Buyer initiated non-recourse factoring of confirmed payables: A major global corporation case study

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1 Endhoven, Novemer 2010 Buyer ntated non-recoure factorng of confrmed payale: A major gloal corporaton cae tudy By H.A. Alfernk Bachelor of Indutral Management 2007 Student dentty numer n partal fulflment of the requrement for the degree of Mater of Scence n Operaton Management and Logtc Supervor: dr. Matthew Rendorp, TU/e, OPAC dr. Marco Comuzz, TU/e, IS

2 TUE. School of Indutral Engneerng. Sere Mater Thee Operaton Management and Logtc Suject headng: Fnance, Supply Chan, Revere Factorng 2

3 Preface Th the report the reult of the graduaton project a a fnal part of the MSc. program Operaton Management & Logtc at the faculty Indutral Engneerng and Innovaton Scence at Endhoven Unverty of Technology. Th experence took place at the gloal pharmaceutcal company and utantally contruted to my experence and knowledge. Therefore I would lke to expre my ncere grattude to the people that enaled and upported th project. I am dtnctly grateful to Matthew Rendorp, my frt upervor, for contnuou npraton and gudance durng all phae of the project. Furthermore I would lke to thank Marco Comuzz for provdng feedack durng later phae of the project. Addtonally I would lke to thank the company upervor at the GSCM and procurement department of the GPC for ther upport and gudance wthn the centfc company. I would lke to thank all fve once agan for ther patence and provdng the freedom to chooe the etup and executon method of the reearch. Addtonally I would lke to thank the procurement colleague who hared an offce wth me, for anwerng more queton than I ever aked durng any ngle project n the pat and for enalng a pleaant tay. Alo I would lke to thank the ecretare of the procurement predent and GSCM predent for ther organzng upport. Furthermore I would lke to thank all employee I communcated wth, that provded nformaton or made my tay pole and pleaant. Th hold pecfcally for the GPC procurement predent, the API ourcng predent and the GSCM SI polcy coordnator. Lat ut not leat I would lke to thank my fellow tudent, frend and famly who upported me durng my graduaton and durng my tme a tudent at the unverty. Erk Alfernk Endhoven,

4 Summary Tradtonally operaton management (OM) and corporate fnance are dtnct reearch dcplne and profeon focung on a ngle corporaton. Gradually upply chan management and later the nteracton etween OM and fnance ganed attenton. Supply chan management addree the nteracton wthn the OM dcplne etween multple lnk n the upply chan. Interacton etween OM and fnancal apect take place when OM decon change the workng captal requrement, mplyng change n decon makng regardng lalte and ther tructure. The three element of workng captal addreed n th the are recevale, payale and nventory. The element are comned wth ale or purchae to three rato and referred to a the cah converon cycle. The cah converon cycle expree the tme etween durement and recept of cah. The longer the cah converon cycle the more external fundng requred and the hgher the cot of captal expene. Th reearch focue prmarly on a tool called revere factorng. Revere factorng (RF) enale recevale term decreae for a uppler and multaneou payment term ncreae for the uyer. RF one ntrument ued y many ank and corporaton wthn a range of upply chan fnance (SCF) ntrument. Ung SCF, the fnancng rate to a company aed on credtworthne nformaton of another company. Pfohl and Gomm (2009) are among the frt to quanttatvely model SCF. They do however not pecfcally addre the tradeoff requred for adequate decon makng n RF. RF offered to a uppler y a fnancal nttuton and a uyer. The uppler can dcount recevale from a RF offerng uyer earler agant a rate that reflect the uyer credtworthne. The uyer can n turn extend the payment term, partly reducng the advantage for the uppler. RF quanttatvely modeled n th reearch ung calculaton method of three major ank that are appled to hundred of thouand compane. Addtonally a model for a prce decreae ntead of a payment term extenon developed. A ample from one uyer and 21 RF uppler cae n Europe ued a a a to tet entvty of the avng to varyng nput parameter, yeldng the followng reult: The longer the ntal payment term and hgher the purchae volume the hgher the avng potental If the uppler cot of captal ncreae or the uyer cot of captal decreae then the uppler ave more and the uyer ave le and vce vera A prce decreae yeld more avng to the uyer f the uyer value the freed cah wth a lower rate than the SCF rate The nterank fnancng rate (EURIBOR) currently at a low level and expected to ncreae up to a factor four n In cae of a term extenon the uyer avng ncreae and the uppler avng decreae a a reult. In cae of a prce decreae avng reman relatvely tale. The longer the uyer take to confrm an nvoce the lower the avng for the uppler The avng rate that a company can allocate to freed cah depend on h pecfc fnancng alternatve. Nether reearcher nor practtoner agree on the rate to allocate to ncreae or decreae n element of workng captal. Wthn the ame corporate holdng a uppler ntegraton trategy precred. A form of uppler ntegraton that hft nventory from a uyer account to a uppler account, whle enalng optmzed producton, tranportaton and capacty plannng for the uppler called uppler managed congnment tock (SMCS). Increaed cooperaton addtonally enale long 4

5 term eneft uch ncreaed ervce level and ale ncreae. Wth SMCS the uppler create the purchae order aed on the demand nformaton exchanged y the cutomer and the tock of good at a uyer tll the property of the uppler. Payment for thee good made to the uppler at the moment when they are ued/wthdrawn y the uyer. Some uppler, however, recognze only few plannng and chedulng advantage and requre compenaton. A uppler can e compenated y a decreaed payment term and/or an ncreaed prce. RF mght alo an alternatve mean to compenate the uppler. A entvty analy on the talty of compenaton yelded the followng reult: The hgher the tem value for whch SMCS appled, the hgher the quantfed fnancal loe for the uppler and the hgher the gan for the uyer A normal payment term decreae utantally more expenve than RF for the uyer and only lghtly more enefcal for the uppler For the uyer RF the lowet cot form of provdng compenaton. RF can yeld more compenaton to the uppler than a prce ncreae f demand varalty low and or uppler cot of captal are hgh The hgher the requred prce ncreae and the horter ntal payment term the le ale wll RF e to compenate the uppler uffcently Wth SMCS the uyer can create the nvoce, mplyng a hort confrmaton tme and more compenaton. RF a well a SMCS decreae the requred WoC n the upply chan and provde ncreaed vlty and flexlty n controllng nflow and outflow of cah and good. Rf a form of SCF wth the only feature eng the alty to dcount recevale efore maturty. Mult ank platform wth addtonal feature ncludng pre-order fnancng and nventory fnancng do yeld hgher avng and are expected to e ncreangly adapted over a range of compane ntead of for one uyer and t uppler. 5

6 Tale of content Preface... 3 Lt of fgure... 8 Lt of arevaton... 9 Lt of varale...10 Introducton...11 Relevance Reearch degn Reearch ettng Reearch queton and ojectve Scope Reearch method Valdaton Workng captal management Interrelated operaton and fnance decon makng Workng captal on alance heet Cah Converon Cycle The cot of captal Analy of the centfc company workng captal related trategy Decreang the cot of workng captal Supply Chan Fnance Modelng revere factorng Valdaton Suppler ntegraton Suppler ntegraton at the gloal pharmaceutcal company Lterature verfcaton of conceptual model Scentfc model Integratng the model Sentvty analy RF entvty SMI wth CS entvty Implementaton Enalng SCF On oardng uppler...70 Concluon...72 Lmtaton & further reearch...74 Blography...75 Index...80 Appendx 1 Reearcher v. practtoner...81 Appendx 2 The centfc company annual KPI...82 Appendx 3 Scentfc company tandardzed and condened alance heet 2008 and Appendx 4 elected compane nvolved n RF...85 Appendx 5 Intervewee...86 Appendx 6 SMI & Congnment mpact...88 Appendx 7 SMI & Congnment mpact reved...89 Appendx 8 Scentfc veru conceptual model...90 Appendx 9 Savng calculaton per agreement...91 Appendx 10 Credt ratng compared...92 Appendx 11 2 and 12 month euror

