The age-old problem of buyers wanting to pay as late as possible and suppliers wanting the cash immediately seems an intractable one at best. Of course, corporate buyers could pay their suppliers in good time, but different markets have different attitudes to this issue. D&B reported a set of figures from its annual review of Asian, European and North American payment practices last year which showed that in 2011 Taiwan led the pack on due-date settlement with 69.3%. Hong Kong had a 34.5% punctuality record and China 33.1%. The European average was 37.8% with Germany way ahead on 74.7%, while Switzerland followed with 55.3% and the UK lagged way behind at 26.3%. Only Portugal was slower to pay, with a punctual payment figure of just 21.8%. The US displayed an average 51% punctuality record, while Canada’s average due-date payment was 44.9% and Mexico was 59.9%.
Lelaina Lim, CFO of RSH Limited, told Treasury Today that when she first started in her role as the Shanghai-based Regional Financial Controller of International SOS (a medical evacuation company) she was faced with a receivables turnover of 350 days. She brought this down to 120 days over a two-year period but said even this was not easy. “It was hard and people thought I was very harsh, but after two years people realised that it was a do-or-die situation. A business that doesn’t collect cash can’t survive.”
In Europe, the EC issued Directive 2011/7/EU to try to encourage a fairer play between both parties. The directive came into force on 16th March 2013 as a means of combating late payment in commercial transactions. However, the Directive does not harmonise payment periods across the region, but instead creates a statutory right to interest 30 days after the date of the invoice, unless of course another payment period has been negotiated in the contract.
A place for SCF
This is where supply chain finance (SCF) has a role to play in easing the tension. SCF has been playing an increasingly significant role in the trade finance portfolios of some banks, with major global institutions claiming an average annual growth rate of up to 40%. According to the annual industry survey of global banks and corporates by working capital solutions, advisory and technology provider, Demica, this sustained uptake will continue to the end of the decade.
Growth in SCF programmes indicated by those surveyed is highest in the US and Western Europe, particularly in the UK (with its low payment punctuality record) and Germany (with quite the opposite), with Eastern Europe, India and China (the worst of D&B’s payment punctuality Asian countries) noted as leading regions with the greatest SCF market potential. Some 90% of bank respondents see SCF as a “must-have” financial product for corporate buyers and more than 75% of them see it as an “added-value” product. Respondents believe that domestic SCF programmes will lead the expansion and that the level of competition between banks will soon commoditise the offering. The adoption of cross-border SCF programmes will continue to gather pace but the greater complexity involved will enable it to retain its ‘value-added’ status.
Sanjay Dalmia, EVP Global Cash Management and CEO of Fundtech India, notes “a pick-up” of interest in SCF, particularly in the Asian markets. “But challenges remain,” he adds. From the banking perspective there is a degree of separation from the actual beneficiaries of the solution. As banks work with the CFOs, it can be difficult to steer procurement managers and suppliers towards a common platform and to get them to understand the benefits of such a programme. The parties often cite perceived issues and complexities around supplier on-boarding and technical integration of systems and workflows as a reason for not doing it.
Although he agrees there may be workflow issues within certain corporates, Dalmia says this is not solely an IT issue, but also one of poor communication caused by operational silos. These silos underpin a misalignment of purpose internally between accounts payable (AP), procurement and treasury, and where respectively each is intent on holding on to cash, keeping suppliers happy and keeping on top of cash management.
The purpose of supplier finance in its various forms is to bridge the payment gap between a supplier’s delivery of goods and the final settlement of its invoice by the buyer. The latter typically initiates a programme via its own bank (and so it does not impact the buyer’s own balance sheet), using its own strong credit rating to secure better rates than its suppliers can on their own. The corporate may even self-fund the programme “if it is flush with liquidity”, notes Dalmia, adding that this obviously has balance sheet implications and that any charges must be set “at arms length”.
