Extending payment terms to 120 days or more frees up working capital for big companies. But it can also increase the financial stress on suppliers and ultimately lead to increased product costs. Although the tactic has attracted much criticism, research underway at the Zaragoza Logistics Center, Zaragoza, Spain, shows that delaying payments to creditors can actually benefit both buyers and suppliers.

Spyros Lekkakos

Spyros Lekkakos

The number of large enterprises that have imposed less generous payment terms on suppliers has increased markedly over recent years. A recent article in the New York Times notes that European spirits company Diageo pays its bills in 90 days, and Mondelez, Mars, and Kellogg take 120 days to pay suppliers’ invoices. “The list of companies doing the same reads like a grocery store version of Who’s Who,” said the New York Times.

By paying suppliers much later than previously, big companies can unlock cash in their supply chains. In 2013 Procter & Gamble introduced a 75-day payment period for suppliers, and added an estimated $1 billion to the company’s cash flow, reported the New York Times.

But for many suppliers the tactic is a bitter pill to swallow, especially small and medium-sized enterprises (SMEs). These companies are particularly vulnerable to market volatility, and are often unable to find cheap external financing owing to the continued fallout from the 2008 global financial crisis.

Opinion_Bug7It seems that SMEs have little choice but to make the best of an unfavorable situation, but there are better alternatives.

In 2010 Unilever extended its payment terms from 30 days to 90 days. Even though industry was still reeling from the aftermath of the 2008 meltdown, Unilever achieved an increase in total turnover of 25%, as well as 50% and 60% increases in operating profit and investments in fixed assets within a three-year time frame. Moreover, while there were rumblings of discontent when the change was announced, supplier protests were relatively muted.

The reason is that Unilever invested the funds freed up by its extended payment program in its supply chain. The efficiencies captured by Unilever were passed on to suppliers in the form of higher order volumes — in effect, a win-win.

The availability of supply chain finance instruments such as reverse factoring (RF) also made it possible for Unilever to extend payment terms without punishing suppliers.

RF is a vehicle for giving suppliers — especially SMEs — access to affordable financing. In a typical arrangement, a large company (the buyer) commits to paying invoices promptly to the factor (a bank) and the factor agrees to pay the supplier earlier than the due dates on its invoices to the buyer. The bank profits by charging fees for the service, the buyer benefits from the extended payment terms, and the supplier is able to get paid earlier and improve its cash-flow position.

Most academic RF models show that when buyers associate their RF programs with terms extension, the value for their supply chain is lower than that achieved without the extension strategy. However, recent ZLC research shows that when the cost of raising funds — in the form of debt or equity — is high for buyers, extending payment terms can be economically efficient as long as the freed up cash is productively used. One such use: plant and equipment investment.

There are many creative versions of RF financing. ZLC research shows that for SMEs, the instrument improves operational performance, mitigates the impact of market volatility on cash flow, and offers the potential to unlock more than 10% of an enterprise’s working capital.

The RF route also has some significant downsides, however. It is effective when the credit spread is large. But when this is not the case, suppliers are advised to look for other sources of financing. And, of course, RF services come at a cost for both the buyer and the supplier.

Therefore, when evaluating RF options, suppliers should keep in mind that the direct benefits gained from improved service levels and profitability are not the only factors they need to consider. They should also assess how the capital freed up by these programs can be put to work in other ways.

The emergence of new variations on the RF theme, including open platforms that provide a wider choice of competing sources of finance, could change these tradeoffs. In addition, new fintech models such as blockchain have the potential to disrupt the RF market.

There is a growing need for insights into better ways to manage working capital. The recently released annual working capital survey by REL, a division of The Hackett Group, which looks at the performance of 1,000 of the largest U.S. public companies during 2015, concludes: “Overall working capital performance continued to degrade, reaching poorest performance levels since the 2008 financial crisis.”

Spyros Lekkakos, is a postdoctoral research fellow, at the Zaragoza Logistics Center, Zaragoza, Spain.

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8 responses to “How Delaying Payments Can Help Suppliers”

  1. Why doesn’t the buyer pay the loan fees to the supplier instead?

    Sounds like the rich getting richer. You have the product, you have the money, so pay up. Stop using the little man’s money to make your money. Spin it the way you want, but to me this is BS.

    I guess paying bills properly has changed. Sounds like a Trump idea.

  2. Obviously the author has not operated a business. We have many large customers pushing us out to 90 and 120 days before being paid, this makes it extremely hard on a business with 50 to 70 employees who are paid weekly, taxes that need to be paid weekly or face stiff government penalties. We have suppliers who also need to be paid. It only benefits the big multinationals who can afford to pay but do not.

