Twenty five years of management and treasury experience in global companies. David Blair was formerly Vice-President Treasury at Huawei where he drove a treasury transformation for this fast-growing Chinese infocomm equipment supplier. Before that Blair was Group Treasurer of Nokia, where he built one of the most respected treasury organisations in the world. He has previous experience with ABB, PriceWaterhouse and Cargill. Blair has extensive experience managing global and diverse treasury teams, as well as playing a leading role in e-commerce standard development and in professional associations. He has counselled corporations and banks as well as governments. He trains treasury teams around the world and serves as a preferred tutor to the EuroFinance treasury and risk management training curriculum.
Clients located all over the world rely on the advice and expertise of Acarate to help improve corporate treasury performance. Acarate offers consultancy on all aspects of treasury from policy and practice to cash, risk and liquidity, and technology management. The company also provides leadership and team coaching as well as treasury training to make your organisation stronger and better performance oriented.
As an early impetus, payment factories (which centralise payment processing), gained from the spread of shared service centres (SSCs). These SSCs sought to improve control in response to Sarbanes-Oxley through standardised processes and contain costs in response to increasing competition through economies of scale, taking advantage of the opportunities for centralisation offered by the internet.
Once accounts payable (AP) was centralised to an SSC, it made sense to handle the payments there as well. Since SSCs tend to run on a single-instance ERP, payment factories are a large, secure pipe connecting the ERP to banks – typically via SWIFT.
The benefits of SSCs in terms of control and costs continue to be attractive, which is why the SSC bandwagon is still rolling on strongly over a decade after the initial boom. More and more operational back office-type processes, that can often be considered hygiene rather than core, are put into SSCs. The objective is to free the customer-facing teams from routine administration so that they can focus on the core business.
However, the high-volume pipe connecting the ERP to banks is not the only argument for payment factories. And not all groups want a centralised model, nor is it suitable for all businesses. Examples include conglomerates spanning different businesses with divergent operational needs, and groups that comprise individual businesses that need to remain independent for various reasons, as well as groups (often in regulated industries) that expand through joint ventures where, lacking control, they cannot avail themselves of SSCs.
Even without the centralisation and standardised processes implied in SSCs, there is a strong case for payment factories to enhance control and reduce costs through economies of scale and efficient payment routing.
Payment factory mass customisation
When a group, for one reason or another, does not want to go down the route of centralisation and SSC, how can they benefit from payment factory technology?
For treasurers who do not want to interfere with their subsidiaries’ operating processes, one model might be simply to replace bank proprietary e-banking with a multi-bank e-banking solution. This need not be disruptive at all, and can preserve the subsidiaries’ existing bank relations and ways of working.
At least when it comes to making payments and receiving bank statements, most banks’ web portals have similar functionality, along the lines of:
Enter or upload payments.
Re-use payment templates.
Approval matrixes by value and seniority.
Payment status tracking.
Read and download statements and advices.
A multi-bank replacement for proprietary e-banking allows treasurers and head office in general increased visibility over flows, balances, controls, and costs – discretely and without interfering with subsidiaries’ autonomy and process idiosyncrasies. SWIFT’s Alliance solution can cover these functionalities, as can many other products.
“Even without the centralisation and standardised processes implied in SSCs, there is a strong case for payment factories to enhance control and reduce costs through economies of scale and efficient payment routing”.
There are many variations between the low-tech e-banking swap out described above and the high-volume pipe connecting ERP to banks. SSCs normally rely heavily on the integrity of their ERPs – purchase orders (POs) and delivery notes (DNs) are approved by business operations, the ERP checks that invoices match the relevant POs and DNs and often pays the invoices automatically – “No PO, no pay”.
Many companies are not fully confident in the security of their ERPs; they want a final check before the money flows out of their accounts. Banks cover this scenario by reading in payments in host-to-host mode (ERP-to-bank file transfer) then allowing authorised signatories to log on to their e-banking and approve payments. Multi-bank solutions offer the same functionality.
Payment factories and OBO
Payment factories have long been associated with payment on behalf of (POBO) and receipt on behalf of (ROBO) (together, on behalf of, or OBO). Basically, instead of using subsidiaries’ bank accounts to collect and pay, the payment factory opens accounts in its own name in relevant countries, and pays and collects from these accounts on behalf of subsidiaries. A variation is that the payment factory commandeers subsidiaries’ accounts in each country for group use.
This eliminates subsidiary bank accounts and thus reduces the number of bank accounts in the group and their associated costs and operational risk. More importantly, OBO facilitates efficient payment routing by eliminating expensive cross-border flows.
Payment factories and IHB
Another logical extension of the payment factory is to warehouse payments for planning purposes and to concentrate intercompany settlements to reduce payment fees, FX spread, float, and operational risk.
In-house bank (IHB) functionality provides for all of this by allowing payments and receipts to be posted on an intercompany account, together with intercompany flows, and settled once a month.
IHB maintains the goal of preserving subsidiary independence. An external bank account is simply replaced by an intercompany account. The intercompany account can have limits such as zero or other overdraft limits, pay credit interest at arm’s-length rates, in addition to other features. This can be helpful if the group does not use value-based management metrics like ROIC, EVA, or other WACC measures.
One caveat is that IHB balances, being intercompany balances, bring tax risks. They may be attacked on transfer pricing, withholding tax, thin capitalisation, deemed dividend, and other fronts. Notional pooling, when done properly, has many advantages in this respect. Another simple workaround is to arrange local third-party funding combined with a zero overdraft on the intercompany account.
Payment factories are global
There is a myth that none of this works in developing countries. In fact in Asia, the majority of these benefits are available in most commercially important countries. Flexibility can bring many of the benefits while complying with regulations. Examples include dropping OBO and using “gross in – gross out” in countries that prohibit netting.
Both OBO and IHB work (and are being done) in China and can be applied cross-border under the new regulatory framework. Being new, it will take some explaining to banks and regulators in far flung corners – for example letters explaining OBO for vendors to show to their banks. Some companies have decided to zero balance IHB accounts for Chinese entities at month end.
Payment factories for decentralised groups
For the avoidance of doubt, I want to state here that I am a big believer in centralisation of back office operations in SSCs, payment factories, treasury centres, etc. I believe that front-line management should be free to focus on attracting and retaining customers – which Peter Drucker called the core purpose of business – not bogged down in back office administration duties.
That said, centralisation does not suit all business models and cultures, so there is a need for effective solutions for such groups. Groups who find the centralising plug-and-play model unsuitable, will find this payment factory functionality allows them to materially decrease costs and reduce operational risk without interfering with their subsidiaries’ unique business models and processes.
The views and opinions expressed in this article are those of the authors.