7 Appendx 12 Dered SCF nformaton and feature...94 Appendx 13 The trade fnance gloary y McKney (2010)...95 Appendx 14 SCF role per department...97 Appendx 14 Excel preadheet ued

8 Lt of fgure Fgure 1 Organzaton chart...15 Fgure 2 Scope of the project...16 Fgure 3 - Intal reearch degn model Mtroff et al. (1974)...17 Fgure 4 Adapted reearch degn model...18 Fgure 5 Standardzed alance heet tem...22 Fgure 6 Condened alance heet tem...22 Fgure 7 the centfc company WACC and det ratng...27 Fgure 8 Factorng...30 Fgure 9 - Intal veru RF arrangement...35 Fgure 10 DPO and cah flow...38 Fgure 11 tmelne of freed cah (example)...40 Fgure 12 - Suppler ntegraton reearch cycle...48 Fgure 13 nventory ownerhp: congnment v. non congnment...51 Fgure 14 SMI varale...52 Fgure 16 RF avng and prce decreae...58 Fgure 15 RF avng and CCC length...58 Fgure 17 RF avng and payment term extenon...59 Fgure 18 RF avng from payment term extenon v. prce decreae...59 Fgure 19 RF avng and purchae value...59 Fgure 20 RF avng and ntal payment term...59 Fgure 21 RF avng and the rate allocated to freed cah...60 Fgure 22 RF avng and uppler tax rate...60 Fgure 23 RF avng and uyer tax rate...60 Fgure 24 Euror htory...61 Fgure 25 Rf avng and Euror...61 Fgure 26 RF avng and uyer cot of captal change...62 Fgure 27 SMI & CS avng and demand level (=300)...63 Fgure 28- SMI & CS avng and demand level (ervce level =0,95)...63 Fgure 29 SMI & CS, uppler proft and demand...64 Fgure 30 SMI & CS avng and uppler order cot...64 Fgure 31- SMI & CS avng and uppler nventory handlng cot...64 Fgure 32 SMI & CS avng and uyer order cot...65 Fgure 33- SMI & CS avng and uyer nventory handlng cot...65 Fgure 34 SMI & CS avng and demand coeffcent of varance (CV)...65 Fgure 35- SMI & CS avng and nvoce confrmaton and proceng tme...65 Fgure 36 SMI & CS avng and uppler margn...66 Fgure 37 SMI & CS avng and euror...66 Fgure 38 SMI & CS avng and uppler WACC...67 Fgure 39- SMI & CS avng and uyer WACC...67 Fgure 40 SMI & CS avng and ntal purchae prce...67 Fgure 41- SMI & CS avng and ntal payment term...67 Fgure 42 SMI & CS avng nvocng effect...68 Fgure 43- SMI & CS avng and compenaton

9 Lt of arevaton B2B BAG C2C CCC CFO COGS CV DIO DPO DSO EBITDA EURIBOR GPC GSCM HTM IFRS IT JIT KPI LIBOR MM MSc. OBSF OEM OM OR OWC R&D RF ROI SCM SEC SI SKU SMCS SME SMI VAT WACC WoC Bune to une The centfc company legal entty Cah 2 Cah Cah Converon Cycle Chef Fnancal Offcer Cot of Good Sold Coeffcent of varaton Day nventory outtandng Day payale outtandng Day ale outtandng Earnng efore nteret, tax, deprecaton and amortzaton Euro Interank Offered Rate Gloal pharmaceutcal company Gloal Supply Chan Management Hgh tech materal Internatonal Fnancal Reportng Standard Informaton Technology Jut n tme Key Performance Indcator London Interank Offered Rate Modglan and Mller Mater of Scence Off Balance Sheet Fnance Orgnal Equpment Manufacturer Operaton Management Operaton Reearch Operatng Workng Captal Reearch and Development Supply Chan Fnance Return on nvetment Supply Chan Managment Securte and Exchange Common (US) Suppler ntegraton Stock keepng unt Suppler managed congnment tock Small & Medum zed enterpre Suppler managed nventory Value added tax Weghted Average Cot of Captal Workng Captal 9

10 Lt of varale f actual uppler fnancng rate Percentage S net avng Euro j c order cot Euro j q order ze unt k j j z j G j order ze multplcaton factor the average nventory level unt the nventory holdng cot Euro D Annual demand unt I Intal nvetment Euro r e Euror rate percentage r f Bank margn percentage t Invoce confrmaton tme day t f RF nvoce proceng tme day T repreent the effectve tax rate percentage t j Payment term day u j unt purchang prce Euro V j Annual purchae volume Euro w weghted average cot of captal percentage w WACC percentage y nventory handlng cot percentage, upper cae ndex, where uppler uyer j,,, lower cae ndex, where α ntal tuaton, β SMI tuaton θ RF term extenon μ RF prce decreae 10

11 Introducton Operaton management and fnancal management are tradtonally two dfferent dcplne. Th characterzed y dtnct lne of educaton and reearch at unverte and y dtnct department n organzaton. Operaton manager and reearcher generally have at mot ref knowledge aout fnance and accountng. Fnance manager and reearcher have generally at mot ref knowledge aout operaton management 1. Yet oth dcplne nteract and nfluence operatonal and fnancal performance of organzaton together. Broadly defned, operaton management deal wth when and how much to produce or order and fnancal decon makng deal wth how much to orrow or how much to dtrute to hareholder (Buzacott & Zhang, 2004). Effectve management of operaton requre adequate fnancal reource. Operaton management doe n turn change the frm level of rk and therey the avalalty of reource (Snghal, Ratur and Bryant 1994; Snhal 1988; Snhal and Ratur 1990). Inuffcent lqudty can e a great contrant, even f a frm proftale from an accountng perpectve. When faced wth ncreaed varalty of demand and/or reduced acce to (affordale) credt, lack of lqudty may force unee to operate le effcently, e.g. reduced ervce level. Th lkely to decreae uyer atfacton and long term performance or even long term extence. Snce n olgopoly market the lqudty prolem can nowall and lead to rk of ankruptcy. A frm uyer and uppler may eek to contan ther rk and do une wth a compettor ntead. Suppler mght offet addtonal rk y mpong more retrctve contract and/or hgher cot, e.g. cah on delvery. Bank may further retrct credt avalalty and mpoe hgher nteret rate. An addtonal drver of neffcent operaton and fnance management the cot of captal ued for operatonal decon makng are n practce et at ome level y decree and ued wthout acknowledgng the mplcaton of operatonal decon on fnance and only changed f major change relevant to the organzaton take place (Slver et al. (1998) pp. 45). Th eg the queton to reconder f the optmal upply chan operaton degn and management alo a rout optmum n a fnancal upply chan degn perpectve and vce vera. The force external and nternal to the company and centfc knowledge avalale develop contnuouly. Therefore the anwer to the aove conderaton develop over tme a well. When organzaton am for et n cla performance, the knowledge aout thee development need to e ncorporated n manageral decon makng. Th reearch doe focu on the nteracton of two tool n the aove mentoned context,.e. congnment tock and revere factorng. Ung congnment tock a uyer ave nteret payment, nce the tock legally owned y the uppler, ut held y the uyer and only nvoced after ue or ale. Wth revere factorng (RF), early payment provded y a ank or factorng company to a uppler agant a rate aed on the uyer credtworthne y ellng confrmed nvoce from uppler to factor. After the payment term the uyer pay the nvoced amount to the ank or factorng company. Revere factorng one opton n a range of upply chan fnance (SCF) oluton. The recent development wll e dcued n the next paragraph after whch the reearch degn dcued n Chapter 1. Once the reearch degn dcued ome mportant concept are ntroduced n Chapter 2 a a knowledge foundaton for SCF. Ung th knowledge foundaton the concept of RF ntroduced n chapter 3 y a cae 1 Hghlghted at 11

