Supply Chain Finance is the optimization of both the availability and cost of capital within a buyer-centric supply chain. The availability and cost of capital is usually optimized through the aggregation, integration, packaging, and utilization of all of the relevant information generated in the supply chain in conjunction with cost analysis, cost management, and various supply chain finance strategies.
A Supply Chain Finance Solution, in comparison, is a combination of trade financing provided by a financial institution, a third-party vendor, or an enterprise itself, and a technology platform that unites the trading partners and the financing partners electronically and provides visibility into the various supply chain events that can serve as financing triggers.
Supply Chain Finance is a lot more than just factoring, early payment discounting, or inventory shifting. It’s balancing credit, financing options, inventory management, and other supply chain variables to optimize working capital, and much more. Thus, given the complexity of supply chain finance in today’s globalized supply chains, it is important to have some good strategies in order to ensure that you are reaping the benefits that are there to be gained. It’s also equally important to understand that some of the classic strategies are more apt to be strategies for failure than for success. To this end, here are three strategies for success and three strategies for failure to avoid to start you on your supply chain finance journey.
Strategies for Success
- Balance Open Accounts and Letters of Credits
It’s important to understand an organization’s cost of capital versus the supplier’s cost of capital. Open account terms, for example, may bear lower fees than a letter-of-credit based transaction, but they can also restrict a seller’s access to working capital financing and increase its costs of working capital. The additional cost borne by the supplier for accepting extended payment terms, for example, could be finding their way back into the cost of goods sold.
- Improve Forecast Accuracy
One of the best ways to take cost out of the supply chain is to take unnecessary inventory out of the chain, as this just leads to additional storage, overhead, and financing costs and losses when it has to be cleared at considerable markdowns.
- Lower Your Supplier’s cost
A recent Aberdeen benchmark report found that 39% of suppliers indicated that their top issue is their ability to access financing at acceptable terms. The more it costs a supplier to make a product, the more it will cost a buyer to buy it. Consider using early payment programs, inventory ownership solutions, and / or virtual consignment financing to lower your supplier’s costs, and your own in the process.
Strategies for Failure
- Shifting Inventory to Suppliers
Considering that most suppliers have to wait an unduly long time between their initial cost outlay to make a product and the eventual payment for that product in an environment where many buyers are now demanding payment terms that include 60, 90, or even 120 Days-Payable-Outstanding (DPO) and that most do not have large storage facilities or inventory management expertise, this drives up their costs from all angles. Their financing charges go through the roof as they have to take out more high-cost short-term financing, often at rates of 20% to 40% per annum (which are especially common in developing economies), their costs of operation go through the roof as they have to either acquire additional assets or pay a third party to manage the inventory, and their opportunity costs rise as they are prevented from ramping up production, due to lack of funds and storage, on New Product Development that could ultimately prove more profitable to them, and to you as the buyer. All of these costs just increase their cost of goods sold, and your price, and your “brilliant idea” to get rid of inventory carrying charges has only served to increase the total cost of ownership of the products you are buying. Nice move, hotshot!
- Increasing Days Payable Outstanding
Most suppliers only have constricted access to short-term financing with a significantly higher cost of capital. This cost-shifting to suppliers might result in better Days-Payable-Outstanding (DPO) statistics to a buyer in the short term, but ultimately results in a less financially stable, and thus higher-risk supply base, and, eventually, an overall higher cost of goods sold to your supplier and you versus your competitors who have mastered sound SCF practices.
- Mistaking Early Payment Discounts and Factoring for Financing Options
Early payment discount programs, regular or automated, do not address the root causes of financial flow inefficiency and can in fact exacerbate the underlying drivers. Instead of shifting inventory to a supplier, you’re essentially shifting costs and this often results in cost increases, rather than cost reductions, across the supply chain.
For more insights on Supply Chain Finance, check out the wiki-paper over on the e-Sourcing Wiki which includes an overview of the benefits to buyers and suppliers, strategies for success, strategies for failure, and tips on both buyer and supplier supply chain finance implementation.