Competition is forcing consumer companies like Electrolux and Sainsbury’s to seek early supply chain finance adoption, writes Justin Pugsley. As well as creating a new fast growing segment in the trade finance arena, it also represents an opportunity for banks.
Cut-throat competition is proving to be a key motivator for pushing consumer goods companies and retailers towards adopting supply chain finance (SCF) techniques.
Generally speaking, reducing costs in the supply chain remains a key focus for most large multinational companies as they seek to remain competitive and deliver value to their shareholders. Indeed, all have poured in considerable investment to make supply chains more transparent, flexible and responsive.
But with many of those savings already in the bag, purchasing managers are increasingly scouring wider for areas that are ripe for driving greater efficiency. The consumer sector may well prove to be a key source of inspiration for the rest of industry.
Research firm Aberdeen Group recently undertook a study on the supply chains of retailers and manufacturers of consumer goods. They discovered that 36% have implemented SCF, compared with a 28% average for all companies.
Indeed, this illustrates that there’s still plenty of scope for expansion for SCF with the vast majority of companies yet to really tap into these new techniques. But so far the main reason for adopting SCF, in 80% of cases, was due to pressure to reduce the cost of goods. A reduction in labour-intensive processes, for 53% of respondents, was the second most important reason, says Aberdeen.
At the heart of this is an attempt to lower the supply chain’s weighted cost of capital, says the report. According to Peter Lugli, vice-president of marketing and corporate development with SCF platform provider, PrimeRevenue, lower cost financing is usually achieved by suppliers leveraging off the credit rating of the buyer. This is often a large multinational manufacturer or retailer with an investment grade credit rating.
“We’re involved in supply chain finance to extend our payment terms rather than to just negotiate lower prices with suppliers,” explains Christer Síderstrím, head of customer and supply financing with white goods manufacturer, AB Electrolux.
According to Aberdeen’s research around 47% of companies operating in the consumer sector use SCF to negotiate price reductions with their suppliers. Some 47% are seeking more automation and better visibility. Around 37% are looking to implement a scorecard system to track their suppliers’s performance. Streamlining transaction processing, better document management and access to financing was a key motivation for 33% of respondents.
But when selecting a financing institution for SCF service, the most important consideration for this industry segment was the cost of the service. Ease of access to capital is also a top consideration.
Reducing suppliers’s costs
Meanwhile, in the US these innovative financing techniques are rapidly taking hold. A typical case is that of national retailer, Big Lots. Its management noticed that many of its smaller suppliers were factoring their receivables to boost their cashflows. This was proving very expensive for some of these firms, which might be paying as much as the equivalent of 13-18% in interest.
All of a sudden those funding costs can be reduced to 25-100 basis points over Libor depending on the credit rating of the buyer. Even for a relatively large supplier SCF can deliver significantly lower margins. For a company with a single or double-B rating selling US$500mn-750mn of goods to an organisation with a single A rating, the savings can still be significant and very worthwhile.
Big Lots’s management saw that such a high cost of financing was putting some suppliers off from tendering for the firm’s business. This would leave the field open to other suppliers, which could more easily charge higher prices thanks to reduced competition.
The solution was to find a way to lower their cost of financing. In this case, the firm used PrimeRevenue’s platform. Typically, the buyer and its suppliers can log into PrimeRevenue’s platform and track the status of their invoices.
Once an invoice is approved by the buyer, the supplier can either wait for payment under buyer’s terms or sell that invoice at a discount to a bank. The bank will then collect the amount due on the invoice on the given payment date.
“Because the buyer has approved it, it is treated like the buyer’s paper rather than the supplier’s. And because the buyer has a much higher credit rating, it therefore attracts a lower cost of funding,” explains Joe Juliano, chief executive officer with PrimeRevenue.
By structuring the funding in this way, the supplier can get finance almost immediately if they wish and do so at a much lower cost than they could from their own bank or through a factoring institution.
Some estimates suggest that unoptimised funding could be adding as much as 4% to the cost of the goods coming through the supply chain. For a firm with a procurement budget running into billions of dollars a year, this adds up to a significant ongoing cost. It also means that implementing SCF should produce quite dramatic returns on investment, especially when large procurement budgets are involved. If there are a large number of SMEs involved – hence paying dearly for funding – the returns can be even more significant.
Indeed, it is hardly surprising that interest in SCF has grown dramatically in the last two to three years.
Signing up Sainsbury’s
Meanwhile, in a first for the big UK retailer, J Sainsbury’s recently signed up to PrimeRevenue’s platform for paying its suppliers. Morgan Stanley will act as the financing bank for Sainsbury’s suppliers on the PrimeRevenue platform.
Sainsbury’s is the third largest retailer in the UK with 16% of the market and spends around £11bn a year. It is hoping to get as many of its suppliers as possible to sign up to the platform, including overseas ones.
