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Supply chain finance is, in effect, lending to or borrowing from your suppliers or customers. This is in contrast with their direct funding through banks, investors or other sources of finance. Does your business really benefit from this approach to changing the typical or traditional individual organisation-focused funding models?
Close integration in the supply chain is evidenced in a number of situations but, in others, there is much more of an arm’s length relationship, particularly where there is an open or commodity market in the product or service that is being bought or sold. Looking at the existing relationships in the supply chain is a good starting point for a strategic review of the fit with supply chain finance. Given the nature of SCF relationships and the longer term commitment required to justify the increased complication and costs, it is likely that a level of operational mutual dependency is in evidence, which can be extended to increased financial interdependency. However, another model is to focus on a simple working capital benefit case for customer or supplier where there may be limited supply chain integration and so a simpler trade-off for each party based on a simple financing approach on the underlying transaction.
Here, we explore three high level areas to focus on to help give an initial view of the potential value in SCF: industry fit; scale; and priorities.
Criterion 1: Industry fit
Industry-based analysis has led a number of researchers to rank the attractiveness of SCF given the different buyer-supplier relationships in each. Where there is sharing of plans, forecasts, technology or new product plans, there is a level of mutual dependence. At the other end of the spectrum, some commodities can be bought from one of many suppliers and the decision made on an order-by-order basis. One view of comparative SCF attractiveness, ranking those industries with the most integration up or down the chain, is shown in Table 7.1.
Another view is one based on the competitiveness of the market and the cash-to-cash cycle (Hofmann and Belin, 2011). Table 7.2 shows the focus on industries most under pressure to extend payment terms with suppliers – often a key situation where SCF will be attractive to suppliers.
And a third view, likely industries (Figure 7.1), is based on responses from users. As this gives a similar order of industries to the research mentioned above, it confirms the reasoning developed in the research that SCF fits best within certain industry structures and where supplier payment terms are under pressure.
Criterion 2: Scale
Having looked as the industry dynamics, does it make economic sense to change standard payment or credit terms with suppliers or customers? The next question most organisations ask is one of specific fit with the scale and scope required to justify implementing a programme. Note, here we are talking about the decision of the focal company or initiating organisation. Once the programme is in place, the decision to take part, by a customer or supplier, is a separate decision and is based on what is being offered in the context of that organisation’s financial situation.
A first cut view is that an organisation has to have sufficient volume and value of transactions to implement a programme. Clearly joining in or linking with a standard consortia model, possibly government-led, may reduce the barriers to entry but in most cases a specific solution has one-off initial set-up costs which have to be justified by the potential benefit. Koch (2009), cited in Hofmann and Belin (2011), estimated the implementation cost of an SCF programme at $100,000 (depreciated over five years), on which must be added $10,000 annual operational costs. A minimum annual volume of SCF benefits in order to offset $30,000 would therefore be a pre-requisite to enrol in an SCF programme:
- A purchasing focal company offering SCF to its suppliers would get benefits from SCF provided that their purchase volume is greater than $3,000,000.
- A selling focal company offering SCF to its customers would get benefits from SCF if turnover volume is greater than $1,900,000.
Criterion 3: Internal priorities
The third criterion is the financial position of the organisation, particularly its cash situation and its cost of capital or borrowing. In cases of constrained or expensive funding, an organisation should be looking at its customers and suppliers to supplement its own cash sources through SCF. On the other hand, if there are excess funds or access to relatively low-cost finance, the organisation’s competitive position could be enhanced by lending to customers or suppliers through some other form of SCF initiative.
Here we have sought to provide some high-level criteria to help organisations decide if they should explore SCF opportunities in general. The next step is to come up with a specific strategy and associated objectives – where, how and why we should implement SCF.
Cosse, M (2011) An investigation into the current supply chain finance practices in business: A case study approach, unpublished MSC Thesis, Cranfield School of Management
Hofmann, E and Belin, O (2011) Supply Chain Finance Solutions: Relevance – propositions – market value, Springer-Verlag, Berlin/Heidelberg
This extract from Financing the End-to-End Supply Chain by Simon Templar, Erik Hofmann and Charles Findlay is ©2016 and reproduced with kind permission from Kogan Page Ltd. Learn more about supply chain finance, and save 20%, when buying Financing the End-to-End Supply Chain with code PLGSCF20 at www.koganpage.com/SCF.