It must have been a huge shock for suppliers. During the heart of the recession in January 2009, beverage giant Anheuser-Busch InBev extended its payment terms from 30 days to 120 days with less than a month’s notice, giving suppliers no time to prepare.

We don’t know exactly how the suppliers responded, but looking at Anheuser-Busch InBev’s financial statements, we know that its trade accounts and other deferred expenses payable went from $4.833bn to $5.657bn between 2008 and 2009. That freed up $824m in working capital for the company. Assuming that it was InBev’s smaller, less powerful suppliers that collectively lost that working capital, they probably also incurred financing costs of around $123m, all told. (This assumes that small and medium-sized suppliers had a financing cost of around 15% at the time (15% x $864m). In contrast, InBev would have saved around $30 mil (3.5% x $864m).)

Around the same time, global beverage giant Diageo went from 30 days to 60 days payment, with no warning or offsetting compensation for its suppliers. Many other large companies, including Johnson & Johnson and Tesco, used the global financial crisis as a rationale for extending terms – even on previously negotiated contracts – and for aggressively monitoring collections from their debtors.

These large companies were, and are, hardly alone in making such moves. A survey by the American Productivity and Quality Center (APQC) reveals growing financial pressure on suppliers as buyers push for longer days payable outstanding (DPO) terms. Over a three-year period, nearly 66% of those surveyed found that one or more key buyers have noticeably stretched the time between receipt of invoice and transmission of payment, according to the APQC survey. The pressure on suppliers is intensifying: nearly 60% of those surveyed by APQC said they will likely have to leave the market because of such extended payment terms

Of course, buyers cannot be faulted for striving to free up cash, and delaying payments is a great way to deliver on shareholders’ expectations. At a 3% interest rate, Walmart earns about $2m each day on its accounts payable owed to suppliers, according to a report in Forbes.

Increasingly, working capital ratios are a core metric for gauging an organisation’s performance. Typically, investors and market analysts applaud when companies bolster working capital by extending their DPO terms.

But what investors and analysts don’t so easily see are the knock-on effects of those new terms – notably the upsurge in supply chain risk at the very time when it is increasingly important to lower such risks. Research shows that investors punish companies when their supply chain suffers from major interruptions – the kind of interruptions that make the news, such as natural disasters and supplier problems.

So what’s the answer? What can supply chain leaders do to minimise risks while meeting the financial needs of both buyers and suppliers?

One area that is attracting markedly more attention these days is supply chain working capital finance (SCWCF.) This financial tool – augmented by technology such as cloud-based computing platforms – is being provided by new financial technology (fintech) specialists as well as by operations set up recently by traditional financial services companies such as Citi Group and Deutsche Bank.

Overall, supply chain financing is on the rise, with enormous room to expand; recently, Treasury & Risk noted that in 2015, only about 17% of 100 companies surveyed (most with annual revenue exceeding $1bn) said they were using supply chain finance, with a very small percentage saying they made “significant” use of it. Meanwhile, fintechs in general are proliferating at an astonishing rate: venture funding in the sector swelled by nearly 11% in 2016, to more than $17bn worldwide, according to data from PitchBook.

Walmart recently used SCWCF services to good effect when it extended payment terms from 20 days to 90 days for 10,000 suppliers of slow-moving items. The retailer negotiated a low-interest credit line with third-party lenders. With its stated goal of “Everyday Low Prices”, Walmart appears to have understood that “…the additional financing costs that suppliers incur because they aren’t being paid promptly work their way back into higher prices for consumers.”

For most organisations, implementing an effective SCWCF programme is a strategic decision – one that calls for close collaboration not only between buyer and supplier, but also among a number of functions within each business. In this article, we outline how SCWCF can help organisations collaborate and create a win-win outcome for both sides. We will provide a clear definition of the tool and explore how it compares to more traditional approaches to managing supply chain working capital. And, we will outline practical considerations for supply chain managers to consider before embarking on the SCWCF journey.

