(126228273) pfm178 lr ralf daniel seifert
TRANSCRIPT
w w w . i m d . c h N o . 1 7 8 O c t o b e r 2 0 0 9
SUPPLY CHAIN FINANCE – WHAT’S IT WORTH?
Supply Chain Finance (SCF) represents
an innovative opportunity to reduce
working capital. Its underlying
mechanism is reverse factoring making
the technique buyer- rather than
supplier-centric. Implementing SCF is a
difficult and time-consuming task that
requires top management attention.
Yet, it promises significant savings. Our
survey results show that, on average,
companies reduce working capital by
13% and suppliers reduce working
capital by 14%. Three factors differentiate
successful implementations of SCF
from less successful ones: Choosing
the right banking partner, ensuring CEO
sponsorship, and involving at least
60% of the supply-base.
Working capital reduction is not
exactly the new kid on the block:
Business press articles have
heralded its benefits for nearly two
decades; it has been explored in
detail in scientific journals for about a
centur y; and numerous conferences
unite practitioners to discuss best
practices ever y year. But, for some
companies, the topic has recently
moved to the top of the agenda. With
banks less willing to hand out loans,
companies are finding it difficult to
maneuver.
Despite the longstanding attention
to reducing working capital, the only
component that has dropped over
the years is inventor y – representing
a mere 30% of total working capital.
Collection and payment delays have
remained largely flat with most
companies sticking to industr
y standards and collecting and
paying invoices after 30 or 45 days.
Also, most continue to keep
suppliers at arm’s length. One
executive we recently inter viewed
described his company’s approach
to negotiating payment terms as a
“no tolerance” strategy.
In the past, suppliers often reacted
to these long payment delays by
factoring their receivables
when they needed cash.1
Factoring is
a transaction in which suppliers sell
receivables to factors for immediate
cash. Because the receivables are
sold rather than pledged, factoring
is different from borrowing – there
are no liabilities on the suppliers’
balance sheet.2
Typically, suppliers
sell receivables from more than one
buyer. Thus, factors have to evaluate
buyer portfolios before entering an
agreement. This has made factoring
an expensive source of finance in
emerging markets. A lack of historic
credit information or credit bureaus,
fraud, and weak legal environments
have meant high operating costs.
Today some buyers are recognizing
their suppliers’ difficulties in
accessing finance. And instead of
taking a “no tolerance” approach,
they have started to implement
a collaborative approach termed
Reverse Factoring or Supply Chain
Finance. This technique’s underlying
mechanism is factoring. There are,
however, three important differences.
Ralf W. Seifert IMD Professor of Operations Management
Daniel Seifert Research Assistant, Ecole Polytechnique Fédérale de Lausanne
First, since the technique is buyer-centric,
factors do not have to evaluate heterogeneous
buyer portfolios and can charge lower fees.
Second, since these buyers are usually
investment grade companies, factors carr
y less risk and can charge lower interest
rates. Third, as the buyers participate actively,
factors obtain better information and can
release funds earlier.
1 Buyer issues purchase orders to supplier and bank
The advantages of this technique are clear.
Truck maker Scania, for example, helped its
suppliers finance growth when demand surged
in 2006. Magnus Welander, Head of Cash
Management, explains: “Our suppliers had
difficulties financing the increased demand. The
situation was especially tense because Scania
didn’t encourage traditional factoring. The
implementation helped them – especially the
smaller ones – to enjoy unprecedented liquidity
levels. Now, they sometimes receive payment3 Citibank checks
documents and notifies buyer
4
Buyer accepts
Supplier delivers 2 goods and pres- ents documents
Citibank
5 Citibank advises acceptance
after as little as five days.”
Yet, the technique is far from being a main-
stream phenomenon. Some companies have
hesitated to adopt SCF because it is unclear
how much buyers and suppliers really save.
Innovators treat their figures confidentially
or report numbers that are hard to compare.
7 Citibank debits buyer at due dateElectronic platform 6 Supplier requests early payment Additionally, it has not always proved to be a fail-
safe solution – stories about companies where
Figure 1 – Example of an SCF process: Citibank the implementation of SCF has failed have been
making the rounds leaving other firms in the
dark as to what it takes to succeed.
As a process, SCF is slightly more complicated
than factoring. Citibank’s process, for example, Therefore, in collaboration with Springer’s
involves seven steps. First, the buyer sends Supply Chain Magazine and IMD, we conducted
a purchase order to the supplier and notifies a worldwide sur vey of executives who use
Citibank. Second, the supplier delivers and SCF solutions as buyers. How much were
presents documents to Citibank. Third, Citibank they able to reduce their working capital?
checks the documents and notifies the buyer. Which approaches to implementing SCF made
Fourth, the buyer approves or rejects. Fifth, most sense? The sur vey’s aim was to assess
Citibank notifies the supplier of the buyer’s the benefits of SCF, both quantitatively and
acceptance. Sixth, if the supplier requests early qualitatively, and to statistically derive the key
payment, Citibank credits the supplier’s account. success factors. We received 213 replies from
Finally, when the invoice is due, Citibank debits executives in 55 countries, covering all major
the buyer’s account (Figure 1). industries. Of the respondents, 23 reported
Buyers Suppliersusing an SCF solution. The following analyses
are based on their answers.0 – 10% 11 10
11 – 20% 9 6 Are SCF programs worth their money?