12 tudy after whch RF t formulated mathematcally. Chapter 4 ntroduce uppler managed congnment tock (SMCS) conceptually and mathematcally. Once the mathematcal model of RF and SMCS are etalhed they are ntegrated n chapter 5. The entvty of the RF model analyzed n paragraph 6.1 and the entvty of the ntegrated RF & SMCS model analyzed n paragraph 6.2. Ung thee outcome, mplementaton recommendaton are provded a well a a concluon after whch recommendaton for further reearch are provded. Relevance Th chapter dcue the relevance and mportance of revere factorng and congnment tock n today economc envronment. The 2009 receon ncreangly mpoed contrant on the lever of workng captal,.e. payale, nventory and recevale. It ecame ncreangly dffcult to otan credt from ank and propect were negatve. A a reult aggreve target for all workng captal lever were ntroduced to mantan a healthy cah flow. Progreve cah collecton polce were mpoed on uyer and payment to uppler wa delayed. Regardng nventore, overreacton to thee negatve propect common and named the ullwhp effect y Forreter (1961). It elaorated on and confrmed y Sterman (1989), Lee et al. (1997) and Croon and Donohue (2006). The ullwhp effect enforce the preure down the upply chan on the nventory lever of workng captal (Franoo et al., 2009). The mpact from credt contrant and the ullwhp effect are llutrated y the outcome of a workng captal urvey (Katz, 2010) ung data from 2009 of 1,000 of the larget U.S. headquartered pulc compane. The tudy analye the workng captal performance y element of the cah converon cycle (CCC). Thee element wll e dcued n more detal n paragraph 2.3. Accordng to Katz (2010) urvey the average CCC jumped 8.2% n 2009, markng the larget CCC deteroraton n fve year. More mportant than the CCC a a whole are the element of the CCC. The change n value of thee element llutrate the effect of the ullwhp effect n workng captal fgure and depct a chan reacton on payale and recevale term. I.e. day ale outtandng (DSO) performance deterorated y 10.4%, mplyng uyer pay later and the day payale outtandng (DPO) ncreaed equally y 11.4%. Addtonally day nventory outtandng (DIO) ncreaed y 8.8%, mplyng an average lack of alty to ell product. Th effect evere at the egnnng of the operatonal upply chan. The weghted average CCC of compane producng chemcal ncreaed 14%, contructon materal 19%, metal and mnng 38% and ol 113%. Under the few ndutre howng a decreaed CCC are many conumer product, e.g. food (-7%) and peronal product (-15%). 2 To dmnh thee effect three polce are dcued. The frt polcy tart wth a practcal example followed y t oluton, the econd polcy congnment tock and the thrd polcy revere factorng. The frt polcy addree DPO and DIO ntroduced ung a chemcal company cae tudy. Once executve explaned ther ucce of applyng dfferent account-payale tratege for low- and hgh-volume uppler. I.e. nfrequent, low-volume vendor are pad wth extended term a new purchae are made and hgh volume, hgh frequency uppler are offered ncreaed volume for etter payment term. Addtonally to etter manage nventory, the company dvded t varou product nto low- or hgh-volume eller. Manager then made decon aout whch product to tock and whch to make to order aed on recent and expected ale volume. The compane CCC decreaed y 24% at the moment of revew, ut are not lkely to utan when ale ncreae. At the moment of revew the ullwhp effect wa 2 U.S. headquartered pulc pharmaceutcal compane face a weghted average CCC ncreae of 7%, ncludng two outler Merck & co (+150%) and Pfzer (+89%). 12

13 fully apparent and thu are nventory and expected ale volume lkely to e et at nadequate level. If ale ncreae th mple ncreaed fnancal performance, ut the compane ervce level lkely to declne y a lack of avalale nventory, caued y the ullwhp effect. It therefore lkely to e unale to realze a much ale a t would when nventory wa kept up to pre-cr level and unale to erve cutomer well. Keepng nventory at pre cr level dcued and mplemented a a remedy y Franoo et al. (2009). Th wa only pole nce Royal DSM a fnancally old mother company DSM management, 2009 n (Franoo et al., 2009). Whle th mght hold for ome compane, many other would fnd t very expenve f pole at all to fnance nventory that eem to e at anormally hgh level n tme of cre. Md 2010 the lack of acce to fnancng and aggreve workng captal target are tll apparent. Th hghlghted y a urvey among 400 U.S. SME of whch 41% unale to otan adequate fnancng, whch more evere than n the pat 17 year 3. SME generally need to otan fnancng from ank or other rk avere fnancal nttuton whle large compane can go drectly to the captal market. Neverthele out of 168 CFO n U.S. compane wth revenue over $500 llon 81% tated n Septemer 2010 that workng captal reducton a hgh prorty 4. 73% of thee 168 CFO tated uppler relatonhp are alo a top prorty. In a German and UK urvey n 2009 among 1000 executve 88% of UK compane and 55% of German frm recognze that ome of ther key uppler wll not e ale to utan further lengthenng of payment term (Demca, 2009). A a oluton compane mght conder uppler managed congnment tock and revere factorng. Suppler managed congnment tock (SMCS) comne two tock pont nto one tock pont - managed y the uppler - wth le tock than the accumulaton of the two eparate tock pont. Th way t utanaly decreae the cot of captal n the upply chan n two way. Frt of all, the total nventory uffer ze decreae y replacng two tockpont wth demand uncertanty y one tockpont wth accurate demand forecat. Second, the uppler doe not need to nvet h own margn n nventory lke the uyer doe. Th decreae nventory value from a uyer and upply chan perpectve. The extent to whch the ncreae of workng captal at the uppler a drawack dcued n chapter 4. Anyway can the uppler e compenated for congnment tock y revere factorng, whch dcued n paragraph 6.1. Revere factorng (RF) wa already mentoned n the ntroducton. Followng Kramer (2010) revere factorng allow uppler to get pad whenever they chooe. Suppler can acce low cot fnancng on demand over the we, thu elmnatng the negatve cah flow mpact of a term extenon. Cot are reduced and cah flow mproved throughout the upply chan rather than mply hftng the urden from uyer to uppler. Th cheaper ource of fnancng offered y the uyer to the uppler mght e ued to compenate the uppler for SMCS. Thee oluton are not only valuale n tme of cr, ut alo valuale n regular and healthy upply chan and even f cah flow are aundant. Freed cah can e ued to fund unedevelopment opportunte wthout havng to rely on the captal market or ank for fundng (Jeff Edward, 2010, CFO of Allergan n (Katz, 2010)). Grant Barer, CFO of Hughe Communcaton add: The more one can fnance that from nternally generated fund, the etter one une model wll e gong forward. (Katz, 2010) 3 Source:

