Category Archives: Economics

The Death of Factoring Will Be Highly Exaggerated

Last Friday, Spend Matters published a great Friday rant by the prophet aptly titled Die Factoring, Die! because Factoring can be the death of many an uninformed supplier who, like desperate individuals, take out payday loans to pay off payday loans at insanely compounding interest rates until they go bankrupt.

Factoring should die. It is no longer needed, but the doctor fears just like the pulp industry has survived for over a century when it should have died out long ago, it will still be around a century later. Just like the pulp industry had the perfect environment to grow until it was big and powerful enough to effectively outlaw the competition, the factoring industry has the same perfect environment to grow and crush the better options.

Before we explain, we’ll point out that just like there is a better alternative to factoring, as the prophet pointed out in his post, there is a better alternative to wood-based paper. In particular, the alternative that was around before the wood-based paper craze: hemp. Whereas hardwood trees take decades to mature, hemp can be grown and harvested in a single growing season. It’s the number one biomass producer on the planet (10 tons per acre in 4 months) and contains 77% cellulose (needed for paper) compared to the average tree at 30%. It’s stronger, the paper lasts centuries longer, does not require any bleaching, and the production requires significantly less water and energy than paper production from trees. (The pulp and paper industry uses more water to produce one ton of product than any other industry and is the fifth largest consumer of energy on the planet.) Hemp for paper is many order of magnitudes better, but since hemp (which contains, on average, 1/5 to 1/10th the THC of cannabis) was made illegal with the delegalization of THC in North America, it’s not an option.

This was possible because the pulp and paper industry was rich and powerful enough to lobby for the delegalization across the board, vs. just the delegalization of cannabis. They got that way because, during the start of the industrial revolution, when paper was needed en-masse to “power” back offices, North America was filled with old hardwood forests and there was not much hemp, as hemp was native to Central and South America. The population was much smaller than it is now, the possibility of deforestation was not even considered (as manual logging could only go so fast), and the technology to produce paper from pulp was understood and easy (at the time). And it could meet demand fast — logging could happen year round whereas hemp could only be harvested once a year in many of the central and northern parts of the US. So it became the defacto paper producing industry, and since everyone needed paper, it obtained a monopoly. And since no one knew better, or was even allowed to learn of a better way, the monopoly persists until this day.

Similarly, the factoring industry has obtained a monopoly on what is effectively “payday lending” to suppliers that need money now, can’t get it from the bank, and don’t want to beg the local “godfather” for a loan (at interest rates that put even North American credit card companies to shame, with default penalties much worse than repossession). How did it get like this? First of all, there have been no other viable options for many of these suppliers (as not all suppliers are lucky enough to get buyers that will offer the [slightly] better alternative of early payment discounting, as not all buyers can afford that). Secondly, growth demands working capital, and the capital has to come from wherever it can, and if you are a supplier in an emerging or tight market, it’s often factoring or death. Thirdly, the banks stayed out of it for too long, allowing the industry to grow and cement on its own, and now that it is “proven”, the banks have been drawn to it like moths to a flame, and they control the global cash flow.

So as long as it is effectively a cash cow, which it is as it is a slow cash drain (death) for most suppliers (meaning that you’ll acquire and keep more customers in a year than you bankrupt), more suppliers need it everyday (as they try to stay in business when times become troubled or they try to grow faster than they can afford), and it’s relatively low risk compared to other types of lending, it’s going to continue to gain support and traction from the lenders, who are going to do their best to present it as the only option available. And some suppliers will believe, lock-in, and get trapped in the factor cycle, factoring more and more invoices over time until every invoice needs to be factored as soon as it is issued just so the supplier can make payroll.

