Supply Chain Finance : You Have To Get It Right

Aberdeen and Hackett are right – Supply Chain Finance is important – and poor supply chain finance can trap millions, tens of millions, and, if the organization is large enough, hundreds of millions of dollars in the supply chain. However, the only way to free up that money is to get it right – and that doesn’t necessarily mean following someone else’s lead. A lot of the initial strategies that have been devised to free up cash are not strategies for success – but strategies for dismal failure in the long run.

And, even worse, a lot of articles, including Where’s The Money? It’s Trapped In Your Supply Chain, which I recently discovered over on Supply Chain Brain, don’t distinguish between the good strategies and the bad strategies. This article in particular mixes recommendations for better handling of payables, early payment discounts, extending days payable outstanding, inventory reduction, better handling of receivables, better supplier management, deployment of EIPP, better collaboration, closer cooperation with finance, VMI, consigned inventories, transit time reduction, global inventory leverage, and activity-based management, and network optimization as if they’re all good and equal – sometimes mixing recommendations for multiple options in the same sentence – when in fact some are quite good, some make little difference, and some have the potential to be disastrous to your supply chain.

Only six of these – better handling of payables, inventory reduction, better handling of receivables, better collaboration with finance, transit time reduction, and network optimization – are guaranteed to always be good if done right. Seven of these – early payment discounts, better supplier management, deployment of EIPP, better collaboration, VMI, global inventory leverage, activity base management – can be good if done right, but can be done perfect and have little effect. This leaves extending days payable outstanding and consigned inventory, two options that are generally bad decisions.

Let’s start with the good. Better handling of payables and better handling of receivables are obviously good – since they deal with the movement of cash, but as suggestions, they aren’t very helpful. How do you handle payables better? How do you handle receivables better? In the latter case, you keep track of who owes you what, when, and make sure to follow up if the payment doesn’t show up when expected. In the former case, well, that’s really a large part of what supply chain finance is all about. The most common recommendations are early payment discounts and extending days payable outstanding, but the first has to be done right to be good and the second is rarely the right decision, unless you have the habit of paying for goods before they are received.

Inventory reduction is always positive, since it costs you money to hold goods in inventory. And if the goods take up a lot of room, or have a high value and require a lot of security, a large amount of inventory can be very costly. Similarly, transit time reduction within a given carrier mode can save money since each day a good is on the truck, or ocean freight liner, adds cost. (Transit time reduction does not imply switching carrier modes as this can raise costs. It means optimizing routes and handoffs within a mode to reduce overall costs.) Collaboration with finance is probably the best thing supply chain can do. Supply chain needs to understand how much each potential buy can cost from a TCO perspective, and this includes taxes, VAT rebates, potential rebates for dealing with MWBE suppliers, and other costs only finance will have a good handle on. Furthermore, finance cannot optimize use of working capital if it doesn’t understand what commitments are outstanding. Finally, network optimization can be effective as this can lead to reduced inventory, shorter transit times, and a better understanding of costs and working capital needs. But it’s not easy – and will require some good optimization tools and a good knowledge of network planning. (In other words, it’s something that should be left to the experts and not the low-hanging fruit you should start with to see some early successes and gain support for your initiatives.)

This brings us to the middle ground where the strategy can be good, or even very good, if effectively employed or of almost no benefit at all if not employed judiciously. Early payment discounts often make a lot of sense, especially when compared to the shortsighted strategy of extending days payable outstanding, but this is only true if the supplier is not forced to take the discount and if the discount amount is more attractive from a suppliers total cost of operation when compared with the costs the supplier would incur from borrowing working capital. Better supplier management is always a positive from a supply chain perspective, but this doesn’t mean that the supplier will be capable of reducing costs. This tactic is very situation dependent.

Deployment of an e-Procurement solution will usually help in terms of speeding up invoice processing and increasing supply chain visibility, but unless checks and balances are put in place to make sure invoiced amounts equal contracted rates and that payments are made at appropriate times, it’s not guaranteed to be a win. Better collaboration always helps, but like supplier collaboration, is not guaranteed to reduce costs or free up working capital. Sometimes, all it does is improve quality and reliability.

VMI can be a good call if the vendor can manage your inventory better, but if the vendor is not experienced in 3rd party inventory management, this can actually end up costing you. Global inventory leverage sounds great, but not all banks will be willing to lend against inventory in countries they do not operate in – you’ll generally have to get a 3rd party financing solution to buy in. Finally, activity based management is good in that it helps you identify the costs corresponding to a process – but your supply chain is more than a collection of activities, so you really have to understand where this fits, and where this does not, to get any benefit out of it.

This brings us to the bad. Let’s start with consigned inventory. All this does is pass the costs on to your supply partner, who might not be in your financial position. This will force them to take out more loans, at higher rates, which will only increase their total cost of operation and, thus, the total cost per unit they have to charge you in the future in order to be sustainable. Then there’s extending days payable outstanding, which like consigned inventory, simply passes operating cost onto your supplier. But it’s even worse – because now the supplier doesn’t even have any inventory to leverage in negotiation for that working capital loan! As a result, they might be forced to take out loans at 20% to 40% interest just to pay their employees, while you fret about only making 2% in your money market investments and only having 500M in your bank account. What do you think that’s doing to do to your cost when the contract comes up for renewal, provided the supplier is still in business and willing to have you as a customer? Extending days outstanding to 60, 90, or even 120 days might make short-sighted wall-street happy, but all it’s going to do is hurt you in the long run. Winners don’t follow the market, they lead it. So do the right thing and pay your suppliers promptly, just like you expect your customers to pay you promptly.

Furthermore, if you really want to get a good handle on what Supply Chain Finance really is, what strategies you should be considering and, more importantly, what strategies you should not, start with the wiki-paper A Supply Chain Finance Primer over on the e-Sourcing Wiki. I think it will be worth your time.