In terms of technology, Dalmia comments that “the tools are improving all the time, but the model of operation broadly remains the same.” David Gustin, President of Global Business Intelligence, a Canada-based international trade research and advisory firm, has been following the industry closely for many years and notes that there are a lot of misconceptions about what the various forms of supplier finance are and how they work. As part of his research Gustin is currently finalising a ‘vendor positioning grid’ that looks at a multitude of vendors that market various working capital technology solutions to try to understand the lay of the land.
“Certainly in an effort to leverage the wider adoption of supply chain automation tools, or in believing specific under-served opportunities exist, many vendors have been adding working capital capabilities to their product suite,” he notes. These solutions may not fit all purposes and Gustin notes too that large-scale buyers – multinationals – that have developed approved programmes have tackled the matter in a way that complements their own industry peculiarities and as such “they are all very different and have met with varying degrees of success”.
The typical view of the supply chain, from the finance perspective, considers the funding of suppliers. This will mostly take the form of post-shipment finance but increasingly in Asia the requirement is for pre-shipment finance, says Ashutosh Kumar, Global Head of Corporate Cash and Trade at Standard Chartered. The beneficiary of post-shipment finance is the direct supplier. Pre-shipment finance will push the finance “much deeper into the supply chain”, to the point of funding the upstream suppliers that supply raw materials to direct supplier, he explains.
These upstream suppliers tend to be in the small and medium-sized enterprise (SME) sector and often do not have a sufficiently strong balance sheet to secure lower-cost bank funding, or may even find that funding in their domestic market is not readily available. The arrangement of pre-shipment finance moves away from a predominantly balance sheet-based discussion towards a supply chain risk analysis, executed by the bank (because it is the one taking the financial risk) in tandem with its corporate client. This, explains Kumar, must consider many points of the relationship between buyer and supplier to determine acceptability, pricing and so on. Assessment includes factors such as the unresolved rejection rate of the goods supplied, the nature and marketability of the products being bought and the dynamics of the market itself.
The other half of the story
But SCF is “only half of the story” in the Asian markets, says Kumar. Corporate clients of the bank are now asking for extended programmes to cover funding of their distributors too. “Of late we have seen a much greater demand for distributor finance; currently every company is looking to sell more and this is a way of helping distributors to achieve more sales without having to worry about finance.”
Indeed, in China, Benjamin Lam, China Trade Head, Managing Director, J.P. Morgan, noted in a recent Treasury Today Question Answered article that as domestic companies increasingly trade cross-border and international firms continue to invest in China, demand is rising for properly integrated SCF solutions that can link upstream and downstream procurement, buyers, vendors and distributors.
Distributor finance mirrors supplier finance in that the large corporate buyer becomes the supplier, using its credit status to finance the distributor’s purchase of goods. It is prevalent in markets such as India, China and Korea and, notes Kumar, it is evolving in quite a few other regional markets, but in all cases cuts across a broad spectrum of industries.
There is a difference between the procurement and sales side in how risk management is handled. As a corporate moves into an Asian emerging market trading on open account terms (because letters of credit (LCs) may prove too administratively restrictive or expensive), a detailed supply chain risk analysis is essential. But this almost takes the reverse view of a pre-shipment finance risk assessment, considering factors such as the marketability of the corporate’s own products, its position in the market, the relative strength of that market and the financial dependencies between the corporate as supplier and its distributors.
AB Electrolux and Deutsche Bank –
AB Electrolux is a global household name. It manufactures white goods for distribution in more than 150 markets, generating revenues in 2012 of $16.9 billion. In June 2011 the company asked Deutsche Bank to help set up a SCF programme for its North American business. Amongst the main aims of the project, AB Electrolux wanted to improve supplier liquidity (funded by the bank) to reduce “often costly” supply chain disturbances, said James Krikorian, North American Treasury Manager, AB Electrolux. Speaking at the recent EuroFinance Miami conference, he said the company also had a keen eye on freeing up its own working capital by extending days payable outstanding (DPO) (using the cash instead for core business growth), moving towards a standardised electronic invoicing (e-invoicing) process and harmonising payment terms for its suppliers.
