Category Archives: Finance

Why Do Suppliers Get Screwed?

In our recent series, we noted that Supplier Pre-Payment where pre-payment is made within the supply chain is an advanced concept and not one even most of the Supply Chain Leaders are doing … even though it’s so simple that anyone can do it. Instead, what usually happens, is suppliers get their payment delayed months and months and months when they should be paid promptly so that, they too, can pay their suppliers promptly. In effect, they get screwed, and their suppliers get screwed.

And it’s a question that we struggle with when the answer is so obvious. But I know the answer, and I’m going to tell you.

It’s because Finance Forerunners are Fools!

Let me be clear that I do not mean that all people in Finance are fools – as many of today’s analysts have PhDs and build financial models that would make the doctor proud if he were still teaching and his students built such in-depth models in an attempt to understand the business world that supply chain lives in. These people are not fools — they are investigators with intuition who could help companies make better decisions. Nor do I mean that their bosses, typically without their education or their brains, are fools. Most people who make CFO are, even if their view of the world is limited and skewed, reasonably intelligent and capable of doing math and logic, which less than 1 in 7 adults in America are capable of doing.

No, it is the people who run the financial world, set the financial and accounting standards, and teach it in Universities who are fools.

Why? Because the way they define the operating cycle, financial net obligations, and cost of capital is stupid. Very stupid.

Why? Because, in the financial world, including the world of CFA (Chartered Financial Analyst), working capital management theory (as per a recent textbook by prominent finance authorities), and, most importantly, accounting standards, the operating cycle does NOT contain “pay suppliers” (that is cash conversion, a secondary requirement of finance), financial net obligation is defined as a fixed amount at a fixed date as per invoice terms (and not the variable function it really is), and the cost of capital is not only not fixed per opportunity (as finance would have you believe), but changes greatly depending not only on payment terms, but payment windows and supplier cost of capital (as defined as their supply chain). Moreover, all the standard financial calculations, metrics, and analysis is internal to the firm or on the firm against the market, nothing looks at the contributing factors within the supply chain.

While I understand that it historically had to be this way because

    1. definitions and metrics had to be uniform for reporting, comparison, and auditing,
    2. the data required was not always (readily) available,

and

    1. the calculations required for what is needed are intensive

…

we are now in a time where

    1. software can produce standard reports using standard analyses for tax authority reporting, comparison, and auditing while also doing variable types of WCM (working capital management) and what-if analysis in the same time frame,
    2. all of the market data can be available all of the time,

and

  1. the software does all the calculations in seconds no matter how complex you make them, the analyst just needs to define and analyze the right model.

So there is no longer any excuse for inferior definitions, models, calculations, and WCM decisions. Except for the ubiquitous excuse of “the financial authorities say this is good enough”. So we, as Supply Chain professionals, are going to not only have to learn to speak their language but teach them how to do their job.

How? You can start by perusing SI’s previous posts on the subject and then dive onto it’s upcoming series as well. Which will follow, or be part of, an expose on why Supply Chain Futurists are so foolish. (Which will take place once I manage to convince LOLCat to put down the shotgun … )

Risk Management and Suppliers: How Banks can Comply with the OCC’s Guidelines on Third-Party Relationships

Today’s guest post is from Rebecca Lorden, Business Development and Marketing Manager of Source One Management Services, LLC.

In October of 2013, the Office of the Comptroller of the Currency released specific guidelines to banks and federal savings associations that outline how their companies should assess and manage risks associated with third-party relationships. The OCC’s reason behind these guidelines was mainly due to the fact that “the quality of risk management over third-party relationships may not be keeping pace with the level of risk and complexity of these relationships“. (OCC Bulletin 2013-29, October 2013).

It is true that third-parties pose a threat if their own security protocols are not up to par with that of a major financial institution. In fact, in March of 2013, Bank of America became quite aware of this when they announced that a hack into TEKsystems, a third-party security firm they contracted, was the reason their internal emails were released to the public. These emails were no ordinary messages, but documented proof that Bank of America was monitoring hacktivist groups. Furthermore, the hacking group, known as Anonymous, later revealed that data was not retrieved from a traditional, time intensive and difficult hack, but “stored on a misconfigured server and basically open for grabs“. (“Bank Of America Says Data Breach Occurred At Third Party”, Computer World, February 2013). The scandal was not only damaging to Bank of America’s reputation, but also an obvious indication that banks needed to manage supplier risk more effectively.

