The Supply Chain Finance Community shares insight into two of its European research projects: Michiel Steeman (professor, SCF) and Christiaan de Goeij (researcher and lecturer, SCF) elaborate on a Dutch project, dubbed SCF 2.0, which deals with new, innovative forms of supply chain finance, and Hervé Hillion (founder and director at Say Partners) describes a French project that is currently being worked on in collaboration with Kyriba and a major aircraft manufacturer.
SCF 2.0: NEW SUPPLY CHAIN FINANCE SOLUTIONS FOR CORPORATES
SCF is more than reverse factoring
Since the credit crisis, banks have been required to hold more liquid assets. As a result, they have been reluctant to lend out money to companies, which has caused liquidity to dry up. For many companies, it has become difficult to obtain enough cash to invest. As a result, numerous big corporates were hit by supply chain disruptions, because their suppliers lacked the funds to secure a safe and steady production. As such, supply chain finance (SCF) addresses the costs and risks of these supply chain disruptions, with approaches and instruments that optimise working capital and transactions.
The most common form of SCF explored and utilised today is reverse factoring, which is a form of post-shipment financing with a growing market presence. However, the liquidity needs of suppliers generally arise before shipment of the goods, and many experts state that pre-shipment financing is more important than post-shipment financing. ‘SCF 2.0’ is a research project that helps companies to understand, develop and adopt pre-shipment SCF models. It looks at SCF from the corporate point of view. Companies such as Heineken and Philips are participating in the project with the aim of realising significant benefits in the fields of operational enhancement, increased supply chain output, profits, cost reductions and risk mitigation.
SCF does not have to be focused on direct suppliers only
SCF programmes are often initiated and facilitated by big dominant buyers. In many supply chains there is a focal company that controls and dominates the chain: usually a big buyer. Suppliers in the chain need the support of the big buyer to successfully implement SCF models, and the large buyer will typically steer the improvement processes in the supply chain. The creditworthiness of the buyer makes it the logical party to initiate SCF programmes.
However, there is a common agreement that collaboration between supply chain partners is crucial for successful implementation of SCF, despite the clear dominance of big buyers. In the last few decades, globalisation has made supply chains more complex. A supply chain collaboration partner can include many different types of companies, in or connected to, the supply chain. A distinction can be made between tier 1 suppliers, which are direct suppliers, tier 2 suppliers, which are suppliers of the direct suppliers, tier 3 suppliers and even tier 4 suppliers. These tier 2, 3 and 4 suppliers are gaining importance, which is the reason why SCF 2.0 not only researches SCF programmes with direct suppliers.
Philips is an example of a corporate that already has successful implementation of SCF for tier 1 suppliers, but now wants to extend the focus deeper in the supply chain to tier 2, 3 and 4 suppliers. With SCF 2.0, we identify which working capital and risk mitigation benefits can be offered by SCF solutions that go beyond reverse factoring, and beyond tier 1 suppliers, for companies like Philips.
SCF solutions do not always need bank involvement
From the perspective of the large buyer in the supply chain, SCF is about leveraging its creditworthiness to obtain the desired benefits. These buyers can often structure themselves. When we are not considering reverse factoring, in many cases, the involvement of banks in SCF is not needed. There is much experience amongst large buyers using payment terms, consignment stock, vendor-managed inventory, vendor-owned inventory, tolling agreements and other structures concerned with optimising financial flows in physical supply chains.
Buyers: better financial performance and risk mitigation
When experts mention the benefits of SCF programmes they refer to different aspects of SCF. They make reference to generally vague terms such as optimisation, value creation or financial benefits. In the end it boils down to two main benefits for the buyer: improving financial performance and risk mitigation. Improving the financial performance includes lowering transaction costs, financing costs, purchase costs and transport costs.
Suppliers: stability, growth and loyalty
Besides improving financial importance, SCF 2.0 aims to examine and analyse ways the buyers can mitigate delivery risk earlier in the chain by working with pre-shipment SCF programmes. This does not mean the project only focuses on benefits for buyers, because successful implementation of these programmes can only be done in collaboration with suppliers. The way to mitigate delivery risk is by increasing stability and allowing for the growth of suppliers, thereby increasing the loyalty of suppliers and providing safety cushions against disruption for both parties.