14 1. Reearch degn On the tmelne of th reearch, the revere factorng opton wa frt analyzed y a lterature revew. Th revew can e found n paragraph 3.1 and ndcated that revere factorng nvolve generally three knd of organzaton: (1) A fnancal nttuton (2) a payment recevng organzaton (3) a payment makng organzaton. Gven RF reearch n exploratory tage a ytematc n depth and focued reearch to RF valuale. Gven the MSc. the tmeframe t nfeale to chooe multple organzaton a the reearch ettng for n depth and focued reearch. In order to ytematcally nvetgate the dynamc of revere n an operaton plannng accountng and control ettng the latter two organzaton are mot utale wth regard to the topc tuded n the MSc. program y the nature of thee organzaton. The ntal lterature revew ha alo hown that generally multple payment recevng organzaton are nvolved n one revere factorng program wth one payment makng organzaton. Therefore a multple cae analy more lkely to e pole at an RF payment makng organzaton. 1.1 Reearch ettng When conderng a reearch ettng the author acknowledge that management reearch uject to conderale dtncton etween reearcher and manager. Followng Shrvatava and Mtroff (1984) reearcher and manager dffer y the nature of the tak n whch each nvolved rought forward y the knd of nttuton n whch they practce (elaoraton n Appendx 1). Ackoff (1979) even tated the future of operaton reearch (OR) pat, expreng h frutraton aout the weak relatonhp of OR to real-lfe practce. Later, Shrvatava and Mtroff (1984) provded three crtera for centfc reearch that hould yeld utanale reult for cence and practce. Frt, the extent to whch the reult capture the organzaton' partcular realty. Second, decrptve adequacy and thrd, poltcally and deologcally feale recommendaton. Bertrand & Franoo (2002) are more OR pecfc on the frt crtera, argung that model hould e tuded whch can e valdated a real-lfe procee and alo the reult of the analy hould e teted n real lfe. Thee crtera are met naturally y the reearcher phycal preence n the organzaton whle carryng out the reearch. Th phycal preence mple a motvaton to relevance, creatng a rk for a lack of focu on generc contruton. After the ntroducton of the reearch ettng, queton and ojectve, the method ecton wll dcu the procedure yeldng generc contruton, alancng rgor and relevance. A tated efore the three generc contruton crtera wll naturally reult from phycal preence n an organzaton. Ovouly a RF payment makng organzaton upport the reearch to the larget extent a decred n the prevou paragraph. One uch RF payment makng organzaton a centfc orented company wth core actvte n pharmaceutcal, nutrton and hgh-tech materal. It am to create value through nnovaton, growth and hgh earnng power n reearch ntenve area. In 2009 the company employed 108,400 people and had ale of 31.2 llon. Of whch 46.5% n pharmaceutcal, 23.5% n nutrton and 26.6% hgh tech materal. An overall EBITDA margn efore pecal tem of 21% ndcate a relatvely hgh earnng power ndeed. It captal expendture amounted to 1.7 llon and R&D expene to 2.7 llon. The corporate holdng defne common value, goal and tratege for the entre group. Herey conderale attenton pad to reduce workng captal. The ugroup operate ndependently and are led y the management of the holdng company, a depcted n Fgure 1. Department Supply Chan Management and Procurement or equvalent are preent n every ugroup. 14

15 The corporate center upport the group management oard n t tak of trategc leaderhp. Supportve department uch a Fnance and Accountng and Control are potoned wthn the corporate center, upportng any ugroup. In lne wth th tructure the fnancal and operatonal tratege and polce are decred for the company a a whole and are daggregated nto executale polce for the gloal pharmaceutcal company (GPC). The poton of the department Fnance and Accountng and control n the corporate center contrute to reult that are at leat generalale over the ugroup. Holdng Accountng and control Fnance Hgh tech materal Pharmaceutcal Nutrton GSCM Procurement Fgure 1 Organzaton chart Wthn the ugroup the attenton for workng captal reducton tructured y varou well managed mprovement procee. In the ugroup hgh tech materal RF one lne of mprovement nce early In the pharmaceutcal ugroup uppler ntegraton a lne of mprovement. Addtonally n the pharmaceutcal ugroup RF mght e enefcal. The reponle department for th lne of development are Procurement and Gloal Supply Chan Management (GSCM). The project group of th reearch ext out of three employee wthn the pharmaceutcal department, the reearcher and the frt and econd aeor at the TU/e. The employee are the enor vce predent n gloal upply chan management, the procurement performance manager and payment term performance coordnator. 1.2 Reearch queton and ojectve In the hgh tech materal ugroup numerou uppler are nvted to adapt RF. The numer that fnally adopted RF veru the uppler ntroduced to RF one of the motvaton for the frt reearch queton. Furthermore the uppler ae of the pharmaceutcal ugroup conderaly dfferent from the hgh tech materal ugroup. The frt reearch queton defned a follow: 1. What uppler electon crtera hould e adopted for a RF agreement? Th queton ncorporate the dentfcaton of advantage, dadvantage and ther drver for the uppler a well a for the uyer. A prerequte for an RF agreement etween a uppler and uyer that the advantage hould outwegh the dadvantage for oth parte. Therefore the anwer to queton 1 hould alo nclude nformaton aout the tructure of varale drvng advantage and dadvantage. To decde on a rout cenaro the varaton of thee varale 15

16 need to e known. If the aove reearch queton anwered t y no mean a guarantee for fnancal performance mprovement. The mng lnk effectve mplementaton of RF, whch lead to reearch queton 2: 2. What knowledge hould e preent at whch poton n the organzaton n order to mplement RF effectvely? The department Procurement and GSCM alo contrute to workng captal decreae ung a trategy of uppler ntegraton to ave nventory cot. Suppler managed congnment tock (SMCS) one opton wthn the range of uppler ntegraton opton. Suppler ntegraton mght nteract wth RF, nce there a cae n whch a uppler requeted a prce ncreae multaneouly wth the mplementaton of congnment tock. Th lead to the fnal reearch queton: 3. How do uppler ntegraton (SI) and RF nteract? Th queton doe not only provde the tructure of varale that overlap. I.e. that are nfluenced y RF a well a SI. It alo erve a nput for a model to nvetgate rout cenaro for a comnaton of RF and uppler ntegraton. 1.3 Scope The cope of th reearch depcted y the gray area n fgure 2. It lmted to the moment of fnhed product at the uppler up to the moment of uage of product at the centfc company. Addtonally the fnancal flow wth regard to th product flow nvetgated, ncludng the fnancal mpact. Comment on the mplementaton and legal apect are provded, ut the operatonal mpact not condered n th project. Alo the varale of the fnancal nttuton are aumed a a gven and the mpact on the fnancal nttuton not explctly dcued. Th dcuon can e found n Hurtrez & Salvador (2010) and Sddall (2010). Cah Flow Fnancal nttuton Cah flow Fnancal mpact Fnancal mpact Suppler Product flow Buyer Fgure 2 Scope of the project The cope nclude the upply of product, ervce and ther related fnancal flow a well a the fnancal related nformaton flow. Th cope wll e narrowed down further n the uequent chapter. 1.4 Reearch method The reearch method defned y followng general emprcal decrptor from Cooper & Schndler (2009) and operaton management (OM) modelng pecfc defnton from Bertrand & Franoo (2002). Thereafter the reearch procedure dcued ung Mtroff et al. (1974). 16

