by Kevin Day, CEO of HPD LendScape
Supply chain finance is rapidly evolving
Not so long ago, supply chain finance was the hot new thing, much talked about and plenty of hype, although in some parts of the world, buyer-centric, receivables finance has been around for 20 years or more – take confirming business in Spain for example. Over time, this financial product has evolved to find its place in amongst the various working capital solutions available to the business world. Barriers to adoption, such as the complexities of on-boarding suppliers, have been dealt with by technology companies. The typical low returns generated by this type of finance has driven improvements in efficiency and volume.
From the buyer’s perspective, SCF can enable the extension of Days Payables Outstanding (DPO) without unduly pressurising its suppliers financially. Moreover, leveraging the credit rating of the buyer can inject a lower cost of financing into its supply chain. And, if done correctly, it can reinforce buyer-supplier relationships and strengthen the links within a supply chain.
As the industry evolves, the opportunities for SCF providers have never been greater. Historically, the target market for this product has been big businesses with a strong credit profile and the ability to leverage this advantage by financing their supply chains at a lower cost. Whilst this is changing and smaller business are now operating SCF, challenges to its wider adoption remain. These include cross-border supply chains and transactions, insufficient credit quality and the complexities of modern, multidimensional supply chains. At the same time, there are significant opportunities, and challenges, for the application of SCF in developing markets.
To help neutralise these challenges and realise this potential, technology is, and will continue to play, an essential role.
Globalisation offers new avenues for growth
Globalisation has naturally created closer trade ties and opened access between developed and emerging economies. This offers new avenues for SCF to support cross-border business and finance suppliers in an international supply chain.
In this multinational scenario, the flow of information, material, and capital is challenging and often complicates cross border financing models. For example, risks posed by KYC restrictions, legal issues and security, become more apparent when the supply chain straddles different territories.
As businesses try to overcome the various frictions in trade and adapt to new challenges, they seek local suppliers and arrange new trading terms across territories. And in order to exploit these new trade corridors successfully, capital is vital to ensure the supply chain stays viable; SCF can help fill the funding gap to drive success.
Supply chains are becoming more sophisticated
It’s important to understand, however, that supply chains are not linear as the term ‘chain’ suggests. They are not one dimensional. They are, in fact, complex, dynamic networks of interdependent nodes. The combination of this complexity and the fact that every node in the network is exposed to different types of risk and uncertainty mean that they are difficult to manage.
Indeed, each supplier in a chain is also a buyer of some kind. This means they have suppliers of their own; that access to working capital is potentially required at every stage in the supply chain.
Simply put, liquidity is needed in multiple areas of these supply networks in order that goods and services flow freely and predictably. SCF must have the ability to address this by providing liquidity to those areas. For this reason, we are likely to see more SCF programmes emerge that accommodate this multi-dimensional aspect of trade, especially as the technology improves.
There is also a potential role for predictive analytics to help reduce supply chain risk. Indeed, Nestlé uses such systems to increase the precision of demand predictions across hundreds of products, from coffee to pet food. Blockchain technology is being used to provide supply chain transparency in certain sectors and more generally, many banks are working in Blockchain consortia to digitalise trade. All these initiatives have the potential to enable more sophisticated supply chain finance opportunities.
Emerging markets present excellent strategic opportunities
Classic receivables finance solutions, such as factoring, have often struggled to gain traction in emerging markets due to the lack of credit information on debtors. The supplier centric products are reliant upon the lender understanding the credit risk in the client’s accounts receivables. Supply chain finance offers a solution in these markets in that the product is organised around a buyer which has the credit quality to support the funding. Recent estimates put annual SCF growth rates at 20% to 25% for these countries, and demand is currently outpacing supply.
Frontier and emerging markets, as we’ve seen, typically lack the infrastructure to attract and accommodate large scale commerce and the big banks’ reticence to lend to smaller businesses has led to a funding gap. The World Bank’s latest figures illustrate this, revealing that there are 65 million SMEs in emerging markets that are credit constrained. This means there is a total demand for SME finance of $8.9 trillion of which only $3.7 trillion is currently met. In other words, there is a funding gap of $5.2 trillion, which SCF can help reduce.
In these emerging markets, the right technology is the key to ensuring simple and smooth transactions, especially as many local manufacturing and development sites are in locations with stringent regulatory and compliance requirements that might exclude offshore financing solutions. But to realise the benefits of SCF it is important for corporates to look very closely at the technology platforms available.
From a corporate or SMEs perspective, one option is to completely build its own technology and use its own liquidity to fund programmes. This is somewhat expensive, but all the revenues are retained by the corporate. An alternative is to work with a platform provider; this can reduce costs, but revenue is ceded to the platform provider, in some shape or form. A third option is to use the services of a bank which effectively allows the SCF programme to run autonomously as a service using the bank’s SCF platform; this has a lower impact on the corporate’s day to day activities.
All choices are equally valid, and the decision comes down to the corporate in terms of what it wants to do itself and how much it wants to push the SCF offering to others to run on its behalf.
Supply chain finance needs to be more accessible for mid-sized companies
Large companies have often used their liquidity or credit to finance their own supply chains. This has been made possible by virtue of their superior creditworthiness. Mid-sized buyer companies are hampered, however, by virtue of their lower creditworthiness, which means they may have issues funding an SCF programme or their funding may be too expensive to attract suppliers to the programme. On top of this, it is unlikely that mid-sized companies will have the same agency and authority to lengthen supplier payment terms, one of the key advantages to SCF from a buyer’s perspective. Another issue is that they will almost certainly lack the in-house expertise that large companies have for understanding difficult, nuanced contracts and managing supplier engagements.
These issues are significant and have meant that supply chain finance has been used less by mid-sized companies. But the good news is that some of these issues can be rectified by technology, especially if partnering with a bank or financial institution. The buyer-risk can be mitigated by having a deeper level of integration with the buyer. Banks are well versed in asset-based finance and can use the operational and financial data of the buyer, including sales orders, inventory and receivables to secure the funding necessary to support the SCF ambitions of the organisation. Costs can be minimised by linking the bank’s systems directly to the ERP of the buyer to enable data to flow freely. Closer risk management of the buyer would enable its purchases to be funded to the supplier, secured on future cashflows emanating from the company’s normal business operations.
Data allows a service provider to fund a business with precision, both in the areas and during the times it needs it most. Such applications of technology will improve the cost and time efficiencies of providing and receiving SCF. They will also permit lenders to link platforms and client accounting software together to provide granular financial data and simplification for corporate treasurers.
Keep it simple, make it easy
In conclusion, it is clear there is a strong argument for increasing the use of SCF. Challenges that sit in the path of increased use are not insurmountable, nor do they reveal fundamental problems with its offering. In a commercial world of ever-increasing complexity, where supply chains are better described as multidimensional and layered networks, and where merchants must address a variety of uncertainties across many borders, it is not surprising that the most effective way to provide liquidity is also complicated.
But whilst that might be seen by some as a real barrier to wider SCF use, the combination of the industry’s experts’ ability to combine experience and understanding with the power of technology has created a suite of available platforms that cut through such complexity.
The SCF industry’s approach can be summed up as ‘keep it simple, make it easy,’ and as long as the sector stays faithful to that ethos it will help an ever greater number of businesses engaged in international commerce to reap the benefits of SCF and increase their contribution to economies’ wealth and prosperity both in the developing and developed worlds.