So even though modern platforms, backed by “big data” (even though the data doesn’t have to be all that “big” to adequately calculate risk and buyer payment time-frames), and enabled by networks (that give the supplier dozens or hundreds of options including half a dozen or dozens of better ones), could provide better options, the doctor just doesn’t see it happening any time soon. We’ve known since 2000 that multi-line item optimization can save an organization 10% or more on just about every sourcing event (and since Aberdeen’s advanced sourcing study in 2005 that it will save an organization an average of 12% across all categories) and still less than 10% of organizations using strategic sourcing platforms are effectively employing it — even though modern optimization-backed sourcing platforms make it easy enough for even junior buyers to use it self-serve and run basic models and identify considerable savings without expert support. (Not always the full 10% to 12%, but enough savings to justify its use on each and every event!) Factoring is finance, and banks have made finance unnecessarily complicated to maintain the monopoly. So it’s here to stay. And when big data and networks enter the picture, you can bet it will be the factorers, and not the factorees, that gain.

It’s sad, but for now — and the foreseeable future, it’s true.

Societal Damnation 41: Fraud & Corruption

As per our damnation post last year, fraud and corruption is everywhere and running havoc on your organization and your supply chain. A recent Kroll Global Fraud Report in late 2013 found that 70% of companies were affected by fraud in the prior 12 months, which represented an increase of 15% over the previous twelve months. In other words, at the time, 7 in 10 companies were hit by fraud in the previous year. But it gets worse. The Economist at the same time also found that fraud was on the rise and predicted that it would continue to rise. If the rate of increase remained steady, then 4 of 5 businesses got hit with fraud last year and 9 out of 10 business will get hit with fraud this year. Yowzers!

Procurement fraud can be particularly costly and damaging regardless of if you are in the public sector or the private sector. The UK public sector estimated that fraudulent purchasing on an annual basis cost it £ 2.3 Billion in 2012! Zoinks! And while it’s harder to find good numbers for the US, a 2011 report by Computer Evidence Specialists found that Fraud cost the US $1.32 Trillion in 2010, of which 733 Billion was Corporate (with 68% committed by corporations and 32% committed by employees). Hamana! Hamana!

If you are a large organization, whether you want to admit or not, there is a small percentage of employees, suppliers, and customers that are looking to rip you off for as much as they think they can get. Every day of the week, including Sunday. Not everyone, not by a longshot, but enough people to make your job miserable.

So what can you do? As per our damnation post, a good start is to

  • have an invoice policy that is strictly followed that only accepts invoices from approved suppliers, only for approved goods or received services, and only at contracted or publicly advertised rates
  • have strict spending limits and controls that enforce them which ensure that only people with authority can grant approvals for bypass, and that such approval is clearly logged in an auditable fashion
  • careful inspections of all goods received to make sure the organization gets what was ordered and what is paid for

But that’s just a start. The organization should also:

  • analyze all invoices or expenses without a PO very carefully to ensure they are not duplicate, that the goods or services were received, and that the prices billed are the prices the organization committed to pay
  • have strict policies on who is allowed to buy and what they can buy and have a policy that repeated or serious offences can, and will, result in immediate dismissal
  • have a standard contract rider that no invoices for off-contract goods or services will be accepted without a PO that all contracted suppliers must sign, as this will severely limit how many unexpected invoices show up
  • use data mining and machine learning to identify potential fraud as the same receipt submitted 3 times two months apart, or patterns of the same no-receipt charges, or duplicate billings for the same service months apart will be immediately identified as suspect, for example
  • keep up on fraudulent statistics and schemes and identify methods to enable the quick identification thereof before new fraud methods and attempts cost the organization too much money

But whatever you do, don’t target employees and treat them like criminals. If you treat them like criminals, they will become criminals. Create good procedures and processes for invoices and payments, install solutions where it is easier to follow the procedures and processes than ignore them, and make it about cost control, not fraud prevention, and you’ll find that fraud just isn’t as much of a concern. (Fraudsters choose easy targets.)

Economic Sustentation 05: Currency Conservation

As we have previously indicated, there is no salvation, at least not now. It’s only going to get hotter, and the best you can do for now is survive. But survival will be easier if you know what to do, or at least know what you might try, so, in this post, and the posts that follow in this series, we will present some of the options at your disposal, starting with currency (conservation).