The OCC’s guidelines outline eight key phases that should be considered when developing risk management processes. These phases include planning, third-party selection, contract negotiations, monitoring, termination, accountability, reporting and reviews. As clear as that might be, banks are still struggling on how to properly implement controls around these factors. That is where supplier relationship management can play a significant role.

Supplier relationship management, otherwise known as SRM, is the actual practice of strategic planning and managing all interactions with third-parties to maximize their value. Many think of SRM as a way to reduce spend. SRM processes can reduce quality issues and delays with suppliers that, in turn, can translate into cost savings. More importantly, however, SRM can function as a main component in reducing a bank’s risk with suppliers. Supply chain experts feel as though SRM offers a “solid framework” that can provide companies with a “formal risk and control process to follow“. (Building The Case For Supplier Relationship Management, May 2014).

For those that already have an SRM program in place, or believe SRM is just a sales tactic for supply chain consultants, now may be the time to reevaluate. First, suppliers can be neglected over the course of their contract. Even if the relationship started off on a good foot, the value from a supplier can diminish pretty quickly, especially if the supplier or the bank is faced with turnover or a redirection in initiatives. SRM dictates a process that continually communicates and supports the relationship, helping build supplier engagement no matter what changes are on the horizon. Secondly, for those non-believers, consider this: if managing suppliers is now a major priority set by the OCC, what better way to adhere to these guidelines than to build a solid foundation on which to base all third-party relationships on?

It certainly seems that these OCC guidelines are a daunting task for banks to tackle. Managing supplier risks and enforcing compliance is not something that can be done overnight. Banks, however, have a secure solution in supplier relationship management. SRM can be the catalyst to successful third-party relationship management, ensuring that the risks are minimized to the best of a bank’s ability.

Thanks, Rebecca.

The New Silk Road Might Be the Biggest Boon to Supply Chain Finance This Year

In yesterday’s post, we asked what impact will the new silk road have on global trade. Specifically, what impact will the new Russia, China, and Germany trade partnership have on global trade — besides simplifying and building Eurasian trade relationships.

One thing it will do is strengthen the resolve of these countries to not only de-couple their currency from the dollar and launch a new reserve currency backed by their union, but to trade in local currencies as well. As trading in local currencies becomes more and more common, banks will become more and more inclined, and even comfortable, to lend in foreign currency denominated debt as well as local currency. Private lending institutions will not only follow, but begin to lead the way.

This will be a great boon to foreign companies which, until now, have been limited to either borrowing from local lenders, at high interest rates, but in the local currency, or a handful of global lenders, at slightly lower interest rates, in a foreign currency, that could cause their debt to skyrocket if their currency weakens with respect to the foreign currency.

The whole point of Supply Chain Finance is to help the cash-strapped supplier. Early payment or dynamic discounting doesn’t help the supplier if the discounts are too high. Arranging for third party lenders to lend using your credit score, and not the suppliers, doesn’t help if the supplier has to take a risk in a foreign currency. And factoring isn’t a solution at all! (Since a third party will only buy your suppliers’ receivables if it can make money off of them — loan sharks at their finest.) Arranging for lending in your suppliers’ local currencies on your credit score when you can’t pay early is safest for your supplier and probably the best supply chain finance solution we’re going to see for a while.

Thoughts?

Is Supply Chain Finance the new Prisoner’s Dilemma?

In the classic logic problem known as the prisoner’s dilemma, there are two prisoners, being held on a minor charge (such as breaking and entering) which comes with a 1 year prison term, suspected of conspiring together to commit a serious crime (such as grand larceny). There is little actual evidence to convict either of them and the police are relying on a confession by one or both prisoners to convict at least one of them of the more serious crime. In an effort to get this confession, the two prisoners are separated and each is offered an identical deal. The deal is that if one prisoner confesses, he’ll be set free, instead of spending 1 year in jail, and the other prisoner will get a 3 year sentence. If neither prisoner confesses, they each do 1 year, and if both prisoners confess, they will both serve time, but only 2 years each for coming forth. What should the prisoners do?