Under the new set up, suppliers will be able to view the status of their trading account with Sainsbury’s and monitor their invoices, debit notes, remittance advices and payment dates. This will give them a much better visibility of their expected cashflow and enables them to plan better. And importantly the whole process will be electronic.
“This is a fundamentally new way of managing the financial relationship we have with our suppliers. The system provides additional benefits giving suppliers the information they need to better manage their financial flows,” explains Mike Coupe, trading director with Sainsbury’s . But crucially: “They can also use the system to leverage Sainsbury’s borrowing power if they opt for early payment.”
If it is a success, and it is still very early days, SCF is highly likely to be adopted by the other three leading UK retailers. After all, the four are constantly engaged in stiff competition with suppliers usually taking the brunt of practices such as heavy discounting to drive footfall in their stores – a practice which often receives bad press in the UK. They also have vast procurement budgets and investing in SCF could yield significant returns for them.
Indeed, SCF may represent an initiative that actually benefits suppliers whilst simultaneously helping drive down costs in the supply chain.
For smaller companies (SMEs) it could prove to be a particular welcome form of funding. These companies usually pay the highest cost of funding and are often the most vulnerable financially.
Ellen Brunsberg, managing director with Morgan Stanley, very much sees Sainsbury’s move as part of the growing trend for companies in the US and Europe to seek new efficiencies in their supply chains.
However, the use of SCF may offer a large organisation more important benefits than just deriving cost reductions from suppliers. SCF enables the corporate to better maximise capital. For instance, capital once tied up in the supply chain can be ploughed into the business instead. For a company with, say, an internal rate of return of 15-20%, this can represent a significant boost to the bottom line. It will also reduce overall group borrowing requirements and help strengthen the balance sheet.
“This is great for someone looking to continuously expand their operations,” says Juliano at PrimeRevenue. “Rather than have funds tied up in working capital they can essentially invest the money into growing their business.” He cites the example of one US retailer, which is using its newly liberated capital to help fund the rolling out of 40 or more stores at a cost of US$25mn each.
Juliano reckons about 80% of their customers chose PrimeRevenue’s platform for the purpose of capital optimisation. Again, this was the main attraction for Sainsbury’s .
In other cases, the buyer may ask the suppliers to invest in improving their products in exchange for the much lower cost of funding. This may include introducing new types of packaging.
Hit and miss
However, introducing SCF can involve some trial and error. Síderstrím explains that Electrolux has been running a reverse factoring programme for around two years for its Asian suppliers. “Unfortunately, it was not very successful. But we have now restructured the programme,” he says.
The problem was that invoices needed pre-approval before being sent to the bank for discounting. This apparently made it difficult for suppliers to predict their cashflows as they couldn’t accurately predict when they would get paid.
“We have removed the pre-approval process, which should make suppliers more comfortable in that they can better predict their cashflows,” explains Síderstrím. Indeed, he now expects the restructured scheme to be a success in the regions where it is being rolled out.
For the Asian side of the supply chain Electrolux has chosen to work with Standard Chartered Bank because of its regional expertise. He adds that the group has introduced a similar programme in Europe.
In line with most large manufacturers, Electrolux has moved much of its sourcing from high-cost Western Europe to the Eastern part of the continent.
To ease the introduction of SCF the firm decided to work with a bank that is familiar with its business and knows its suppliers well. In this case it is Banca Lombarda’s factoring company, CBI Veneta Factoring. This relationship stems from Electrolux’s large industrial footprint in Italy. Indeed, the group has been shifting much of its production out of Italy.
Traditionally, suppliers in that country are paid after 120 days. In many East European countries common credit terms tend to be shorter – around 45 to 60 days.
Although going east may mean cheaper inputs, it can impact on the cashflow of the company when payment cycles are shorter.
“We are trying to standardise our payment terms in Europe to effectively 120 days,” says Síderstrím. “This programme will effectively allow us to keep our credit terms, whilst still being able to work with suppliers in east European countries.”
Also, using the financing facilities set up by Electrolux, those suppliers can obtain much more competitive funding rates than they could from their local banks.
Another benefit to Electrolux is a reduction in paperwork. It’s a case of making one payment to the bank and then it is the bank that pays all the suppliers and deals with a lot of the paperwork. The benefit of this is that the suppliers know exactly how much they’re going to get paid and crucially when.
Indeed, the proliferation of SCF could in time have a dramatic impact on financing costs in many emerging market countries. Often, local banks have a near captive market and earn rich lending margins as a result.
For companies exporting much of their output to OECD buyers SCF represents an opportunity to obtain far more competitive rates of funding. This will effectively throw down the gauntlet to local banks. So as not to lose out on being involved in domestic export financing, they will have to come up with much more competitive propositions.
