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N o . 17 8 O c t o b e r 2 0 0 9
SUPPLY CHAIN FINANCE – WHAT’S IT WORTH?
Supply Chain Finance (SCF) represents
companies
an innovative opportunity to reduce
standards and collecting and paying
sticking
to
industry
working
underlying
invoices after 30 or 45 days. Also,
mechanism is reverse factoring making
most continue to keep suppliers
the
capital.
Its
than
at arm’s length. One executive we
supplier-centric. Implementing SCF is a
recently interviewed described his
difficult and time-consuming task that
company’s approach to negotiating
requires top management attention.
payment terms as a “no tolerance”
Yet, it promises significant savings. Our
strategy.
technique
buyer-
rather
survey results show that, on average,
companies reduce working capital by
In the past, suppliers often reacted
13% and suppliers reduce working
to these long payment delays by
capital by 14%. Three factors differentiate
factoring
successful implementations of SCF
they needed cash. Factoring is a
from less successful ones: Choosing
transaction in which suppliers sell
the right banking partner, ensuring CEO
receivables to factors for immediate
sponsorship, and involving at least 60%
cash. Because the receivables are
of the supply-base.
sold rather than pledged, factoring
their
receivables
Ralf W. Seifert
IMD Professor of
Operations Management
when
1
is different from borrowing – there
Working capital reduction is not
are no liabilities on the suppliers’
exactly the new kid on the block:
balance sheet. Typically, suppliers
Business
sell receivables from more than one
press
articles
have
2
heralded its benefits for nearly two
buyer. Thus, factors have to evaluate Daniel Seifert
decades; it has been explored in
detail in scientific journals for about a
buyer portfolios before entering an Ecole Polytechnique
agreement. This has made factoring Fédérale de Lausanne
century; and numerous conferences
an expensive source of finance in
unite practitioners to discuss best
emerging markets. A lack of historic
practices every year. But, for some
credit information or credit bureaus,
companies, the topic has recently
fraud, and weak legal environments
moved to the top of the agenda. With
have meant high operating costs.
Research Assistant,
banks less willing to hand out loans,
companies are finding it difficult to
Today some buyers are recognizing
maneuver.
their
suppliers’
difficulties
in
accessing finance. And instead of
Despite the longstanding attention
taking a “no tolerance” approach,
to reducing working capital, the only
they have started to implement
component that has dropped over
a collaborative approach termed
the years is inventory – representing
Reverse Factoring or Supply Chain
a mere 30% of total working capital.
Finance. This technique’s underlying
Collection and payment delays have
mechanism is factoring. There are,
remained largely flat with most
however, three important differences.
First, since the technique is buyer-centric,
factors do not have to evaluate heterogeneous
The advantages of this technique are clear.
buyer portfolios and can charge lower fees.
Truck maker Scania, for example, helped its
Second,
usually
suppliers finance growth when demand surged
investment grade companies, factors carry
in 2006. Magnus Welander, Head of Cash
less risk and can charge lower interest rates.
Management, explains: “Our suppliers had
Third, as the buyers participate actively, factors
difficulties financing the increased demand. The
obtain better information and can release funds
situation was especially tense because Scania
earlier.
didn’t encourage traditional factoring. The
since
these
buyers
are
implementation helped them – especially the
smaller ones – to enjoy unprecedented liquidity
Buyer issues purchase orders to supplier and bank
1
levels. Now, they sometimes receive payment
3 Citibank checks
documents and
notifies buyer
Supplier delivers 2
goods and presents documents
after as little as five days.”
Yet, the technique is far from being a main-
4
Buyer
accepts
stream phenomenon. Some companies have
Citibank
5
hesitated to adopt SCF because it is unclear
how much buyers and suppliers really save.
Citibank advises acceptance
Innovators treat their figures confidentially
or report numbers that are hard to compare.
7 Citibank debits buyer at due date
Electronic
platform
Additionally, it has not always proved to be a fail-
6 Supplier requests early payment
safe solution – stories about companies where
the implementation of SCF has failed have been
Figure 1 – Example of an SCF process: Citibank
making the rounds leaving other firms in the
dark as to what it takes to succeed.
As a process, SCF is slightly more complicated
than factoring. Citibank’s process, for example,
Therefore, in collaboration with Springer’s
involves seven steps. First, the buyer sends
Supply Chain Magazine and IMD, we conducted
a purchase order to the supplier and notifies
a worldwide survey of executives who use
Citibank. Second, the supplier delivers and
SCF solutions as buyers. How much were
presents documents to Citibank. Third, Citibank
they able to reduce their working capital?
checks the documents and notifies the buyer.
Which approaches to implementing SCF made
Fourth, the buyer approves or rejects. Fifth,
most sense? The survey’s aim was to assess
Citibank notifies the supplier of the buyer’s
the benefits of SCF, both quantitatively and
acceptance. Sixth, if the supplier requests early
qualitatively, and to statistically derive the key
payment, Citibank credits the supplier’s account.
success factors. We received 213 replies from
Finally, when the invoice is due, Citibank debits
executives in 55 countries, covering all major
the buyer’s account (Figure 1).
industries. Of the respondents, 23 reported
using an SCF solution. The following analyses
Buyers
Suppliers
0 – 10%
11
11 – 20%
9
21 – 30%
31 – 40%
More than 40%
are based on their answers.
10
6
1
6
0
average reduction in working capital of 13%
0
ø13%
Our data paint a fairly positive picture: The
23 executives using an SCF solution report an
1
2
Are SCF programs worth their money?
ø14%
Respondents using SCF solutions, n = 23
Figure 2 – How much has the Supply Chain Finance solution decreased your working capital/your suppliers’
working capital?