Shifting the burden – the wrong way

When large buyers unilaterally impose new payments terms on their suppliers, they are essentially shifting the working capital burden further up the supply chain. But in doing so, they add significant risk to the supply chain, including business continuity risk, supplier viability risk, material cost inflation, relationship deterioration, lack of support from suppliers and more.

The problems are exacerbated by the cost and volatility of debt for many small and mid-sized suppliers; it can often cost more than twice what comparable debt would cost their large buyers. During the global financial downturn, banks tightened their funding significantly, particularly for small and medium-sized enterprises (SMEs), increasing the pressure on their cash flows. In the United States, SME loans as a percentage of all bank business loans fell by nearly one-third. In the Eurozone, borrowing costs for SMEs versus those for large corporations increased by 150%.

At the core of the problem is the dissonance between the goals of the buyer’s finance department and those of its supply management group. The finance people are incentivised to improve working capital while supply management wants to cement relationships with suppliers to gain the best possible quality, pricing, availability, delivery terms, responsiveness and new ideas – and those sets of objectives can collide when it comes to paying suppliers.

The authors of this article saw the challenges up close during recent research on the impact of the recession on buyer-supplier relationships. The buyer – a global consumer products company – had extended payment terms significantly; doing so in ways that adversely affected a supplier that it had declared was valued highly. The buyer’s purchasing team was powerless to change the situation. (See sidebar: Hard feelings, ruined relationship)

Hard feelings, ruined relationship

Recently, the corporate offices of a global consumer products company issued a mandate that payment terms to all of its global suppliers would go from net 30 days to net 60 days unless prohibited by law. The company did not distinguish between suppliers – and it learned the hard way why it should have done so.

Caught in the extended payments net was a high-end packaging supplier that designed and manufactured distinctive packaging for the consumer products corporation. The purchasing team characterised the packaging specialist as its “preferred supplier” and “a company that is very good to do business with… a supplier we would hate to lose.”

But purchasing’s perspectives were not part of the decision to stretch payment terms. The purchasing director disclosed that he was “not given a choice” in implementing this mandate; it was his job to notify its suppliers. The purchasing chief’s hope was that his suppliers – in particular the packaging specialist – would understand that he and his team were “forced” by top management to extend payment terms, and that supplier relationships would remain solid.

Not so. In fact, the extended payment terms were only one of the unilateral moves pushed onto suppliers; the corporate office also mandated greater use of reverse auctions.

Although it is difficult to separate the impact of the extended payment terms on the buyer-supplier relationship from those of the reverse auctions, there is no doubt whatsoever that the packaging supplier viewed the extended terms negatively. The supplier understood that the purchasing director was not to blame, but that did nothing to assuage how it now saw its relationship with the consumer products corporation.

Actions had spoken louder than words. The packaging specialist’s executive team saw that, far from being treated as a preferred supplier, they would be squeezed to reduce costs further and would not be valued for bringing innovative solutions. They declared that they felt “hurt” by the buyer’s moves, and indicated that their company would have to start charging for services previously provided without fee as part of the relationship.

The consumer products company quickly felt the impact of its actions. It soon found itself paying for new product trials for new product and packaging changes. Furthermore, the packaging supplier acquired some of its specialty competitors, giving it more leverage and reducing the buyer’s options. In short, the packager began treating the consumer products company more like a price-buyer than a collaborator.

That wasn’t the end of it. Within a couple of years, the buying company’s purchasing chief quit – leaving for a new organisation where he could have more sway in decision-making. The relationship between his former employer and the packager never fully recovered.

Sharing the burden – the right way

Factoring has long been a costly “last resort” way for suppliers to get paid – at least in part – when buyers’ payment terms have stretched too far. It typically involves selling a firm’s account receivables to obtain about 80% cash immediately, usually with recourse to the seller of the debt if the debt is not paid. Putting it bluntly: Factoring is one-sided, putting the onus on the supplier.