So how can you protect against the currency fluctuations that can cause you significant economic damnation?

As indicated in our original damnation post, one preventative measure you can take is to determine the Purchasing Power Parity (PPP) of a currency to determine whether it is undervalued, and likely to rise, or overvalued, and likely to fall, and base your total cost of ownership models not on the current value against your base currency but the expected (average) value over the course of the contract.

But of course, this is not enough to predict every fluctuation in currency as some currencies rise and fall as the result of significant investment being pushed into a country (because of low wages, energy costs, etc.), being pulled out (because of new, burdensome, tax laws, etc.), or political actions that cause boycotts of goods from a certain country, or even trade embargoes. The latter situations can cause currencies to rapidly rise or fall seemingly overnight. So what can you do?

First, whenever possible, try to buy in the standard, or preferred, currency of the organization, and, in particular, the currency that most of the customers are paying in. If the organization is being paid in US dollars, then it should, whenever possible, try to buy in US dollars. This even eliminates (potentially costly) exchange fees from the picture.

Second, if this is not possible, because demand exceeds supply and the supplier has more negotiating leverage or the customers are buying in a currency that is not the preferred currency of the organization going forward, try to negotiate discounts as a result of currency strength increases against a major currency or gold. If the supplier suddenly has considerably more buying power from their dollar and their customers have considerably less, then it might be in the best interest of the supplier, especially if it is producing its goods from raw materials bought in a different market using a weaker currency, to pass on a bit of savings to its customers that might otherwise have to default on a contract or risk bankruptcy otherwise. It won’t always be possible, but if your organization is a major customer whose absence would be felt financially by the supplier, it’s worth a try.

Third, if you have to deal with multiple currencies, keep investments in multiple currencies so that trades can be made at strategic times to allow the profits in the currency trades to cover the increased costs of an unexpected rise in the currency required to pay a supplier. While the currency markets aren’t a zero sum game, generally speaking, value lost in one market always appears in another. And while SI realizes that, in the eyes of an economist this is a gross simplification, economics and trade works because, at any one time, there is a fixed amount of GDP in the world and a fixed value of a currency related to that GDP. Thus, at any point in time, value is conserved just like energy is conserved in our universe under thermodynamic laws.

There’s no silver bullet, but there’s enough lead that, if properly sprayed, will get the job done.

Economic Damnation 04: Gen X, Gen Y, and Gen Z

Why are:

  • Generation X, the generation born between the early 1960s and the early 1980s,
  • Generation Y, the generation born between the early 1980s and the early 2000s, and the
  • Generation Z, the generation born between the early 2000s and the present day

An economic damnation? As will be discussed in detail in societal damnation 50 on talent, talent is required to keep your supply chains moving. People are required to enter the data to keep the information chain moving, to move the money to keep the financial chain moving, and to move the goods that keep the physical chain moving.

The majority of this talent is a workforce between the ages of 20 and 55, who will have been born between 1960 and 1995, and will thus be primarily composed of Generation X and the Generation Y Millennials, and as Generation X begins to retire en-masse, Generation Z will begin to enter the workforce in a few more years.

As a result, not only is talent a damnation, but it’s a damnation that comes in three different flavours.

Generation X

Generation X wants stability. They are at least half way through their career, if not nearing the end, and they are looking for their last (long-term) full-time gig that will give them fair pay, a great pension / 401 K / RRSP, flexible hours to help manage their children’s, or grandchildren’s, schedules, time-off to help good causes and volunteer in the community, good healthcare and wellness programs (as they aren’t getting any younger), and career development — as they have been out of school for (quite) a while and need help keeping up with new skills and work requirements.

Generation Y

They are looking for unique opportunities (such as overseas assignments, travel-intensive positions, or opportunities to work with cutting edge technology or developments, even if they might not succeed), work-life balance (as they are very active), social responsibility (as they care about working for an employer that cares about the environment and humanity beyond their local community more than previous generations), modern technology (as they grew up with technology), and mentoring (as they want to learn how to succeed and thrive in the real-world).