In total, AB Electrolux uses 300 suppliers with which it has an annual spend of around $2.7 billion. The majority (225 businesses with a spend of $1.115 billion) are based in Europe, with seven in Asia (spending $400m), 60 in South America ($750m) and 20 in North America ($400m annual spend). AB Electrolux’s more than 50 buyers are located in 25 countries, with US and Australian dollar, euro, Thai baht and Chinese renminbi as the main currencies. This structure is not set in stone and given the changing economics of global manufacturing AB Electrolux has some major plans involving some 450 targeted Asian suppliers located in eight countries in the region. The flexibility and scalability of its SCF programme will be tested, but the preparation work has ensured it has a solid base to work from.
The original project was managed by a cross-functional team within AB Electrolux covering procurement, legal, AP, IT and treasury, and followed discussions with other companies that had already implemented similar programmes. Krikorian advised anyone considering this path to start by gaining top management buy-in and to use key performance indicators (KPIs) throughout to “keep focus on the SCF programme and ultimately to reach those targets”.
In practical terms, the first step for Krikorian’s team was to build a comprehensive picture of flows with a view of seller and buyer locations and currencies. From here it was possible to build a business case and evaluate the inherent risks, which might include counterparty risk (whether that is the chosen bank partner or platform provider). Therefore, a set of what-if scenarios were prepared so that should the worst happen and the programme had to be wholly or partly terminated the results could be understood. The regulatory environment for each jurisdiction and the accounting treatment of the programme was also considered as part of the foundation project.
In assessing its banking partner – naturally the chosen one had to match the existing supplier and buyer locations of AB Electrolux, have the credit capacity to handle the full programme (using a syndicated structure where necessary) and not present any IT integration issues – both credit capacity and IT integrity were considered “pass or fail” criteria. However, AB Electrolux was seeking not only financial, technical and IT expertise for operations and support (including the ability to provide data extracts of AP) but also the ability of the bank to on-board and follow up on suppliers in additional countries and in local languages, especially as the Asian expansion programme was on the horizon.
Having established the partnership with Deutsche Bank, AB Electrolux was able to form a rigorous on-boarding strategy using the experience of the bank to support its decisions. Krikorian also reported that one key contact was appointed from procurement for the SCF programme and other members of the department were trained to assess and understand the effects of the programme on the suppliers, each considered for their criticality to the manufacturing process, their current payment terms, level of business and spend and current credit rating. In building out the approach for its supplier base, AB Electrolux established a number of on-boarding models, using one-to-one meetings, seminars, webinars and mailing of details regarding the mandatory change of current terms. Suppliers were then divided into one of three tiers (as Krikorian noted, “one size does not fit all”) and some “low-hanging fruit” were identified as potential “quick and easy wins”.
By defining a timeline for supplier negotiations and establishing the level of internal resources needed it was possible to allocate with precision “who does what and when” and to set expectations. To test its processes, AB Electrolux set up a small number of “well connected” suppliers as pilot cases to try “two or three of the preferred on-boarding strategies” and to test its file and payment transfers before evaluating and adjusting prior to full roll-out.
The role of SWIFT’s BPO
Where a corporate exhibits a level of discomfort with the counterparty risk of its buyers, credit insurance would be appropriate but, says Standard Chartered’s Kumar, this is not readily available in some Asian markets. This drives companies to use LCs as a risk mitigation tool but, he notes, these can be inefficient from an administrative perspective, often adding up to ten days in processing time.
This is where the International Chamber of Commerce (ICC)-approved SWIFT Bank Payment Obligation (BPO) (which became effective in July of this year) could play a major role by helping firms working in and out of the region to mitigate the counterparty risk arising from open account trading. Standard Chartered has already carried out transactions – with BP Chemicals and its client Octal – using this tool (see Treasury Today’s May 2013 Corporate View with BP Petrochemicals’ David Vermylen).