RISK, CREDIT CHAIN & SUPPLY CHAIN MANAGEMENT (RCSM) PROJECT
The lack of effective financial and operational collaboration in a global supply chain between a large corporate buyer and manufacturer, and its network of supplies (in tiers 1, 2, 3 and 4), results in major inefficiencies:
- From an operational standpoint, there are often excess inventories all along the supply chain that do not prevent disruptions (the typical ‘bullwhip’ effect). The latest PWC working capital survey (2013) indicates that almost €340bn of cash is tied up in excess working capital (excess inventories plus payment terms) for European manufacturing companies only.
- From a financial standpoint, the lack and excessive cost of credit for SMEs (knowing that a great number of suppliers of large manufacturers are SMEs, especially tier 2 and above), has squeezed the investments needed to make the supply chain more agile and flexible, and has negatively impacted the ROCE (return on capital employed) as a whole.
As a result, there is today a vicious circle in supply chains: SME suppliers cannot invest as needed because of liquidity issues, causing disruptions to their large corporate buyers, which increases risks for all parties (suppliers, corporates, banks) and in turn makes the situation worse.
The aim of the RCSM (Risk, Credit and Supply Chain Management) project is precisely to address this situation and to turn it into a virtuous cycle: in short, turn excess working capital into cash through an improved operational and financial collaboration between corporates and their network of suppliers (both on inventory management and payment terms), and funnel this cash to help finance suppliers in being more agile and more flexible, thus resulting in additional working capital reduction. By doing so, the risk level will also be much lower, both for operations and credit rating, making it easier for SMEs to raise liquidity.
The RCSM project is supported by the pole de compétitivité finance innovation in France, with key partners that include research labs specialising in supply chain and finance, a major aircraft manufacturer, a leading bank and Kyriba, a SCF technology provider. The project, led by Say Partners, has several key workstreams and deliverables:
- First, to design a collaborative working capital management model between corporates and their network of suppliers, to achieve a win-win situation. This issue goes way beyond well-known reverse factoring schemes, which only address post-shipment financing. In many complex and globalised manufacturing supply chains today, the real challenge for suppliers (especially SMEs) is to be able to finance orders and projects, sometimes with long lead-times, before the product can be shipped out. It is a change of paradigm in the way companies should manage their working capital and collaborate with suppliers, with key impacts for finance, purchasing and supply chain managers.
- Second, to create a new rating for assessing the credit risk of suppliers, away from the traditional methods used by banks or insurance companies. Obviously a company’s financial strength is largely dependent on its operations: for globally interconnected supply chains, it means that the credit risk/default of a supplier can no longer be evaluated only on its past performance and financial ratios, but on its own supply chain metrics and the level of existing systemic operational risk. How to balance the risk of a supply breakdown with a risk of inventory? This is a typical issue in the supply chain, yet it is not necessarily reflected on the traditional credit rating approach.
- Third, to design new financial products, the equivalent of what we could call ‘supply chain bonds’, specifically aimed at financing a network of suppliers involved in a project/product driven by a large corporate. This innovative financial instrument, alternative to traditional bank credit lending, will be specifically designed for SMEs, which have a much more limited set of options today than large and rated corporates. The interest rate of these bonds will eventually be determined in large part by the supply chain credit risk model. Those bonds are financed, at least partially, from the cash released through working capital improvements, so as to create the virtuous cycle previously mentioned.
- Finally, this project will come up with a prototype of an advanced supply chain finance technology platform that will both provide an extended visibility of working capital needs and allocation in a globalised supply chain, as well as a marketplace between buyers and sellers of supply chain bonds. The aim is to offer a large portfolio of services in supply chain finance, from reverse factoring to more advanced solutions, and facilitate the interconnection between corporates, SMEs, financial institutions, funds and so forth.