Now SCWCF is emerging as a way to constructively share the burden of working capital costs between buyer and supplier. The Global Supply Chain Finance Forum (2016) defines supply chain finance as “the use of financing and risk mitigation practices and techniques to optimise the management of the working capital and liquidity invested in supply chain processes and transactions.” Where factoring involves suppliers selling the buyer’s accounts at deep discounts, SCWCF balances the various costs of capital available to different supply chain members so a supplier can access funding based on the buyer’s credit rating. It allows the buyer to lengthen payment terms or negotiate discounts with suppliers while enabling the suppliers to get paid early at a far cheaper rate than what is typically afforded under the buyer’s imposed terms. The supplier has access to “cheap money, fast money” through a third party – usually a financial institution. And suppliers can choose when they want to get paid, and how early, in light of their cash flow requirements.

In addition, rapid and significant improvements in information technology have simplified this process immensely by affording easy invoice upload and increased online invoice visibility for payment flexibility. This collaborative approach has benefits for both buyers and suppliers and allows them to unlock working capital and reduce costs and risks.

The new technologies are coming from a blizzard of new fintech firms (see sidebar, New “fintechs” firms bring new solutions).

New “Fintech” firms bring new solutions

Traditionally, mainstream banks provided supply chain financing. Today, specialty “fintechs” (financial technology) firms are proliferating, offering innovative, easy-to-use, online platforms, software services and funding choices. These non-banking institutions – firms such as PrimeRevenue, Taulia, MarketInvoice, Demica and Timelio (fair disclosure: one author of this article is a Timelio executive) – often work with banks, private investors or even the buying company to fund SCWCF programmes.

Some are bringing new technologies, such as blockchain, which have the potential to transform supply chain financing overall. Indeed, the sheer proliferation of fintechs makes vendor selection an overwhelming task for even the best-informed treasurers and supply chain leaders. This is not the place to explore vendor selection in detail, but it is worth pointing out a few pertinent questions.

Financial technology. Is the online portal easy to setup and use? Can it be integrated into ERP systems to offer seamless processing? Are there capabilities such as e-invoicing platforms?

Expertise across regions. Are dedicated supply chain finance specialists available in all relevant markets? What is the overall size of their portfolios and what volumes are they processing? Does the provider have experience with all relevant currencies? With overseas regulations?

Reliable funding at attractive cost. How does the fintech keep pricing attractive? How does it ensure that funding is transparent to suppliers? How many sources of funding can it provide?

On-the-ground implementation. Does the fintech have web-based tools to explain the benefits? Can they work with most suppliers and not just the top tier?

Benefits for buyers – and suppliers

The benefits of SCWCF are clear. Besides being able to increase their working capital, buyers get an additional negotiating lever to use with their suppliers. SCWCF also promotes efficiencies in accounts payable processes, including e-ordering and invoicing systems that connect buyers, suppliers and financing institutions. Giving preferred suppliers new ways to access funds at discounted rates, buyers can also earn suppliers’ loyalty and goodwill. The technique also helps buyers to stabilise supply chains that feature many start-ups and other small firms. Furthermore, SCWCF can help differentiate buyer organisations now that ethical procurement has become an issue for investors and end consumers.

Suppliers benefit from SCWCF not only by gaining liquidity but by having more options for when they can receive payment. And because discounted rates are typically pre-negotiated by the buyer, the supplier’s financing transaction costs are lowered too. Any risk of a buyer’s insolvency is covered because the funder bears that burden. And suppliers gain visibility and control of cash flow using the newest SCWCF technology tools.

