Insuring the supply chain
How can we reconcile the demands of supply chain managers for speed and efficiency with the needs of the banks for assured repayment of the funds they advance, asks James Boyd of Boyd International Consultants. He outlines a new insurance solution, ‘Specification Compliance Insurance’ (SCI), that pays the lender if goods are found, after arrival, not to conform to buyer specifications and payment is refused.
‘Supply chain" is the modern buzzword used to describe the age-old activity of moving goods from sellers to buyers. In ancient times, the most famous supply chain was the Silk Road by which goods were moved from China all the way to the Mediterranean and on into Europe. It operated successfully because the buyers and sellers wanted it to work – and the only computer they had was an abacus!
Traders have always wanted three things: speed, efficiency and security. Over 2,000 years before Suez was even thought of, the Greeks dug a canal across the Isthmus of Corinth. This cut about two weeks off the sailing time from Athens to the Greek colonies in Sicily and Italy. It was faster, more efficient and more secure, since it greatly reduced exposure to storms at sea. They say that the Greeks had a word for everything, so they probably had one for supply chain.
Today, practically everything that happens in trade is prefaced with this magic phrase. So, we have supply chain managers, supply chain logistics services, supply chain IT solutions providers, supply chain insurers and, last but not least, supply chain financiers.
Platforms are no longer things found in railway stations or at high-diving competitions. Now they are virtual reality concepts suspended in cyberspace, on which billions of binary bits wait in orderly queues for the right electronic impulses to arrive and whisk them away to mate with other friendly bits to produce and deliver information about things that have happened, are happening or will happen in and around the supply chain.
Their functions fulfilled, they apparently disappear into cyber oblivion, perhaps coming to their final rest in some Great Server in the sky. Among the information technology experts, there is fierce competition to reduce processing times from hours to minutes to seconds to milliseconds, even to nanoseconds.
Need for speed
While all this high-speed activity is going on, the ship carrying the related cargo is plodding its weary way across the ocean. It takes a container ship about 21 days to travel from Shanghai to the US west coast and about 45 days to reach destinations in Europe; to allow for unloading, customs clearance and transit to the buyer’s warehouse, we can add at least another 10 days; lots of time, one would think, to process documents and settle accounts.
The need for speed in document processing, however, is driven by the fact that suppliers want to be paid promptly at time of shipment. Traditionally, this has been accomplished by means of letters of credit or, in some cases, documentary collections. The result is that the point of shipment becomes a point of crisis.
Documents have to be completed, transmitted, reviewed and approved before payment can be made, while exporters and their banks won"t let their goods leave until they are assured of payment. Ships and planes, trucks and trains all wait in a state of high anxiety for the banks to process their LCs.
Since LCs are contracts between banks rather than buyers and sellers, there has been enormous pressure on the banks to minimise processing time – hence the drive for digitisation and high-speed telecommunication and the accompanying expense. It is ironic that banks have invested many millions in order to reduce a cost that is a tiny fraction of the overall cost of the transaction itself
Of course, while banks have invested hundreds of millions, the big buyers and sellers have invested billions in sophisticated supply chain systems. If you buy a pair of socks at Wal-Mart, within moments after your purchase is entered, the information travels via a fast but intricate system, culminating in an upward adjustment to a production order at a factory in China, Indonesia or Honduras.
If you and others like you do not buy the socks, that also may result in a downward adjustment to the production order. Supply chain managers and IT professionals who run these complex systems find LCs totally frustrating. In their world, everything operates in straight lines, except when it comes to paying the supplier.
The terms of an LC are fixed in advance between the issuing bank, the beneficiary’s bank and, quite often an advising or confirming bank. On the other hand, the needs of the buyer and the delivery capability of the supplier are constantly changing. If the Wal-Mart computer says "we will need 10,000 more pairs of socks than originally forecast”, the system has to go off at a tangent to instruct the banks to issue amendments to the LCs.
At a recent Baft conference, the treasurer of The Limited told the audience that 95% of his company’s LCs required at least one amendment; their supply chain VP must find that intolerable.
Once a company has invested billions in a supply chain system, the executive who runs that system undoubtedly has the ear of top management. If he or she says that LCs inhibit the smooth operation of the system, that claim has to be taken seriously. The obvious answer is to buy on an open account basis, but that means transferring the financing costs and transit risks from the big buyer to the relatively small supplier.
In most countries, the LC is used as collateral for pre-export financing; without that security, banks are able to advance funds only to exporters who are financially strong. That eliminates at least half of the potential suppliers in the emerging countries.
If I were still a buyer, I would protest vigorously, because most of the unusual, innovative or attractively-priced merchandise originates with small and medium-sized companies.
One only has to look at the history of some of Asia’s biggest manufacturers. LG Electronics, for instance, started off as Lucky Goldstar, a maker of small electrical products. Buyers bought their products because their quality was good and their prices were low; however, they had to be paid by LC or they might not have survived. There are hundreds of similar stories.
Reconciling demands and needs
How can we reconcile the demands of the supply chain managers for speed and efficiency with the needs of the banks for assured repayment of the funds they advance
Banks by their nature have to be averse to risk, so it makes sense to turn for help to the insurance industry, which is in the business of accepting risk. Credit insurance has been used for many years to address the risk of buyer insolvency or default, but it refuses to address the risk of a product dispute between buyer and seller.
Lately, insurance companies and brokers have joined the supply chain bandwagon by offering coverages specifically designed to address various risks inherent in the supply chain process.
All-risk marine cargo insurance is, of course, the cornerstone of any trade insurance programme, but it is now possible to cover additional risks such as losses due to trade disruption, loss of profit, and so on. The ultimate objective is to take each and every peril throughout the supply chain and cover it with insurance. When this is achieved, banks can safely advance funds to finance open account transactions and LCs will no longer be necessary.
There is, however, one final hurdle; at the end of every supply chain there are buyers who reserve the right to refuse payment for goods that fail to meet their requirements. Product disputes occur infrequently, but when they happen it means huge headaches for all parties concerned, including the bankers.
The contents of a container are not seen by anyone between the date of loading and the date when it is opened at its destination, anywhere from 30 to 60 days later. Banks are understandably reluctant to advance funds against a cargo whose acceptability is uncertain. Pre-shipment inspection helps, but inspection certificates all contain disclaimers absolving the inspection companies from financial responsibility (there are good reasons for this that need not be gone into here).
There is now an insurance solution to this problem, ‘Specification Compliance Insurance’s (SCI), that pays the lender if goods are found, after arrival, not to conform to buyer specifications and payment is refused. (At this point, I have to declare self-interest as I am the inventor of SCI).
This is the missing link in supply chain finance, which, when combined with marine cargo and credit insurance, makes it possible for banks to finance trade transactions on an open account basis regardless of the exporter’s size or financial strength. Supplier performance is insured, as if one had credit insurance on the product as well as on the buyer.
The LC is a tough animal. It has been around in one form or another for hundreds of years, so is not likely to disappear. Supply chain insurance, when fully implemented, can cover all types of manufactured goods and certain commodities, but it can’t cover everything. LCs will still be needed for shipments of bulk cargoes such as petroleum, fresh produce, sugar, wheat, and so on, but they will be a less significant player in the streamlined world of the supply chain.
For more information about SCI contact:
For the US, Structured Trade Services, Michael Hosny, phone (1) (713) 552-0400, e-mail: firstname.lastname@example.org
For Canada and the rest of the world, Unison Insurance International, Bill Carser, phone (1) (905) 624-5300, e-mail: email@example.com