(Figure 2). Based on average assets of around
€8.5 billion, an assumed working capital ratio
of 30%, and an average cost of capital of 5%,
these reductions represent annual savings
of around €16 million (Figure 3). This amount
SUPPLY CHAIN FINANCE – WHAT’S IT WORTH?
compares with an investment of € 0.1-1.5
million in information technology as suggested
by the Aberdeen Group in their Technology
Platforms for Supply Chain Finance report.
3
Even if the savings are lower than suggested
by the above business case, the program should
still break even in less than a year.
Similarly encouraging is the observation that
SCF seems to help suppliers too. The same
23 executives report that, on average, their
suppliers were able to reduce working capital
Smallest risk
premium: 0%
Average risk
premium: 2%
Largest risk
premium: 9%
Assets
8,531.0
8,531.0
8,531.0
Working capital
2,559.3
2,559.3
2,559.3
332.7
332.7
332.7
10.0
16.4
39.9
Assumptions
• Working
capital over
assets: 30%
• Working capital reduction
due to SCF:
13%
• Risk free
rate: 3%
Working capital reduction
Annual cost savings
Averages of 23 companies using SCF solution, € million
Figure 3 – Supply Chain Finance – Business Case
by 14% by participating in the SCF program.
Second, roughly half of these respondents –
Asked about intangible benefits, more than
52% – say that internal sponsorship plays an
half of the respondents – 57% – say that SCF
important role. Consistently, our regressions
helps standardize payment terms and 52%
found implementations to be more than twice
say that SCF helps improve supplier relations
as successful when the CEO rather than the
(Figure 4). Asked how SCF links back to other
CFO leads them. The message is clear –
projects, 68% say that its implementation
although it might be tempting to delegate, CEOs
improves Purchase-to-Pay processes, 14% say
should personally lead the effort. Individual
that it improves Order-to-Cash processes, and
departments do not seem to have the required
another 14% say that it improves Record-to-
leverage to keep the stakeholders – especially
Report processes. Intangible benefits attributed
suppliers – at the table.
to suppliers include more transparency and
fewer disputes (65% and 52% respectively of
these respondents). Finally, executives seem
to perceive the drawbacks as limited: 30%
perceive no drawbacks at all. Of the rest, 44%
report reduced credit availability, 31% report
pressure to guarantee payments, and 25%
Standardization of payment terms
Improvement of supplier relations
Information gain about suppliers' finances
Given the wide range of outcomes, it is
None
the way businesses implement SCF. What
distinguishes
a
successful
from
a
less
successful implementation? Our data reveal
three key success factors.
52%
Reduction of prices
report other drawbacks.
legitimate to ask if there are differences in
57%
26%
17%
9%
Other
4%
Percent of respondents using SCF solutions, n = 23
Figure 4 – What other benefits has your company experienced?
First, the majority of executives – 65% – say
that the banking partner is a key success
factor (Figure 5). We tested this assertion
by regressing working capital reduction on
banking relationship strength and found this
factor to be positively related at a statistically
highly significant level. Thus, executives should
Banking partner
65%
Internal sponsorship
52%
Other (mostly supplier involvement)
17%
IT implementing partner
13%
invest sufficient time into selecting a banking
partner. Important criteria that we determined
during in-depth follow-up interviews included
the bank’s geographic reach, its legal expertise
and its financial muscle.
Technology platform
0%
Percent of respondents using SCF solutions, n = 23
Figure 5 – What were key success factors in implementing the Supply Chain Finance solution?
Finally, some executives – 17% – stress the
This finding is consistent across different life
need for supplier involvement. Our in-depth
cycle stages, i.e., implementation and operation.
suggest
that
companies
face
difficulties in convincing suppliers to participate
Given the attractive benefits and the clear key
in SCF programs. One executive reported that
success factors, we recommend executives
suppliers would rather accept late payment
take a closer look at SCF. It will not solve the
than be involved in a seemingly complicated
liquidity issues that some companies will face
program
understand.
over the next months. But it seems a sustainable
Executives should, therefore, critically assess
approach to reducing working capital in the long
which suppliers to include in the first wave
run. As our analysis suggests, there are three
and which ones to include in the final rollout.
key success factors that companies should
Our tests suggest that implementations are
focus on: Choosing the right banking partner,
most successful when they include at least 60%
ensuring CEO sponsorship, and involving at
of the supply-base in the first wave.
least 60% of the supply-base.
Contrary to our expectations, cross-functional
Admittedly, getting these three factors right is
teams do not appear to play a role. At least
a difficult and time-consuming task and is one
statistically, it does not matter which or how
of the reasons that companies have been slow
many departments a company involves. The
to adopt the technique. But persevere and the
most successful implementations involve five
payoffs, in terms of working capital reduction,
departments (Finance, Purchasing, Supply Chain
will be worth working for. So while it may no
Management, IT, Legal), but implementations
longer be the new kid on the block, it seems
that involve only two departments (Finance,
working capital reduction will continue to create
Purchasing) closely track their performance.
a buzz for some time to come.
that
they
did
not
1. Some suppliers employ early payment discounts instead
of factoring. Early payment discounts, however, are a
far more expensive source of finance. The most common
discount scheme (2/10 net 30) implies an annual
interest rate of over 43% whereas factoring commonly
entails an annual interest rate of 6%.
2. There are, however, variants. Recourse factoring, for
example, creates a liability that is contingent upon the
We recommend
executives take a closer
look at SCF.
buyer’s payment. For further information see Klapper,
L. (2005). The Role of “Reverse Factoring” in Supplier
Financing of Small and Medium Sized Enterprises.
Working Paper, The World Bank, 2005.
3. Aberdeen Group (2007). Technology Platforms for Supply
Chain Finance. Aberdeen Group, Inc., Boston, MA, March
2007.
IMD is ranked first in executive education outside the US and second worldwide (Financial
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