17 A wll e ndcated paragraph 2.1 Interrelated operaton and fnance decon makng, there ha not een much attenton for nteracton of operatonal and fnancal decon makng. Extng lterature n a decrptve tate and therefore the reearch queton are defned for exploratve and model uldng reearch. Th reearch not prmarly drven y an dealzed model telf and cannot e defned a axomatc Meredth et. al. (1989). In fact th reearch doe not even manly am to tet a quanttatve model at all, t am to dentfy relatonhp among varale to ultmately propoe a model on RF and SMCS. The centfc trength of emprcal cae tude lke thee are novelty, tetalty, and emprcal valdty, whch are from the ntmate lnkage wth emprcal evdence (Eenhardt, 1989). Followng Bertrand and Franoo (2002) emprcal quanttatve model aed reearch ha not een very productve from a centfc pont of vew y t pecfed condton and lack of decrpton of meaurement method. Depte th reearch not manly quanttatve model aed, ut rather develop the model t mportant to pay conderale attenton to decrpton of meaurement method n to enhance the alty for cro cae valdaton polte for uequent reearch and to avod contrant on generalzaton. Conceptualzaton Conceptual Model Modelng Realty, Prolem tuaton Scentfc Model Implementaton Model Solvng Soluton Fgure 3 - Intal reearch degn model Mtroff et al. (1974) Followng Bertrand & Franoo (2002) th reearch emprcal normatve, nce t doe follow the whole cycle of reearch y Mtroff et al. (1974) a depcted n Fgure 3. Emprcal decrptve reearch would only follow the upper de of the model, and valdate the model wth realty, ut not provde a oluton. The four phae of th reearch are depcted y the connector etween the node n Fgure 3. In the frt phae a conceptual model of the prolem and ytem under tudy made. In th conceptualzaton phae, the cope of the model, the varale to e ncluded and ther meaurement are determned. In th reearch th phae extenve a depcted n Fgure 4. At frt workng captal management n practce wll e confronted wth lterature to provde the contextual concept gven the cope. Th provde the context for nvetgatng the RF trategy wthn the hgh tech materal dvon and health care dvon are confronted wth each other and wth RF lterature, n order to provde a conceptual RF model. In the ame context, the uppler ntegraton trategy confronted wth uppler ntegraton lterature. Thee two parallel confrontaton yeld conceptual model. In the econd phae a quanttatve model uld, defnng the nature of relatonhp etween the varale. Gven the conceptual model the varale and ther relatonhp wll e quantfed for RF a well a uppler ntegraton. Whle th quantfcaton take place, the 17

18 model wll e ntegrated. Th an teratve proce, nce model on RF a well a uppler ntegraton mut repreent the relevant truth and eng ale to e olved eparately, whle havng the polty to e ntegrated and eng olved. It alo teratve for valdaton purpoe a wll e explaned n the next paragraph. Conceptulzaton Workng captal managment trategy analy Paragraph 2.5 Workng captal lterature revew Chapter 2 SCF lterature revew Paragraph 3.0 SCF trategy nvetgaton Paragraph SI trategy Invetgaton Paragraph 4.1 Suppler ntegraton (SI) lterature revew Paragraph 4.2 SCF conceptualzaton Paragraph 3.1 SI conceptualzaton Paragraph 4.2 Modellng SCF centfc modellng Paragraph 3.1 & 3.2 Model ntegraton Chapter 5 SI centfc modellng Paragraph 4.3 Model olvng RF entvty Paragraph 6.1 RF & SI entvty Paragraph 6.2 Implementaton Implementaton Chapter 7 Fgure 4 Adapted reearch degn model In the thrd phae Model olvng the reearcher am to olve the model ung mathematc, anwerng reearch queton 3. The model on RF or uppler ntegraton erve a a comparon ae for a tuaton n whch nether RF nor uppler ntegraton ued. The fnal phae cont of mplementaton of the model reult. Although reearch can tart from any tate, th reearch tart wth a realty, prolem tuaton. I.e. a lack of n depth undertandng of the dynamc of RF. For a thorough dcuon on th model I refer to Mtroff et al. (1974) and Bertrand & Franoo (2002). 18

19 Data collecton The data collecton n the company rele on communcaton rather than montorng, nce no drect oervaton are ncluded n th reearch. Intervew are roughly degned n two way (1) the uject matter ntroduced y the ntervewee and only refly re-quetoned y the ntervewer (2) the fndng of prevou ntervew and theory are verfed wthout mentonng a ource. The exact degn depend on the phae of reearch and purpoe and wll e ndcated efore t fndng are dcued. A complete lt of ntervew ncluded n appendx 5. The forthcomng negatve effect of nterpretaton and percepton are lmted y the method dcued n the next paragraph. Data collecton took place cro ectonal and ex pot facto, wthn the frt x month of Valdaton Depte emprcal valdty an mportant trength, Mtroff et al. (1974) tate there uually an over-concern on valdaton n one reearch when revewng a lne of development for an ue. When lmtng valdaton the role of nterpretaton ncreae from a centfc perpectve and the relevance decreae from a practcal perpectve. A a conequence the mportance of meaurement method decrpton ncreae for a econd lne of development a far a generalzaton the am of multple lne of development. Furthermore lmted concern for valdaton nuffcent for th reearch, nce mplementaton and uequent performance mprovement an am. Therefore three knd of valdaton are ued: external, nternal and face valdty. If conflct n fndng occur, then frt the fndng of one cae wll e verfed wth the ntervewee of another cae and vce vera. If the conflct n fndng tll occur t wll e dcued n the project group and approprate acton wll e taken. Th mght nclude further nvetgaton of other cae or the decon to contnue ung a pecfc nterpretaton or ettng. External valdty (Cro-cae analy and replcaton trategy) A far a the RF reearch concern, uppler of the hgh tech materal ugroup erve a cae. Twenty-one cae of RF are analyzed. Th numer of cae allow for tetng whether the fndng of one cae make ene eyond t own pecfcaton. To enhance external valdty further Mle and Huerman (1994) refer to the replcaton trategy advocated y Yn (1984). Th trategy ue a theoretcal framework a generated from the lterature revew to tudy one cae n depth. Thereafter ucceve cae are examned to ee whether the pattern found matche that n prevou cae. Ultmately the frt RF contract wthn the pharmaceutcal dvon could e analyzed to ncreae the generalzalty. Th prolonged generalzalty cannot e ued for decon makng on the fealty of mplementaton of RF for the GPC. It doe neverthele yeld nght. Th nght can e ued to ncreae the mplementaton effectvene and effcency y ncreaed generalzalty. The mplementaton phae wthn the pharmaceutcal ugroup wll e tuded cloely. A far a the uppler ntegraton reearch concern, the cro cae analy prolonged, ung forty uppler ntegraton cae wthn the pharmaceutcal ugroup. Th trategy for RF a well a uppler ntegraton am to fnd out where the ame varale have the ame effect to enhance the undertandng of varale on the total mpact of a concept. Th doe not yet contrute to undertandng the nteracton n practce drectly, nce only cae of ether RF or uppler ntegraton are avalale. The numer of cae and nformaton per cae avalale for RF a well a uppler ntegraton expected uffcent to propoe a vald model. Addtonal to the cro cae replcaton trategy the lterature revew provde an external perpectve on the uject matter and opnon from RF expert outde the centfc company are gathered to contrute to external valdty. 19