Another potential benefit of SCWCF: inclusion of many more small suppliers. Until recently, the complexities of connecting suppliers to traditional supply chain financing techniques has meant that they were extended chiefly to big suppliers – those whose financing needs were large enough to be of interest to the banks. But the online technology at the core of new SCWCF techniques is easier to work with, integrating easily with the enterprise resource management (ERM) systems of companies both large and small

At the same time, the entire SCWCF is open to many funding entrants – not just banks and fintechs but growing numbers of cash-rich buyers that see the mechanism as a tool for getting better returns than they could from a regular deposit account. Typically, SCWCF programmes are targeted primarily at investment-grade buyers, but there are very sizeable opportunities – hundreds of billions of dollars’ worth – for non-investment grade buyers as well, according to a report from McKinsey.

Two basic models of SCWCF

There are two basic models of SCWCF: One is buyer-led (payables-centric); the other is supplier led (receivables-centric). The buyer-led model is optimal; it involves the buyer partnering with the funder – traditionally the banks, but increasingly fintechs. (And today, more and more cash-rich buyers are their own funders.) The funder assumes the risk that the buyer can make payment for its orders as a going concern. These types of solutions are also referred to as approved payables finance, supplier finance and reverse factoring. The authors believe that this is similar to the approach that Walmart is suggesting for its suppliers.

The buyer-led approach works as follows. The buyer transmits to the funder the electronic files containing data for approved invoices (based on invoices it has received and accepted from suppliers). The data is made available for the suppliers to view and to elect early payment if they wish. If the supplier does choose early payment, the funder will discount the invoice (net present value) based on the buyer’s risk grade, paying the supplier the discounted sum.

Let’s walk through an example to show how adding a SCWCF option when a buyer decides to extend its payment terms can make this attractive for both parties. In the scenario shown in Figure 1, a buyer extends its payment terms from net 30 days to net 70, but adds in a SCWCF option for early payment whenever the supplier would like it. This early-payment approach (in this example, on day 10) gives the supplier a significantly better interest rate (2.5% in this example) than it could achieve by factoring, and often better than its own costs of funds (12%). If the supplier elects to be paid as early as day 10, it incurs a cost equal to the SCWCF rate of 2.5% for the 60 days “early” that it elects. If the supplier has selected early payment, the funder/SCWCF provider will pay the discounted amount to the supplier. The buyer then pays the funder when the invoice comes due.

The SCWCF rate is set at a combination of an interest rate benchmark (eg, Libor) plus a margin that reflects the risk at the buyer’s credit rating and the revenue the funder expects to generate from the programme. This compares to about 24% per annum with factoring, or 8% per annum on the bank’s typical business loans, or (in this example) 12% for the supplier’s own cost of capital. If the original terms were retained and the supplier was paid in 30 days rather than 10 days, this is costlier than getting paid in 10 days and taking the discount because of the favourable financing rate versus the buyer’s cost of capital. As expected, getting paid in 70 days is more expensive still. A further benefit of getting paid early: the supplier has an injection of cash into the business on day 10 (via the discounted early payment) – money that can be used to pay bills, re-invest in growth and free up debt for other purposes.

The supplier-led (receivables-centric) model relies on the same concept, except that the funder deals only with the supplier. The supplier sends the funder the file containing the accepted invoice data for those invoices for which it wants early payment. The funder discounts these invoices at a rate that reflects the credit rating of the buyer’s risk grade to the supplier. At maturity, the buyer either pays the supplier that then pays the funder, or it pays the funder directly. Under the supplier-led model, the funder is effectively purchasing the receivable and taking on the risk that the buyer might not pay in case of insolvency.

Where SCWCF programmes work best (and where they don’t)

Very long cash conversion cycles, supply chains with global reach and/or a sharp focus on supplier risk management characterise industries that are best suited to using SCWCF. The supplier risk management factor is of particular preoccupation for sectors such as aerospace, automotive, chemicals, pharmaceuticals, consumer packaged goods, grocery chain, apparel, and technology and telecommunications