21 – 30% 1 6Our data paint a fairly positive picture: The
31 – 40% 01 23 executives using an SCF solution report an
More than 40% 20
average reduction in working capital of 13%
(Figure 2). Based on average assets of aroundø13% ø14%
€8.5 billion, an assumed working capital ratio
Respondents using SCF solutions, n = 23 of 30%, and an average cost of capital of 5%,
Figure 2 – How much has the Supply Chain Finance solution decreased your working capital/your suppliers’working capital?
these reductions represent annual savings
of around €16 million (Figure 3). This amount
Improvement of supplier relations 52%
Reduction of prices26%
Information gain about suppliers' finances17%
None
SUPPLY CH A IN FIN A NCE – W H AT’S IT WORTH?
compares with an investment of € 0.1-1.5
million in information technology as suggested
by the Aberdeen Group in their Technology
Platforms for Supply Chain Finance report.3
Even if the savings are lower than suggested
by the above business case, the program should
still break even in less than a year.
Similarly encouraging is the obser vation that
Assumptions
• Working capital over assets: 30%
• Working cap- ital reduction due to SCF:13%
• Risk freerate: 3%
Assets
Working capital
Working capital reduction
Annual cost savings
Smallest risk premium: 0%
8,531.0
2,559.3
332.7
10.0
Average risk premium: 2%
8,531.0
2,559.3
332.7
16.4
Largest risk premium: 9%
8,531.0
2,559.3
332.7
39.9
SCF seems to help suppliers too. The same
23 executives report that, on average, their
suppliers were able to reduce working capital
by 14% by participating in the SCF program.
Asked about intangible benefits, more than
half of the respondents – 57% – say that SCF
helps standardize payment terms and 52%
say that SCF helps improve supplier relations
(Figure 4). Asked how SCF links back to other
projects, 68% say that its implementation
improves Purchase-to-Pay processes, 14% say
that it improves Order-to-Cash processes, and
another 14% say that it improves Record-to-
Report processes. Intangible benefits attributed
to suppliers include more transparency and
fewer disputes (65% and 52% respectively of
these respondents). Finally, executives seem
to perceive the drawbacks as limited: 30%
perceive no drawbacks at all. Of the rest, 44%
report reduced credit availability, 31% report
pressure to guarantee payments, and 25%
report other drawbacks.
Given the wide range of outcomes, it is
legitimate to ask if there are differences in
the way businesses implement SCF. What
distinguishes a successful from a less
successful implementation? Our data reveal
three key success factors.
Averages of 23 companies using SCF solution, € million
Figure 3 – Supply Chain Finance – Business Case
Second, roughly half of these respondents –
52% – say that internal sponsorship plays an
important role. Consistently, our regressions
found implementations to be more than twice
as successful when the CEO rather than the
CFO leads them. The message is clear –
although it might be tempting to delegate, CEOs
should personally lead the effort. Individual
departments do not seem to have the required
leverage to keep the stakeholders – especially
suppliers – at the table.
Standardization of payment terms
Other 4%
Percent of respondents using SCF solutions, n = 23
Figure 4 – What other benefits has your company experienced?
57%
First, the majority of executives – 65% – say
that the banking partner is a key success
factor (Figure 5). We tested this assertion
by regressing working capital reduction on
banking relationship strength and found this
factor to be positively related at a statistically
highly significant level. Thus, executives should
invest sufficient time into selecting a banking
partner. Important criteria that we determined
during in-depth follow-up inter views included
the bank’s geographic reach, its legal expertise
Banking partner
Internal sponsorship
Other (mostly supplier involvement)
IT implementing partner
Technology platform
Percent of respondents using SCF solutions, n = 23
17%
13%
0%
52%
65%
and its financial muscle. Figure 5 – What were key success factors in implementing the Supply Chain Finance solution?
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Finally, some executives – 17% – stress the
need for supplier involvement. Our in-depth
inter views suggest that companies face
difficulties in convincing suppliers to participate
in SCF programs. One executive reported that
suppliers would rather accept late payment
than be involved in a seemingly complicated
program that they did not understand.
Executives should, therefore, critically assess
which suppliers to include in the first wave
and which ones to include in the final rollout.
Our tests suggest that implementations are
most successful when they include at least 60%
of the supply-base in the first wave.
This finding is consistent across different life
cycle stages, i.e., implementation and operation.
Given the attractive benefits and the clear key
success factors, we recommend executives
take a closer look at SCF. It will not solve the
liquidity issues that some companies will face
over the next months. But it seems a sustainable
approach to reducing working capital in the long
run. As our analysis suggests, there are three
key success factors that companies should
focus on: Choosing the right banking partner,
ensuring CEO sponsorship, and involving at
least 60% of the supply-base.
Contrary to our expectations, cross-functional
teams do not appear to play a role. At least
statistically, it does not matter which or how
many departments a company involves. The
most successful implementations involve five
departments (Finance, Purchasing, Supply Chain
Management, IT, Legal), but implementations
that involve only two departments (Finance,
Purchasing) closely track their performance.
Admittedly, getting these three factors right
is a difficult and time-consuming task and is
one of the reasons that companies have been
slow to adopt the technique. But persevere
and the payoffs, in terms of working capital
reduction, will be worth working for. So while
it may no longer be the new kid on the block,
it seems working capital reduction will
continue to create a buzz for some time to
come.
We recommend
executives take a closer
look at SCF.
1. Some suppliers employ early payment discounts instead of factoring. Early payment discounts, however, are a far more expensive source of finance. The most common discount scheme (2/10 net 30) implies an annual interest rate of over 43% whereas factoring commonly entails an annual interest rate of 6%.
2. There are, however, variants. Recourse factoring, for example, creates a liability that is contingent upon the
buyer’s payment. For further information see
Klapper, L. (2005). The Role of “Reverse Factoring”
in Supplier Financing of Small and Medium Sized
Enterprises. Working Paper, The World Bank, 2005.
3. Aberdeen Group (2007). Technology Platforms for Supply
Chain Finance. Aberdeen Group, Inc., Boston, MA, March
2007.
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