SWIFT promises that the BPO will give easier access to risk mitigation around pre and post-shipment finance. It allows sellers to electronically send trade documentation to their buyers and exchange the documentation data with both obligor and recipient banks. This enables them to get involved earlier facilitating payment as soon as the buyer raises the purchase order (PO), not delaying until the invoice has been approved as is the case with LCs. The four-party approach also means suppliers can use their own local bank rather than the buyers’ banks (as would be the case in the traditional SCF programme), removing Know Your Customer (KYC) from the process and potentially lowering on-boarding costs.
“Asia is the centre of global trade growth and as the supply chain space evolves, more corporates will be looking towards open account and supply chain solutions,” says Vinod Madhavan, Standard Chartered’s Global Head, Local Corporate Products and Receivables and SCF. “Our expectation is that many corporates will now start using BPO to free up their working capital.”
Whilst treasurers know that freeing up working capital is beneficial, an increasing number of large corporates are aware that doing it by extending days sales outstanding (DSO) too far can harm their suppliers – as such SCF is gaining traction. The two case studies illustrate different ways in which it can be approached.
Stanley Black & Decker (SBD), a global supplier of tools, hardware, appliances and security systems for industrial and consumer use, has an inclusive approach to improving its working capital management including supplier finance. Yannick Croiger, Director of Financial Risk Management and Corporate Finance, explains that since 2007 the company’s primary focus has been the implementation of the group-wide Stanley Fulfilment System (SFS), covering the central management of inventory, accounts payable (AP) and receivable (AR). The system is based on a number of common platforms including SAP, Hyperion, Navision, JDA, Red Prairie, Demand Solution, Share Point Server, Business Objects and Citi’s Supplier Finance platform.
The problem with working capital, Croiger notes, is that it is cash that is locked up in operating the company from day-to-day and as such it is preferable to have as little as possible in this state; it is money that could be used for more accretive purposes. Decreasing inventory, collecting payables sooner and working out how to pay suppliers later without damaging them is the goal. “The concept is extremely easy to understand. Implementation on the other hand requires effort and discipline.”
What SBD is creating (it has been an ongoing project since 2007) is a methodical, process-based approach to supplier finance and working capital that provides a “user friendly, automated and error-proof customer experience, from intent-to-purchase to shipping and billing to payment”. From a group perspective it has become a “critical business process that keeps supply and demand in balance”.
Kicking off a project of this nature will require senior management buy-in and it is also essential to communicate a policy on minimum terms and to enforce this policy right from the start. The centralisation of the project team at corporate level helped SBD leverage the knowledge and experience of cross-functional teams drawn from treasury, global sales and marketing, IT and accounting departments.
In practice, SBD’s suppliers follow existing protocol for submitting and processing invoices but, for those within the scheme, twice a week SBD will upload payment files (which include invoice-level details based on established terms between SBD and the relevant suppliers) to Citi’s web-based Supplier Finance platform. Suppliers are then notified of the due payment of their approved invoices via email. They may then log into the system and elect to discount some, all or none of these. Having done so they will typically receive funds (less the discount) on the next working day, with SBD paying Citi in full on the invoice due date, according to the agreed terms.
Entities (and thus their suppliers) within SBD that wish to join the scheme are prioritised around considerations of jurisdiction, currency and internal credit capacity as well as practical matters such as connectivity with the ERP. Croiger says it now takes between three to six months to admit a new company member. This allows the team to assess the most suitable supplier candidates, the preparation of legal documentation, any IT work and of course for the procurement team to introduce the Citi Supplier Finance concept to their suppliers.
For SBD, its efforts and actions have resulted in outperformance of its industry peers in terms of working capital reduction despite continued growth through acquisition. Croiger feels that the process may have initially “caused headwinds” but ultimately it has provided opportunities; SBD has seen a working capital reduction in the last 12 years of over $450m. However, he is adamant that the kind of discounting alternative the company has used “should be used to supplement good operating procedures, not to mask poor or lagging performance”. Indeed, Croiger warns anyone considering this model to first establish rigorous operating processes, especially as it requires the business to strive for automation and the leverage of common platforms where possible. As well as ensuring the structure is as scalable as possible, he advises companies to invest time and money automating as much as possible up front, “even if the implementation takes longer”.