20 Internal valdty (trangulaton) Trangulaton am at confrmng a fndng y howng that ndependent meaure of t produce generally convergng concluon (Mle and Huerman, 1994). There are dfferent knd of trangulaton avalale. Denzn (1978) clafe trangulaton nto four type: data ource trangulaton (whch nclude peron, tme, place, etc.), reearcher trangulaton (multple nvetgator for a reearch), method trangulaton (ung more than one method to collect data, e.g., oervaton, ntervew, document or quetonnare), and theory trangulaton (whch nvolve ung more than one theoretcal cheme to nterpret the phenomenon). In th reearch all four knd are ued. Data trangulaton Multple ntervewee are contacted multple tme each. By th teraton the reearcher undertand the uject matter more n depth, verfe h undertandng and therey gan a etter undertandng after whch the cycle tart agan. Th rule out mnterpretaton and dentfe change n perpectve over tme. Dependng on the uject nvetgated the numer of teraton can e up to ten tme or more wth one ntervewee aout one ue. Furthermore a wde range of perpectve on a ngle ue ganed y data gatherng from varyng herarchcal level, varyng department and varyng ugroup. Th doe epecally hold among other ue for the value of freed cah n paragraph Reearcher trangulaton Trangulaton take place y comparng the undertandng of one pece of nformaton gathered etween multple peron, yeldng to a convergng concluon. In th reearch once every month the data gathered verfed wth the project team. Furthermore there are approxmately once per two week verfcaton moment etween the reearcher and the TU/e profeor and more often etween the reearcher and a procurement employee equpped wth the executon of the RF mplementaton and payment term performance. Th procurement employee wa alo preent n everal ntervew together wth the reearcher ede the ntervewee. Method trangulaton Bede ntervew, th reearch alo adopt other method for data collecton uch a revewng company document and ytem data. Secondary materal (document) from the cae company nclude company wete and hared folder on ntranet. The fndng from ntervew are motly qualtatve, whle the data collected from company document regardng RF and SMI cae provde quanttatve complement to the qualtatve fndng. The reearch doe not ue drect oervaton accordng to the defnton y Cooper & Schndler (2009), ut ue multple method, data ource and reearcher to otan data ntead. Face valdty (Utlzaton) Th reearch degned to erve the project group n the cae company. The reearcher therefore valdate the model n varou tate to the relevant takeholder. A ndcated once every month the model that are developed wll e valdated n a meetng wth elected takeholder. Fnally, the reearch reult,.e., the uppler electon decon makng framework preented to procurement and upply chan management employee. Hence the framework explaned to the potental uer and feedack on the practcalte wll e ncorporated n the fnal framework. The context n whch thee model are developed wll e explaned n the next chapter. 20

21 2. Workng captal management Th chapter tart wth the revew of nteractng operaton and fnance modelng attempt. Thereafter t create a framework of relevance y confrontng topc n lterature wth the GPC practce. Th provde the context for the ntroducton of opton to mprove the workng captal (WoC) tuaton y RF and uppler ntegraton. 2.1 Interrelated operaton and fnance decon makng Operaton management and fnancal management are tradtonally two dtnct reearch dcplne. Fnancal model treat operaton frequently a a lack ox and et harmful contrant (Reaon, 2005). On the other hand operatonal model frequently gnore fnancal contrant, e.g aumng the cot of captal a an unlmted exogenou varale (Hopp and Spearman 1996; Slver et al. 1998). Inventore do however change the frm level of rk and therey the avalalty of reource (Snghal, Ratur and Bryant 1994; Snhal 1988; Snhal and Ratur 1990). But many of the OM model gnore thee nteracton and contrant for the ake of optmalty, whch thu lkely to e u-optmalty. At mot the author dcu how to deal wth thee hortcomng when ung the model (Slver et al.,1998). Buzacott and Zhang (2004) argue a mlar gnorance hold for fnancal lterature. From a fnancal perpectve, the treatment of operaton a a lack ox hghlghted y the Modglan and Mller (MM) (1958) propoton. Vdelcet n perfect and compettve market, fnancng decon (the mx of det and equty) are rrelevant to operatonal decon (e.g., the level of captal, laor, output, acceptng or rejectng a project) of a frm, and hence can e made ndependently. Suequently Modglan and Mller (1958) argue, n cae of market mperfecton (e.g., there are tax advantage of det, ankruptcy cot, nformaton aymmetry, conflct of nteret among manager, ondholder, and tock-holder on nvetment and fnancng decon, and o on) are ntroduced, the rrelevance no longer hold. Followng Protopappa and Seftert (2010) the lack ox percepton doe not alway hold nce an ncreae n the level of workng captal allowance: (1) ncreae n the return on workng captal nvetment when operatng under a very contraned cenaro, and (2) decreae the return on workng captal nvetment when operatng under a le contraned cenaro. After 1990 the attenton for the nteracton of operaton and fnancal management ncreaed (Buzacot & Zhang, 2004) whle multaneouly a hft of attenton took place from ngle company approach to upply chan approach (Wllam and Tokar, 2008). From a ngle company perpectve L et al. (1997) eek to model the relatonhp etween producton decon, orrowng and dvdend polce under demand uncertanty wth no retrcton on the amount of orrowed. Wth a dual company perpectve Lederer and Snghal (1994) conder the jont fnancng and technology choce when makng manufacturng nvetment, howng conderale value can e added to nvetment through fnancng decon. Other ngle company perpectve nclude Brge (2000), who adapt opton-prcng method for ncorporatng rk nto capacty-plannng model, and Brge and Zhang (1999), who apply the rk-neutral prcng argument from opton theory for ncorporatng rk nto an nventory prolem. Thu whle there eem to e nterrelated modelng lterature on ngle company hort term operaton decon (.e. producton and nventory) and ngle and multple nterrelaton modelng lterature on long term operaton and fnance (nvetment) decon (.e. company capacty, nvetment plannng), there eem to e no nterrelated modelng lterature on dual company current aet and fnancng prolem (Fellenz et al, 2008). Furthermore doe extng lterature am to model a tradtonal operatonal and fnancal tructure, not takng new and 21

22 mportant fnancng and nventory opton explctly nto account, depte a trong correlaton etween ntegratve nformaton technologe, upply chan ntegraton, uyer ervce and fnancal performance (Vckery et al. 2003). Before an RF and SI model can e developed and valdated, the theoretcal and practcal ackground relevant to the prolem wll e dcued to avod contradctng nterpretaton of the fnal model and t reult. The concept workng captal, operatng workng captal, cah converon cycle and captal tructure play a role. 2.2 Workng captal on alance heet Th paragraph wll dcu the poton of workng captal management a part of total fnancal performance management n general, ung the centfc company holdng a an example. In total fnancal performance, aet turnover a drver of a compane return on equty. It decompoed n two area of management,.e. workng captal management and management of noncurrent aet. Several apect of the frt area (workng captal management) are dcued n th paragraph,.e. t relatve poton on fnancal tatement, the cah converon cycle and the cot of workng captal. Fgure 5 Standardzed alance heet tem Fgure 6 Condened alance heet tem Workng captal defned a the dfference etween a frm current aet and current lalte Palepu et al. et al. (2007). Th defnton doe not dtnguh etween operatng component and fnancal component. The operatonal component are trade recevale, nventore and trade payale. The fnancal component are cah, marketale ecurte and note payale. Thee operatonal and fnancal component nteract a wll e dcued n the cot of captal paragraph 2.4. The operatonal component do nfluence the weghted average cot of captal (WACC) and the WACC doe n turn nfluence decon makng on operatonal workng captal component. The performance of the operatonal component of workng captal can e expreed ung the defnton operatng workng captal (OWC), whch exclude the fnancal tem cah and marketale ecurte. When rearrangng a tandardzed alance heet (depcted n Fgure 6) to a condened alance heet (depcted n Fgure 5) one otan the OWC (Bauwhede, 2009). Managng workng captal (WoC) uject to a complex et of trade-off etween the lqudty and proftalty of a frm current aet gven uncertanty. The three WoC tem analyt 22