    Cash flow is the lifeblood of a business, regardless of how well the financial statements look, if there is no cash on hand it spells the death of a business. Of course the banks may like this as well, as small businesses dig deep into their line of credit to finance day to day operations.

    Maybe the author can tell his employer he can wait 90 to 120 days for his paycheque? I would like to see how he feels about this after having to wait this long to get payment for services rendered.

  3. Absolute BS to make the big companies feel better. You are screwing your suppliers using antiquated means. Get your own financial house in order and stop taking it out on your supplierd

  4. We are a SME and a client, who is part of a rather large entity, “offered” to pay in terms that turned out to be reverse factoring. Unbeknownst to us, there is a UCC filing connected to this arrangement. Our lender objected to it and almost pulled our line of credit. Another example of a big company sticking it to the little guy.

  5. It’s bullshit! Big fleas have little fleas upon their backs to bite ’em. Little fleas have smaller fleas and so ad infinitum…. Just pay up and on time.

  6. Thank you all for your comments and for giving me the opportunity to resolve some misunderstandings.

    First, the article does not claim that extending payment terms to SME suppliers is something good. On the contrary, it clearly states that “when buyers associate their RF programs with terms extension, the value for their supply chain is lower than that achieved without the extension strategy” (actually, I have already published a paper that shows this: http://www.emeraldinsight.com/doi/full/10.1108/IJPDLM-07-2014-0165). In other words, even if the credit spread between multinational buyers and their suppliers is large, the integrated supply chain is always better off when there is no terms extension.

    Then, a question that naturally follows is “why do large firms associate their RF programs with payment term extension if this is not economically efficient?” To answer this question we studied published data from some firms (among which, the Unilever) to get more insights.
    One of our models shows that when an –otherwise, creditworthy- firm is faced with increased cost of external financing (which may have been the case for Unilever’s long-term investments in the aftermath of the 2008 liquidity crisis), then it may hold back on its investments (thus, cause underinvestment for the entire supply chain). In this case (and only), getting funds from within the supply chain by extending payment terms may be beneficial for all parties involved.

    To be more specific, by taking a look at the example discussed in the article, notice that the suppliers in this example tradeoff a 60-day term extension with 25% increase in turnover during a period when the market was (and has been until very recently) stagnant.

    • Spyros,
      Your article, in theory, sounds real good… to the MNCs, that is!
      As someone from supply chain, l’d like to comment here:
      1. When you push Net 60 to Net 90 or Net 120, suddenly you are no longer the Tier-1 customer for your supplier! They’ll grit their teeth and keep quiet: till they score a big league customer like Unilever (or-whoever-who-cares!). The moment that happens, you can kiss that outstanding service goodbye! Heck, they’ll do you one better: They’ll actually call you up going,”Hey you need product from us? Sure thing, but here’s how we are rolling: you either pay COD or by wire or by credit card. Anything else then please lose our number!”
      They have bills to pay, their suppliers to pay. So while the MNC is funding other projects using THEIR money and maximizing their profitability, you seriously expect suppliers to, what, grin and bear it because a big client has graced them with their business? I don’t think so!
      2. I have an alternate proposal: how about the MNCs offer these suppliers dynamic discounting? With their cash reserves they can fund the entire operation and post tangible, quantifiable cost savings and the suppliers walk away happy too!
      3. If we are having any suppliers here reading this who’s got clients mandating you to use their Ariba platform to do business with them then there’s something you should know: SAP doesn’t charge these big clients for doing business on their platform; they charge the suppliers!!!
      What you need to do: In your invoices, add a separate line item for the service fee that SAP would charge you and bill your customer! The way I figure, since it’s their grand idea to use Ariba, why should you be paying for the back-end charges? This is slightly out of context from the centent of this article, I know but it wouldn’t hurt to mention it here. I have nothing to lose but you guys have something to gain! 😉

  7. The suggestion that “efficiencies captured by Unilever were passed on to suppliers in the form of higher order volumes — in effect, a win-win.” and is therefore a blueprint for others aiming to extend payment terms is laughable, or worse, risible.
    This is nothing more than the abuse of commercial power (or leverage) to create a ‘win’ for the buying organisation. Anyone with an ounce of experience is getting the best value out of key supplier relationships knows that extending payment terms through coercion is counter-productive, erodes trust, and promotes cheating or guile from suppliers, who load up prices to compensate. I’m afraid to say that this is the sort of c**p procurement professionals have to deal with from some close to the CFO’s office.

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