Last week I had the privilege of delivering a presentation at the CFO Rising conference in Orlando, Florida on the topic of Supply Chain Finance. I was fortunate to be presenting jointly with Neal Harm who is the Chief Administrative Officer of BB&T’s Commercial Finance group. BB&T was a key exhibitor at the show, promoting their new integrated financial supply chain product – Supply Chain 360 (http://www.bbt.com/bbt/business/products/supplychainsolutions/supplychain360.html). Working with the BB&T team on their product launch activities has been a rewarding experience for me as I have found their Commercial Finance team to have some of the most visionary thinking in the industry. We were fortunate to draw a crowd of over 40 CFOs and senior level finance executives, who were all very actively interested in this hot topic.
Why such a crowd? Because, supply chain
finance promises to enable radical new efficiencies for managing
working capital in the value chain. Supply Chain Finance is a
multi-faceted concept. Some of these concepts can be leveraged today
while others are more visionary at this point. Without question the
most widely embraced aspect of supply chain finance today is the idea
of post-export supplier financing. The term is intimidating
to those not familiar with trade finance, but the principles are
actually quite simple and familiar to anyone who has used a credit
card.
Comparison to the Credit Card
We are all familiar with how a credit card
model works, but I will recap a few of the more relevant points that
help to illustrate the analogy to supplier finance. Let’s suppose that
you are a sports fan that has decided to invest in a high definition
plasma television to enhance your viewing experience. Perhaps, if you
are in the US you may wish to buy a new HDTV in time for this month’s
NCAA basketball tournament. So after evaluating the various brands and
product options you make a visit to your favorite consumer electronics
retailer to purchase the TV. The easiest way to purchase a high value
item such as a TV is probably not to carry cash, but instead to use a
credit card. Using a credit card, you can purchase the HDTV on credit,
taking possession immediately without having to present any cash to the
merchant (electronics retailer). The merchant assumes little risk as
the bank who issued you the credit card guarantees payment in all but a
few scenarios. And the merchant is paid quickly. Within just a few
days of uploading their point-of-sale transactions to their bank, the
merchant is reimbursed for the value of your purchase. However, you
(the consumer) do not have to remit any payment for at least 30 days
when your next monthly statement arrives. At this point you can decide
to pay the balance in for your monthly purchases (including the TV)
full or defer payment until later. Or you might pay only a percentage,
financing the remainder of the balance.
The credit card model has become the most
popular means of retail payment due the benefits it offers to both
consumers and merchants. Consumers can purchase goods and services on
credit, deferring payment until a later date that enables them to
optimize their cash flows. The merchant offers a simple, hassle-free
approach for consumers to make payment, but also benefits from the
relatively fast inward cash flows that the credit card system offers.
Both the issuing bank and the merchant’s bank also benefit by charging
a processing fee to the merchant for facilitating the settlement
process. The issuing bank that provides the consumer the credit card
also enjoys significant upside, in that, the consumer may elect to
defer payment of the balance. The issuing bank then enjoys an
additional income stream as interest accrues on the consumer’s balance.
Supply Chain Finance – A Credit Card for International Trade
Supply Chain Finance operates under similar
principles as the credit card model except that the transaction is
business-to-business rather than business-to-consumer. Suppose, for
example, a large UK-based department store is purchasing a line of
apparel products from a third party contract manufacturer in Vietnam.
After reviewing samples and finalizing on a sales forecast, the
retailer places a bulk order for the clothing with the manufacturer.
The manufacturer acquires the fabric materials, performs the sewing
process and then ships the product to the retailer’s distribution
center outside of London. Concurrently, an invoice is sent from the
manufacturer to the retailer’s accounts payable department. The
retailer performs a series of validations and matches on the invoice to
ensure consistency with the quantities, colors and sizes specified on
the original purchase order. The invoice is then approved to pay. In
a traditional buyer-supplier relationship, the retailer may withhold
payment of the invoice until its maturity which could be another 30 or
60 days after receipt of the goods. Why? Because, most buyers prefer
to hold onto their cash as long as possible so that they can put it to
use in other ways. However, in the supply chain finance model, a
different sequence of events occurs – very similar to the consumer
credit card example described earlier.
In the supply chain finance model the retailer
will instead notify the bank of their intention to pay the supplier at
term. The bank will then approach the supplier asking if they would
like to be paid immediately. Most suppliers, especially smaller ones
in emerging markets such as Vietnam, are cash constrained. As a
result, the early payment option is appealing to them. Upon
confirmation from the supplier, the bank immediately transfers the
appropriate funds to the supplier’s account. The supplier has now
collected its revenues from the products it manufactured. And the bank
has assumed responsibility for collecting the payment from the
retailer. 30 or 60 days pass until the date the original invoice is
due is reached. Now the bank will collect the appropriate funds from
the retailer. At this point, the retailer may elect to settle the
transaction in full with the bank. Or they may request to extend the
payable to a future date based upon their cash flow situation.
Let us compare the retailer B2B example to the
earlier B2C HDTV purchase example. In both scenarios, the suppliers
(the apparel manufacturer and the electronics retailer) are compensated
shortly after delivery of the goods. In both scenarios, the buyer (the
department store chain and the sports enthusiast consumer) has the
option to settle their transaction balance within the original purchase
terms or to extend terms with an interest-based financing approach. In
both scenarios, the banking system provides short term financing to
bridge the time-span between when the buyer takes possession of the
goods and the buyer makes payment. The most important concept is the
value created to all three parties in the transaction. The timing of
the supplier’s inbound cash flow is accelerated. The timing of the
buyer’s outbound cash flow is maintained or extended. The financial
institution generates income from the processing and financing of the
transaction.
Given the analogy above, you might ask why the
credit card companies are not participating in the supply chain finance
market today. The answer is that they plan to. Facilitating B2B
payment transactions and short term financing arrangements are a
natural extension of the value proposition and capabilities credit card
processing networks offer today. Of course, the funding sources for
the short term financing will be the actual banks. There is an
interesting study in contrasts when one compares the situation in the
banking sector to the major credit card brands. MasterCard and
Discover have both enjoyed tremendous success with their IPOs. The
Visa public offering scheduled for this week promises to be one of the
largest in history. By contrast, the banks are struggling to keep
afloat as the credit crisis continues to worsen. With the collapse of
Bear Stearns over the weekend and the recent turmoil in the financial
markets, one might question whether adequate liquidity and credit
facilities will exist to support supply chain finance…
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