23 prmarly focu on are trade payale, nventore and trade recevale. Regardng the latter, credt and dtruton polce determne the optmal level of trade recevale. The econd tem decred n a rch ody of lterature on upply chan trategy and operaton plannng achevng target uyer ervce level or fll rate 5, often aumng fnancal parameter. The latter two tem requre a certan amount of captal. The frt tem, trade payale a routne ource of fnancng for the latter two. The normal level of payale determned y ndutry practce (Palepu et al., 2007). For the centfc company holdng (gven the tandarded alance heet n appendx 3) the current aet are approxmately 1/3 rd of the total aet at the fnancal year end 2008 and From the condened alance heet, the OWC porton of net aet wa 25% n thee year. (See appendx 3) The workng captal element numer on alance heet do not provde much nformaton aout performance y themelve. Therefore they are often ued n a rato a a nomnator wth ale or purchae, whchever relevant a a denomnator, a depcted n appendx 2. Change n th rato are compared over tme to track performance. Note that the workng captal numer from the alance heet are naphot oppoed to ale and purchae numer from the ncome tatement, whch are accumulaton over tme. It commonly aumed that the aet at the egnnng of a perod create the ale and purchae for the perod. 2.3 Cah Converon Cycle The nformaton gathered from thee rato can e expreed n another way, e.g. y the cah converon cycle (CCC), ndcatng the average numer of day etween the moment of payment for ncomng product and the moment of recept from old product. Th ometme referred to a cah to cah (C2C) cycle a well. It am to repreent: day recevale + day n nventory day payale. Equaton 1 correpond to one of thee opton and to the centfc company meaurement ytem of CCC element 7. 1 net trade recevale net nventore trade payale CCC (Equaton 2.1) 365 ale CO G S In fnancal lterature varou alternatve to otan the CCC are mentoned (Palepu et al., 2007). The horter the CCC, the horter the perod etween durement of cah and collecton of cah. Conequently, ceter paru, the need for workng captal fnancng y det and/or equty decreae. E.g. f trade payale reman equal or are extended (a dcued n chapter relevance) whle the other tem reman equal or decreae they provde an ncreang percentage of the workng captal fnancng. When extrapolatng th effect even a negatve CCC pole n theory and practce, n th ene the company Dell erve a an example. In cae of a very hort or even negatve CCC a frm can tll face llqudty or nolvency. It can face nolvency e.g. f t face hgh ndrect cot and low proft margn, lowly leadng to ankruptcy. It can face Illqudty for example f t purchae vat quantte on hort payment term and plan to ell thee n the long term. Adequate WoC management therefore a prerequte, explaned n paragraph 2.5. named analy of the centfc company workng captal related trategy. At the centfc company holdng the CCC KPI wegh the aolute magntude of recevale, nventore and payale y etmaton 8, amng at repreentng the mpact on cah flow. 5 For defnton of fll rate and uyer ervce level reader are referred to (Slver et al., 1998) 6 Calculaton provded n appendx 3. 7 Source: the centfc company manual for Operatve plannng A depcted n appendx 2. 23

24 Payale are not the only way of fnancng WoC a depcted n appendx 3,.e. a porton of det and hare are ued a well. Thee det and hare are alo ued to fnance fxed aet and requre an nteret rate y credtor and nvetor. Th rate depend to a conderale extent on the rk of default of the orrowng company, e.g. the chance that the external nvetor or credtor wll not get pad. Th the doe not focu on fxed aet nvetment, ut on OWC. It doe however take the lalte of OWC nto account. Longer CCC, ceter paru, ncreae the cot of thee lalte n two way. (1) It ncreae the captal requred to fund OWC and therey ncreae the aolute amount of captal requred. When the cot of captal would reman equal th would already ncreae the aolute amount of captal cot. But the cot of captal are lkely to ncreae a a reult of an ncreae n requred captal, aumng equal revenue and COGS. Furthermore (2) the more nventore and recevale, ceter paru, the hgher the rk of nalty to captalze nventore or trade recevale, ncreang the wrte off, mplyng ncreaed cot. 2.4 The cot of captal The CCC length not the only factor nfluencng the cot of captal. It one out of multple apect that ndcate the extent of rk a company face. The hgher th rk the hgher the rate of return requred y nvetor and credtor. Th rk compared wth alternatve nvetment opportunte y credtor and nvetor after whch the requred rate of return determned. The weghted average rate of return equal the WACC of the centfc company. Th rate cover at leat for nflaton. The add up of the rate often determned ung at leat a det ratng, ndcatng the rk of lo arng from a orrower who doe not make payment a promed. Th alo called a default and therefore another word for credt rk default rk. Det ratng Det ratng are a prmary ource of nformaton for nvetor and credtor. Thee ratng vary from AAA (prme nvetment grade) to D (hgh lkelhood of ankruptcy) (See Standard & Poor, 009; SEC 9, 2010 and appendx 10). Generally the etter the ratng, the lower the cot of captal. There are of coure rate dfference drven y varyng condton and charactertc of fnancal ntrument. The ratng of the centfc company depcted n the followng tale. the centfc company am to get a ngle A ratng, requrng mprovement a wll e explaned n paragraph 2.6 decreang the cot of workng captal. Tale 1 the centfc company credt ratng Ratng Agency Long term ratng Short term ratng Outlook Lat update Standard & Poor A- A-2 Negatve March 30, 2010 Moody' A3 P-2 Stale Augut 4, 2010 Det ratng agence have complex polce and frequently analyze rated compane trategy and une plannng. Thee polce are tred to capture y everal reearcher n model amng to predct the ratng y pulcly avalale fnancal fgure (Palepu et al., 2007). The well known Kaplan-Urwtz model wa ued to predct Standard & Poor ratng for 251 European compane n It predcted 55% of the categore rght, 41% one category off (e.g. AA ntead of AAA) and 4% were two categore of. Thee det ratng were prmarly drven y frm ze, proftalty, rkne of the proft tream and leverage (n order of tattcal gnfcance) (Altman, 1968). The latter three drver are nfluenced y the CCC when det pad off y free 9 US Securte and Exchange common 24

25 cah flow. Rkne of the proft tream may mpoe too lttle cah nflow and too much cah outflow reultng n ankruptcy. In the cae of the centfc company, every percent OWC decreae can contrute to approxmately 0.45% decreae n net det accordng to the alance heet of 2009 a depcted n appendx 3. Intead of decreang det other nvetment opportunte can are a well, a mentoned at the end of the chapter Relevance. Paragraph the value of freed cah elaorate on th dcuon. Weghted average cot of captal A det ratng one apect taken nto account y credtor to determne the requred nteret rate (Standard & Poor, 2009). Bede det ear nteret cot, equty provder requre a return on ther nvetment n equty. The total cot of det and equty can e calculated wth the weghted average cot of captal (WACC) formula a n equaton 2 (Palepu et al., 2007). The relaton etween det ratng and WACC wll e explaned n paragraph 2.6 Decreang the cot of workng captal C E w C ' 1 T E ' C E C E ` (Equaton 2.2) In th equaton C repreent the market value of det and E repreent the market value of equty. C repreent the cot rate of det and E the cot of equty. Addtonally T repreent the effectve tax rate. Th equaton apple to any frm and alo ued wthn the centfc company. The mot dffcult part to approprately determne the return on equty (E ). For more nformaton aout th topc reader are referred to (Palepu et al., 2007). The allocaton of nternal nteret rate for ncreae or decreae n workng captal element wll e dcued n the paragraph 3.1 modelng RF 2.5 Analy of the centfc company workng captal related trategy The mportance of CCC decreae n general wa dcued n the relevance chapter. Before dcung the opton avalale to the centfc company, t tuaton and trategy are dcued, provdng a frame of relevance for the revew of opton to mprove WoC performance. The prmary ojectve of fnancal management (n whch WoC management play a role) at the centfc company twofold. I.e. to ecure lqudty and to ncreae the enterpre value of the centfc company. Securng lqudty an enaler for ncreang the enterpre value, nce t protect agant ankruptcy. Followng Kaplan and Norton (1996), thee ojectve hold n general. Th general am pecfed n fnancal and operatonal value drver at the centfc company. Fnancal value drver are a utaned reducton n captal cot and an mprovement n fnancal cah flow. 10 Important operatonal value drver are the mprovement of the three CCC tem, whle mantanng ervce level and enurng an agle, rout and utanale upply chan. E.g. y flexle capacty, or hgher nventory level. Bede amng for ale growth, the reducton of det (ntroduced n paragraph 2.6 Decreang the cot of workng captal ) of conderale mportance. The operatonal value drver CCC reducton wll now e dcued from a cah flow perpectve. The CCC change can e derved from a cah flow tatement. At the top of th tatement the tem that add up to gro cah flow are lted. For the centfc company th amount 10 Source: General Gudelne for Fnancal Management at the centfc company 25

