Financial sweetener for suppliers
By Richard Milne
Published: October 22 2009 03:00 | Last updated: October 22 2009 03:00
W hen KPN, the Dutch telecoms group, last year decided to extend how long it took to pay suppliers it knew it would not be a popular decision. So, as it moved its payment terms from 45 to 90 days, it looked into a mechanism called supply chain finance. "Obviously [the lengthening of payment terms] is a negative thing for suppliers. So we were looking for a sweetener to smoothen the implementation and then we found this," says Toon Huiskes, a financial manager in KPN's procurement division.
Supply chain finance is seen by many supply chain experts and managers as the great hope for easing problems with suppliers. Although it actually refers to several different solutions, at its most basic it allows both the buying company and the supplier to improve their working capital - a crucial attribute given the recent financial crisis. Companies such as J Sainsbury, Nestlé, Syngenta, retailer Metro and truckmaker Volvo have all used it.
The way it works at KPN is typical. The Dutch group pays its suppliers later, improving its own working capital by holding on to its money for longer.
But suppliers can now access their invoices to KPN on an internet platform and sell them on to a bank as soon as they are approved. That means they can get their money almost three months ahead, against the payment of a fee they need to pay the bank. The bank eventually collects the money from the buyer on the official payment date.
"It supports our supply chain because it is a win-win for everybody," says Mr Huiskes.
"Win-win" is a term used by many in supply chain finance. Both sides improve their working capital while the banks get a fee. It looks similar to the widely used practice of factoring but the main difference is that the risk is transferred from a group of buyers to one, usually more creditworthy, buyer. It also tends to be cheaper as the supplier essentially uses the buyer's credit rating, and the risk for the bank is low as the invoices have been confirmed by the buyer.
Supply chain finance has even caught the eye of the Bank of England as it seeks to encourage lending in the real economy. The UK's central bank is consulting on whether to introduce such a programme itself to help suppliers who are facing financing problems as banks tighten credit. "The Bank of England is going to be opening the floodgates for supply chain finance," says Mark Perera, head of the Procurement Intelligence Unit.
But the sunny language of win-win situations belies the difficulties involved in setting up such a scheme. Those challenges in turn demonstrate why, for all the interest in supply chain finance, its application so far has been slower than expected.
The main challenge when introducing supply chain finance is simply to get everybody on board, both internally at the buying company and among suppliers. "You need to cover a lot of angles," says Mr Huiskes. The treasury, procurement, accounting, IT and accounts payable departments were all involved at KPN.
The problem is that all of the departments speak different languages and have different incentives. "It is like procurement speak Chinese and finance speak English," says David Brown, head of Oxygen Finance, a start-up attempting to use credit card processes in procurement.
It can also be difficult and costly to roll out globally. Legal and audit issues mean it is tricky to do worldwide while the retrenchment of banks to their national markets means there are few genuinely global institutions left to help set up the schemes. Even if a bank can be found, some worry that they are reticent to push into it because they do not want to give up the larger profits from factoring.
Even banks agree, to a point. Alan Keir, head of European commercial banking for HSBC, says: "If you are an intermediary the issue is: how do you make money?" His colleague, Adrian Rigby, points to the advantage on risk for banks of dealing with buyers rather than suppliers: "On a pure margin side it may not be so profitable, but overall on risk it is more secure."
Companies also need to invest in infrastructure such as IT and ensure they have efficient processes. That can lead to high set-up costs. But it can help in other ways such as minimising disputes. A supplier can see its invoice - and whether it is correct - long before the technical payment date. "Due to this platform we eliminated a lot of disputes," says Mr Huiskes.
But suppliers themselves need convincing. Many have fared so badly - such as in the retail and car industries - that they are distrustful of anything proposed by their buying companies. Daniel Corsten, a professor at IE business school in Madrid, calls their worries the "adoption paradox". He says suppliers that need the finance are the most reluctant to adopt because they fear they might become more vulnerable: "It might mean that you are dependent on your customer not just for business but also for finance."
Even if they are in favour, companies are tending to extend the scheme to a few select suppliers, which are normally their biggest ones and in less trouble than the smallest. "There is nothing very supply chain about finance right now," says Mr Brown.
KPN started out with only its two biggest suppliers and will soon have 25 on board, representing 15 per cent of its total spending. Mr Perera warns: "It needs to be there for the smaller suppliers as well as the big ones." The irony is that the smallest suppliers are often weaker financially than the big ones to start with, says Prof Corsten.
But despite the imperfections, supply chain finance can be a useful tool for companies to help them and their suppliers. Some companies such as Crédit Agricole and SCF Capital have even applied it to mergers and acquisitions.
Back at KPN, the launch has been a success. "This has been very well received," says Mr Huiskes. "This is the main game in town now."
How Nestlé chewed over an invoicing conundrum in Russia
The 1998 financial crisis, coupled with the general expense of financing in emerging markets, made Russia and its 3,500 Nestlé suppliers an obvious place for the Swiss group to test extending payment terms through the sweetener of supply chain finance.
According to a case study by the IE business school, suppliers set up an account with Citibank, and received a purchase order and shipped goods as normal.
Nestlé would then approve the goods and after the suppliers then contacted Citi, the bank would pay 90 per cent of the invoice on the first day. The remainder would come on the official payment day, when Nestlé would also pay Citi the full amount.
The approach ultimately proved successful but it took longer than expected to be accepted.
Initially, Nestlé's Russian purchasing department resisted the change as did many suppliers through a lack of understanding. Suppliers were unused to dealing with an international bank and were more worried about the longer payment term than the lower working capital.
What does it mean?
Supply chain finance allows a supplier to sell its invoices to a bank at a discount as soon as they are approved by the buyer. That allows the buyer to pay later and the supplier to secure its money earlier. Instead of relying on the creditworthiness of the supplier, the bank deals with the buyer - usually a less risky prospect.
Copyright The Financial Times Limited 2009. You may share using our article tools. Please don't cut articles from FT.com and redistribute by email or post to the web.