When the dilemma is analyzed using game theory, each party is most likely to betray the other and spend 2 years in jail rather than remain silent and enjoy the best possible outcome of only 1 year in jail. This is because, regardless of what the other prisoner chooses to do, each prisoner believes they improve their likely outcome by confessing, even though an analysis of the possibilities …

 

P1 Confess? P2 Confess? P1 Sentence P2 Sentence
N N 1 1
N Y 3 0
Y N 0 3
Y Y 2 2

 

… indicates that each Prisoner is expected to do an average of only 1.5 years, and betrayal increases time served. Why? It has to do with something called the Nash equilibrium, which is a solution concept of a non-cooperative game where no player has anything to gain by changing only their own strategy (which is often the case when both players have to choose their strategy in secret) and results from the fact that the payoff relationships from each prisoner’s perspective make confession the only case where each player would do worse by unilaterally changing strategy. In simple terms, this means that if prisoner 1 chose confession and prisoner 2 chose confession, then either prisoner changing their choice on their own would result in that prisoner serving more time. In psychological terms, if you don’t confess, and your colleague does, you serve an extra two years while he walks free.

So what does this have to do with Supply Chain Finance (SCF)? Peter Loughlin does a great job making the comparison in his new Purchasing Insight paper on Demystifying Supply Chain Finance, sponsored by Taulia. Simply put, even though the best situation for many buyer-supplier relationships (where a SCF solution that would help both parties is not available) is the status-quo (of no supply chain finance), there is often an incentive for one party to choose a solution that benefits them, even though, as in the case of the prisoner’s dilemma, the choice of that solution often damages the other party considerably (by adding cost to the other party, just like the prisoner’s dilemma adds time).

The reason for this is that each primary SCF solution, for reasons that are clearly explained in the white-paper, has a sweet-spot and any relationship that falls outside of that sweet-spot isn’t helped by the solution, and may even be hurt by it. In a very cramped nutshell:

  • Supplier Finance only helps large volume/dollar suppliers of large buyers because banks aren’t willing to bear the cost of on-boarding the long tail of the supply chain
  • Dynamic Discounting only helps favoured suppliers because most buyers typically don’t’ have the liquidity to pay the entire supply chain early and not all suppliers have e- solutions that integrate with the buyers’ dynamic discounting solutions (assuming that the buyer will extend or negotiate terms across the entire supply base)
  • Pre-Shipment Finance doesn’t help the buyer or give the supplier access to borrowing at the buyer’s creditworthiness

For more details, download Purchasing Insight’s new white paper on “Demystifying Supply Chain Finance”. It’s worth it.

15 Years Ago Today, The Internet Rocket Begins to Run Out of Fuel

15 Years Ago today, the Dow Jones Industrial Average closes above the 10,000 mark for the first time during the height of the Internet boom. It was the beginning of the end, which started a year later after the NASDAQ peaked at an all-time high of 4,048.62 on March 10, 2000. It was all downhill in the dot-com bust from that point on. But what can you expect from a frenzy that results in an online property spending $188 Million in a mere six months in an attempt to create a global online fashion store?

The lesson here is that if something looks too good to be true, it’s probably too good to last. If a supplier is significantly undercutting the market in their bid to win your business, it’s a desperation move and cutting prices to levels that are barely at, or below, cost is not going to improve the supplier’s financial viability. If your newly launched product is commanding a considerably larger share of the market than you expected, the market was probably a blue ocean and your lead will only last until a rival launches a similar product with new features and more marketing dollars behind it. If everything has been going smooth in your supply chain for the last year, given the current rate of supply chain disruptions and the ever increasing frequency of black swan attacks, your luck is probably about to run out. So be prepared for the unexpected. It’s bound to happen eventually, and likely sooner than you think!