last paragraph of the pedge does give me some reason for positivity: We will not use our pledge to offer financing solutions as a means of extending payment terms with our current small business supplier base. If heeded, that qualification would alleviate the cynic’s concern about the true motivation for supporting this approach. No, it doesn’t change things for suppliers that have already accepted extended terms, but it is a good starting point for future dealings.

The optimist in me is hopeful that the first option in the pledge’s section 1 (paying small suppliers faster) is a true possibility, and not just a stopping point on the way to the second piece, offering alternative financing. If that is the case, then small businesses really will benefit, as their cash-flow situation improves. Further, any improvement here is helpful — we don’t need exact details, and we don’t need to fix a specific time-span for payment (e.g., everything paid within 30 days). If they currently receive payment in 60 days, then 55 is still something, especially if it comes with no strings attached.

When it comes to “lower cost” financing, there are some attractive options. Traditional discounting, as I’ve discussed, doesn’t work out so well. Vendors I’ve spoken with have said they can facilitate financing (based on the credit of very large buyers, of course) at a rate of 1-3% per annum. If that’s on the table, then the optimists can rejoice. It will be interesting to see how things play out, but that’s a rate at which discounting or supply-chain finance can become a desired working capital lever for the small businesses too.

The Realist
The cynic and the optimist represent extremes, and reality is likely somewhere in between. It is easy to see the business justification (read: brand perception) of making the pledge, but is much more difficult to see the justification for actually following through on it.

When large companies warmed to the Green-oriented messaging of optimizing their transportation strategies, it worked because the external messaging (being more environmentally friendly) was backed up with a compelling internal justification: reducing miles traveled, along with the attendant labor, fuel and maintenance costs. Lean is Green and Green is Lean. But that secondary piece isn’t present here.

If a supplier is truly important (i.e., does not provide a commodity or near-commodity product that can be easily sourced from one or more competitors), then it’s already a strategic partner that isn’t being squeezed. If it is being squeezed and you need a pledge to stop you from putting your strategic partners out of business, you’re not long for this world anyway. So that just leaves non-strategic suppliers.

Paying non-strategic suppliers earlier than you have to, and not doing everything in your power to push prices down (and/or terms out), is really just voluntarily agreeing to forego exercising your superior negotiating position. If you can get all of your competitors to sign the pledge as well, I guess that’s some strange form of market-supporting collusion. Otherwise, you’re agreeing to pay more (directly or indirectly) for the things you need than your competitors will.

Either the categories and volumes of purchases this applies to are immaterial, or they are material and you’re volunteering to occupy a weaker competitive position in the market. The offset, then, would be the expected top-line growth associated with more positive brand perception that will compensate for the slightly-larger-than-necessary expense and/or COGS line-items that chip away in transit from the top to the bottom line.

Making SupplierPay Work
If the pledge is non-binding and there is no true business justification for following through, what can be done to keep things moving forward? There are four main approaches that come to mind, though this list is certainly not exclusive. In rough order of their palatability (from least to most), they are: government mandate, tax incentives, repatriation benefits, and government influence via purchasing policies.

Government Mandate. When it comes to interstate commerce — in which large corporations can’t help but take part — the government has some pretty wide leeway to regulate. It could simply require compliance with terms that resemble those outlined in the pledge. Or it could require periodic reporting of compliance, which would be subject to potential audit, much like current compulsory tax and securities filings.

The downside, of course, is that this would either increase an existing agency’s regulatory workload or require the creation of another agency. Worse still, it could have the unintended consequence of hurting those it is meant to protect by effectively increasing the cost of doing business with a smaller company (since the underlying value proposition has not been addressed). That doesn’t seem like a desirable outcome.

Tax Incentives. This option addresses the value head-on by providing tax-based offsets for prompt payments made to smaller suppliers. At base, it is a simple transfer — less tax collected from compliant businesses means more tax revenue derived from individuals (and potentially the small businesses this is meant to help as well). We could avoid that consequence if the lower tax collections were matched with corresponding decreases in government expenditures, but regardless of political leanings, that seems unlikely. I’m not a political pundit, but I would assume that a direct transfer from public to private (especially large-enterprise) coffers would be inadvisable in the run-up to the 2016 elections.

Repatriation Offsets. I like this option, as it provides a valuable incentive without shifting tax burdens. Here, prompt payment to small suppliers would provide a credit against which repatriated international earnings could be offset. Yes, there’s some moral hazard here: it provides a benefit to companies that have shifted income abroad in order to avoid domestic taxation. On the other hand, in light of current laws, this is money that likely would not return to the domestic market (and be available for investment, distribution etc.). There’s some risk: it trades tax revenue for small-business support and the potential for greater domestic investment. That said, it’s also flexible, since fiscal policy experts can haggle over the best conversion rate, cut-offs, etc.

Government Influence. This one starts from a simple premise: the government is a fairly large buyer in its own right, and can use that clout to effect the desired change. There are two main avenues for this: (1) increasing the number of small businesses with which it transacts, and (2) creating a policy to only transact with businesses that honor the pledge.

The first option would help small businesses directly, in the form of greater demand for their products and services, while also bringing them within the auspices of QuickPay, the government’s own program for prompt payment.

The second option is an indirect mandate, at least for those companies that count the government as an important customer. This one appeals to me personally, since it honors and encourages the continuance of market dynamics. It accepts the role that leverage can play and simply asks one very large buyer to step up to the plate.

A solution that bypasses adding complexity to an already-complex tax code and avoids simple transfer mechanisms seems like a good start.

Scott Pezza is principal analyst at Blue Hill Research. His focus is on accounts payable, accounts receivable, electronic invoicing, dynamic discounting and supply-chain finance. This article was originally published on Blue Hill’s website.

Photo: Nick Saltmarch, CC BY 2.0. The photo was unaltered from the original.