Negotiation is a process conducted on the sharp edge between cooperation and conflict, and you are well aware that your Director of Operations and your Director of Logistics negotiate a lot almost every day. If that were not the case, the role of Director of Supply Chain (SC) would never have been appointed in your organization.
Now the negotiation in your business is shifting to top-notch level as your CFO is coming on stage. Hence, let me warmly welcome you to the world of Supply Chain Finance (SCF) just before it gets hot in your hands. If you believe that you are good at SCF because you succeed in managing inventory on hand and safety stocks, youâ€™d better flip through a number of web pages. You will never forget again at home your SCF toolbox before letting your CFO and your SC director stay in the same boardroom.
Several factors push towards a more intense use of SCF, including a worldwide trend: buyers are looking to adjust their quarterly P&L sheets by delaying inventory ownership. As a reaction, suppliers are looking to get funds increasingly upstream along the SC, earlier in time and at lower rates. Every player in the market is looking to monetize overseas inventory to increase liquidity, whilst most small and medium-sized suppliers are located in countries that lack well-developed capital markets, which eventually results in a significant increase of production costs or in a high risk of suppliers going out of business.
Some skilled academicians stated that the potential worldwide market for SCF would account for 1 trillion US$ or above in annual traded volume. I am unable to assess the sophisticated approaches used to get to that figure, mainly because bank and/or customer confidentiality prevent some information from going public in many countries. However, the estimated market size of SCF reveals a large potential for growth and it is expected to expand at a double-digit rate per year mainly in US and Western Europe, closely followed by India and China. This means that there is a huge gap to fill and a tremendous opportunity for many companies, if not for all.
On the other hand, to make a SCF program successful, there are some challenges to face. Indeed, almost so far, the majority of financial institutions have focused primarily on large buyers, whilst a number of suppliers are to be brought on board, even though they are less structured in their financial procedures. Then, most funders require know-your-customer checks to be performed on suppliers, and they use legal proprietary documentation, which makes the signing of non-standard agreements complex and time consuming, thus increasing the overall processing cost. Finally, most of the liquidity in SCF programs is still provided by large, global commercial banks, which means that such financial institutions cannot cover a significant amount of trade assets.
In the end, SCF (or supplier finance or even reverse factoring) is a win-win set of solutions not just for large companies. SCF optimizes cash flow, by allowing buyers to lengthen their payment terms to their suppliers while providing suppliers the option to be paid early. In this way, buyers optimize working capital, and suppliers generate additional operating cash flow, thus reducing the risk across the SC.
Therefore, SCF is neither a loan nor can it be considered a financial debt. It is instead an extension of the payable buyerâ€™s accounts and it represents a true sale of receivables. SCF is not factoring: the whole invoice (minus a tiny transaction fee) should be paid to the supplier, and there is no recourse burden on the supplier once the invoice is paid. SCF does not require specialized software, apart from your browser and your computer or mobile device. SCF should not be tied to one bank and â€“ in the coming years â€“ it might not even require a bank: in some SCF programs, buyers, capital markets, and financial institutions have been already sharing financing.
The author of this article is professor Roberto Cigolini, Director of the Global Executive Master in Operations & Supply Chain (GEMOS) at MIP Politecnico di Milano – Graduate School of Business.