Generation Z

The beginnings of generation Z are just beginning high-school. And whereas Generation Y grew up in the information age, where technology was becoming more ubiquitous by the day, Generation Z grew up in the communication age where not only was technology becoming ubiquitous, but communication technology was becoming ubiquitous and just about every Gen Z is growing up with a smartphone where they can call, text, and e-mail 24/7. While we don’t know what they will want from a job perspective, we do know that they will want to be connected to their friends and colleagues 24/7 so any company that has not entered the communication age will not be able to recruit this coming generation.

In other words, every generation wants something different from the workplace and gone are the days when all it took to get an employee was job security, a fair pay check and some health benefits. Today, that’s the entrance fee to join the employer’s club. If you want talent, that costs more. Much more.

Procurement Trend 05. Return to Regional and Local Sourcing

Just two very trying anti-trends remain. We’re one post away from fearlessly finishing our formidable burden, but the sour taste in our mouths still remains as we must continue to provide those factually-challenged futurists with counter-examples to the trends of their forerunners who saw this coming a decade ago. (Check the very early SI archives if you don’t believe me. Go ahead. Check. This post will still be here.) We want to abash them for their apathy, but we will leave their hard-earned humiliation for LOLCat, who wants to point out to these Rip van Winkles that when it comes to sleeping through life, No One Out-sleeps a Cat!

So why do these garbage hauling patrons of Quark keep pushing us trends from their flights of fantasy? Besides the fact that some of them obviously spent the best part of last decade hauling garbage, it’s probably because they look around, see the laggard organizations still struggling with the insourcing/outsourcing balance, and assume they can still sell last decade’s leftover snake oil in today’s marketplace. Thus, if most organizations are losing hand over fist in their outsourcing arrangements, maybe it’s time to pull them back, especially if

  • energy, and thus transportation, costs are going higher and higher
    and since oil, natural gas, and coal reserves ARE limited, and the dwindling supplies that remain are getting harder to extract, cost have nowhere to go but up, up, and away
  • labour costs are rising in emerging and emergent markets
    and the faster they emerge, the faster labour costs increase
  • nearby markets have low transportation costs and high automation can
    contain labour costs

    since the shorter the distance, the less energy required to cover the distance; plus, intelligent automation decreases the amount of manual labour required to product any product

So what does this mean?

Understand the Total Cost of Outsourcing

Remember, it’s not just landed cost (unit cost and transportation cost), it’s also import/export costs, communication and remote management costs, on-site visits, liability costs, return costs, and other related costs. If many of these costs are rising, then outsourcing is probably not the right idea. If only one or two of these costs are rising then it depends how much, and how fast, and what the alternatives are.

Understand the True Opportunity in Near-sourcing / Insourcing

Near-sourcing will have many of the same costs, but transportation, remote management, and return costs will often be lower. Plus, if you pick/invest in a more advanced plant with newer automation technology, the higher labour costs are probably negated by the lower overhead costs, and the opportunity costs that are often lost waiting for delayed shipments, prototypes to land in your hands for testing, and emergency issue-resolution sessions (across time-zones 8 to 12 hours apart) are often minimized as well. However, a lack of automation can result in significantly higher labour costs, a lack of appropriate trade agreements with respect to the products being purchases can result in higher import or export fees, and energy costs could be higher as well (if renewables don’t enter the equation). The whole cost model has to be evaluated (and compared to the whole cost model associated with outsourcing).

And make a decision based upon true (future) costs

One should never make an insourcing, near-sourcing, or outsourcing decision on today’s costs – make it on expected costs over the next five years. Use the market data that you are collecting for market trend analysis and predictive analytics to figure out what the costs are going to be over the next five years and then choose the optimal production strategy based upon the amortized five-year cost. Consider the hard and soft costs associated with relocating production and/or services, making a change for a very short term gain will not result in any savings being realized. Do the math and make the right choice.