Companies with supply chains that extend around the world lend themselves to SCWCF techniques. With the rise of offshore manufacturing in Asia, Eastern Europe and Mexico in particular, many SME suppliers may struggle to generate cost-effective financing because they are located in countries with relatively undeveloped capital markets. This is especially true because the more traditional form of liquidity through letter of credit discounting by suppliers is decreasing in favour of trading on an open account basis. Suppliers tend to finance their business with short-term loans from local banks, frequently incurring interest rates of 15% or more, which leads to strong credit arbitrage across trade corridors. In such scenarios, new supply chain finance solutions can help reduce supply chain risk

More generally, SCWCF tends to work best where a supplier’s cost of working capital is higher than the buyer’s. It is still attractive to many firms where the capital costs of buyer and supplier are on par. The supplier would prefer to have cash on its balance sheet versus accounts receivable, particularly when it is issuing financial statements at quarterly or year-end close. By contrast, there are few benefits to either buyer or supplier in those instances where a supplier has what it perceives to be a significantly better working capital risk profile than the buying organisation.

Five steps for setting up an effective SCWCF programme

Companies should undertake a SCWCF payables programme only after they have a complete understanding of the programme’s effect on their supply chains, and a clear view of how well it fits with their overall business environments. No supply chain financing programme can be expected to be successful if it is applied as a hasty fix to a discrete point problem; given that it touches so many parties, both within the buyer’s organisation and outside, across its network of suppliers, it must be approached as a strategic initiative.

Nor can any SCWCF succeed if it is viewed as another form of unilateral mandate from the buyer. Each supplier will have its own view of extended payment terms and of the attractiveness of a supply chain payables financing proposal. The acceptance of this solution will vary depending on each individual supplier’s ability to access funding, its cost of funding, its growth agenda, its leverage profile and its short-term liquidity requirements. Furthermore, a stable, long-time preferred supplier of major subassemblies or components – engine manufacturers supplying truck companies, say, or a producer of touchscreens for smartphones – will have quite different perspectives from seasonal suppliers or innovative start-ups with potentially attractive technology offerings. Those differences have to be understood by both finance and supply management groups before they embark on such a programme

The authors envision the following five-step checklist for setting up a SCWCF programme:

1 Establish the business case. What are the business drivers? What is the company looking to achieve? What savings are being targeted, and by when? What are the necessary key performance indicators?

2 Ensure alignment. Who will be the programme’s sponsor in the C-suite? On the board of directors? Who will be the executives involved on an ongoing basis from the supply chain/procurement group? From finance/treasury? From legal? IT? Audit?

3 Select SCWCF provider(s). Which financing partners are best suited to your supplier network, geographically, strategically and operationally?  Which have the experience of your industry? The best technology? The credit appetite? The onboarding approach? The regulatory and currency capabilities? Do we opt for specialist technology platforms versus broader platforms offered by traditional financial services providers? What are the potential benefits of going with several providers versus one?

4 Introduce the programme to selected suppliers. How do we segment our suppliers to get the most momentum from our SCWCF programme? How then do we engage the key suppliers in the segments we select? How do we explain the benefits to them? What messages do we send? How best do we target and convey those messages?

5 Expand and regularly refresh the programme. How do we cement buy-in from all parties internally and externally? Which parties need to hear what messages? How do we identify and recruit other champions for the programme? How do we run the programme so that it can adapt easily to other business changes? How do we monitor supplier adoption of the programme? How do we use the programme when adding new suppliers?

An alternative source

SCWCF is emerging as an alternative source of financing because it gives corporations more flexibility and options to fund their growth, improve working capital and mitigate their risks.

But such financing programmes cannot be effective unless they are applied as part of a coherent business strategy that balances the legitimate concerns of the buyer’s finance department with those of the company’s supply chain management experts. That calls for consistent, open collaboration between those teams, and with other groups, such as legal, that can help build the necessary frameworks for such programmes to succeed over the long term. And in turn, that collaboration requires unwavering support from the C-suite.

In short: SCWCF cannot be viewed as a temporary fix or a quick patch for a one-off problem; it has to be applied strategically. That’s easier said than done, to be sure. But the discussion should begin now.