Also, in times of financial turmoil, which hit emerging markets from time to time, SCF could spell the difference between survival or failure for some enterprises. With supply chains having expanded dramatically in recent years, organisations are growing increasingly weary of supply disruptions. For the more enlightened organisations such as Toyota this has brought about a much more collaborative approach to dealing with suppliers. Again, SCF is an integral part of that thought process.
Helping suppliers benefit from much better credit terms effectively makes them more financially robust and that in turn helps secure the supply chain.
Also, “OECD financial institutions are excited about access to all these different suppliers without having to take on that geography risk,” says Juliano.
So buyers may argue that rather than getting involved SCF, they can simply extend credit terms indefinitely by disputing invoices and letters of credit. Or they simply ask for longer and longer credit terms.
The view is that there’s so much competition that suppliers will carry on doing business with them because they can’t afford not to.
However, these age-old tactics prove contentious and if nothing else cultivate ill feeling and can jeopardise commercial relationships. Indeed, some hard pressed suppliers may simply decide to no longer deal with the firm in question. This happened to at least one UK retailer, which was left struggling to find suppliers after pushing them too hard on credit terms. It eventually had to offer them more reasonable payment terms to get them back on board.
Many SME manufacturers in China for example already work on razor thin profit margins and simply cannot afford to extend credit for long periods of time. For many of them getting paid within a certain time frame is simply a matter of survival. Also, the cost of financing from banks in emerging markets tends to be particularly onerous.
Indeed, SCF is a successful attempt at resolving the conflicting needs of suppliers and buyers regarding time frames for payment. As well as creating a new fast growing segment in the trade finance arena, it also represents an opportunity for banks. Those that fully embrace SCF open themselves up to the opportunity of gaining more business from the various players in a supply chain. Indeed, Bank of America, Morgan Stanley and Macquarie Bank are among those which have adopted PrimeRevenue’s platform as part of their offering to some of their clients.
Oracle builds up to trade solution
Aberdeen expects leading ERP (enterprise resource planning) vendor Oracle to make the first release of its Global Trade Solutions product sometime in 2008. In a recent market alert, the research firm describes the possible road map for the roll-out.
Indeed, GTR covered the march of the ERP vendors into the trade finance space back in the September/October 2006 issue in the Trade Services & the Supply Chain section. At the time, a spokesman for Oracle told GTR that the group is developing a multi-banking platform. No doubt the development of its global trade solutions product will be closely allied to such a platform.
The new product includes import/export compliance tools, for example. This will help users to lower the risk and cost of global sourcing and selling. Apparently, numerous large multinational clients have been actively requesting that Oracle develop such a product – probably some of the same multinationals which have been pushing for a multi-banking platform.
Indeed, adding trade applications to its suite of products seems like a logical extension to ERP. The theory behind ERP is to integrate an organisation’s data processes into a unified system. Often this will revolve around a unified database with various system modules attached for functions such as finance for example. In practice, large multinationals may have 20 to 30 different ERP systems installed.
Meanwhile, globalisation and the explosive growth of supply chains means that trade-related data plays a growing role in understanding the company’s financial position.
That data in turn cascades through to various functions relating to stock control, sales, procurement through to financing and the status of bank balances. At the same time corporates are for ever seeking greater transparency in their supply chains. This enables them to pick up inefficiencies and optimise various functions of the business relating to stock control and ‘just-in-time’s manufacturing systems.
According to Aberdeen, Oracle will be building the trade management platform on the same technology on which it delivers its transportation management system. This became part of Oracle’s family of products after the acquisition of G-Log. “This is a proven scalable technology foundation that already processes complex global transportation transactions,” says Aberdeen in its market alert.
This should mean less teething problems with the early versions as it is built around a proven architecture.
The report adds that the global trade management platform will represent a separate suite of products, which will be interoperable with Oracle’s other enterprise applications. It will also be deployable as a standalone product.
Aberdeen expects that Oracle will source data from third party content providers for functions such as trade compliance. Indeed, this is what SAP does for its trade compliance applications. Oracle meanwhile will focus its attention on developing the software.
Aberdeen reckons Oracle will opt for a muti-year phased roll out of the product with the first release probably out next year.
Phase 1 would most likely be restricted to party screening, export documentation, partial import documentation and landed cost. Phase 2 is likely be dedicated to enhancing import documentation functionality, landed cost calculators, licence determination and quota management and maybe some aspects of origin management. Phase 3 could be focused on areas such as enhanced origin management, duty drawback and restitution tools, says Aberdeen.
“The trade compliance landscape has changed dramatically in the past 24 months with more companies seeking a full platform of global supply chain capabilities along with their import/export compliance processes,” adds Aberdeen.
According to research by the firm some 30% of corporates have budgeted for trade compliance projects. These projects can include new system implementations, internal development or enhancing existing systems. Around 37% of large corporates say they have budgeted funds to enhance their export compliance technology.