26 approxmately 5 llon per year n 2008 and Lted elow gro cah flow on the cah flow tatement are change n cah from operatng actvte, a depcted n tale 2. In cae of potve change (lack numer), cah requrement reduced, provdng the opportunty to pay off det or nvet n une opportunte. Ceter paru, cah requred for negatve change (red numer). Th lmtng effect had a magntude of 15% on gro cah flow n 2008, a depcted n Tale 2. A recoverng effect took place a year later. Tale 2 Cah flow change y nventore, trade account recevale and trade account payale Cah flow tem Gro cah flow 100% 100% Decreae (ncreae) n nventore (13%) 13% Decreae (ncreae) n trade account recevale (3%) (1%) (Decreae) ncreae n trade account payale 0% 5% Net change n cah provded y WoC tem (15%) 17% Net change n cah provded y WoC tem Further down the cah flow tatement nvetng actvte requred 3 llon n 2008 and 1 llon n In the comng year the centfc company det mature on average wth 1.57 llon per year, varyng etween 0.6 and 2.5 llon. A mplfed wort cae cah flow cenaro, n equence of the aove text would e (n llon): 5(gro) 3(nvetment) (det retrement) = llon,.e. hortage cah mple llqudty. Note that th doe not even take a change n CCC - e.g. lke n tale 2 - nto account. Therefore t can e concluded that a CCC change havng a cah flow mpact of 0.81 llon a conderale mpact. The amount fnanced y payale wa approxmately 8% of the amount fnanced y det and equty n 2008 and The opton avalale to decreae workng captal related nteret payment are dcued n the next paragraph. 2.6 Decreang the cot of workng captal At leat three opton are avalale to decreae the cot of workng captal wthout detalzng the upply chan,.e. modfcaton of captal tructure, ncreang the proft margn and decreang the CCC. The frt opton wll e dcued n depth, econd opton wll e dcued refly, the latter opton udvded n three polce and dcued more n depth, whch eventually lead to the opton uppler ntegraton and revere factorng Modfcaton of captal tructure A frt opton would e to decreae the WACC y changng the captal tructure. Th opton related to modelng n the uequent chapter. Takng the tax held of det n conderaton, det ear generally a lower rate than equty. Wthn the det range, hort term det ear generally a lower rate than long term det (Cox et al.,1985). From a ngle frm perpectve, th rate vare not only for dfferent tme to maturty, ut alo depend on the collateral avalale (Palepu et al, 2007). The opton of fnancng wth collateral not condered wthn the cope of th reearch. For more nformaton on th topc reader are referred to an nterrelated fnancal and operatonal performance model y Buzacot 11 Source: the centfc company annual report, 2009, pp

27 & Zhang (2004). Th leave the maturty tructure of det and tradeoff etween det and equty a dcuon for th paragraph. Thee wll e ntroduced here and elaorated on n the modelng chapter. The frt topc dcue replacement of long term det wth hort term det. The econd topc dcue replacng equty wth det. Snce long term det ear generally hgher cot than hort term det the frt topc mght ound a an attractve opton. However, replacng long term det wth hort term det caue det to mature efore the cah flow arrve from nvetment and th det mut e refnanced at term that depend on a frm future credt ratng (Damond, 1991). The dependence on the future credt ratng would mpoe a conderale nteret rate cah flow rk f a utantal amount of long term lalte replaced wth hort term det 12, nce a company cannot any longer negotate aout fundng when t can, ut now t mut negotate when t ha to. Addtonally Barclay and Smth (1995) provde a meta revew on three group of hypothee,.e. contractng cot hypothee, gnalng hypothee and tax hypothee. The centfc company take thee four conderaton nto account n decdng on the optmal maturty tructure of det. Current ratng Fgure 7 the centfc company WACC and det ratng 13 The econd topc of potental mprovement the replacement of equty wth det to decreae the cot of captal. Followng Guerard and Schwartz (2007) f the orrower rk ncreae too much y overleveragng wth det, the market may et a lower prce for hare than t would gve for mlar hare wth maller earnng ut a more conervatve fnancal tructure. The compane equty value would decreae a a reult. Replacng equty wth det doe addtonally ncreae the cot of captal y a decreaed credt ratng. Invetor conder the fnancal rk of the frm captal tructure and the ntenty of the economc or operatng hazard typcally faced y the ndutry (Guerard and Schwartz, 2007). The total mpact from a change n the det/equty rato depcted n fgure 7. Th fgure take Hamada equaton (1972) and proceedng nto account. The optmal leverage prefer equty, nce the hazard faced y a company can e uffered wth havng acce to a reaonale amount of ncremental det n varyng economc and captal market condton. Addtonally unued det capacty provde the opportunty to otan captal on a very hort term perhap wth jut a phone call. Addtonally unued det allow a company to take advantage of unuual major opportunte (e.g. acquton) or avod eng forced to take acton t deem underale. If hareholder hare th vew, then unued det capacty add to hare prce (Groth and Anderon, 1997). Thu y devatng from the optmal lalte tructure a company would e le ale to act 12 Source: Scentfc Company Corporate Fnancal Controllng 13 Source: Scentfc Company Corporate Fnancal Controllng 27

28 adequate to market opportunte or thread when dered. Addtonally a devaton would e enforced y hareholder and lead to a devaton wth a larger magntude Increang proft margn A econd opton to ncreae the proft margn. Followng an economc approach, the extent to whch th accepted y uyer could e modeled y a prce (P) - quantty (Q) elatcty curve. Th opton and any cot reducton n producton proce are outde the cope of th reearch Decreang CCC The thrd opton a utanale CCC (equaton 2.1) decreae. Herey the dfference etween OWC and the CCC hould e taken nto account. Aumng a lnear ale growth rate, payale and nventore grow wth an equal rate to meet demand, ceter paru reultng n an equal recevale growth rate. Furthermore ale and COGS ncreae wth the ame rate. Th altogether reult n an unchanged numer for the CCC. If the CCC ncreae utantally, then lqudty at rk. E.g. f ale uddenly declne and utantal amount of cah locked n nventory, not eng ale to e captalzed, a dcued n the chapter relevance. Therefore not only aglty n the upply chan mportant to keep the CCC teady, ut alo a contnuou focu on mean to decreae the CCC. Note that th doe not mply OWC reducton acheved, nce ale growth amed for. There are roughly three way of decreang the CCC,.e. payng later, advancng recevale and reduce the tme of an tem n nventory. The reducton of nventory value n the upply y optmzng nventory level elewhere n the upply chan than at the pont of exchange etween a uppler and uyer outde the cope of th reearch. The three opton wll e dcued n the remander of th paragraph. I Increang payment term Unlateral payment delay, a decred n the chapter Relevance, an opton harmng the upply chan, nce the payment term for one company the recevale term for another company. Wthn the cope of th reearch, t harm the uppler. Furthermore annual upply contract commonly ued wthn the centfc company - pecfy a payment term. Unlateral devaton from thee contract can not only lead to a detalzed relatonhp wth the uppler, t could eventually lead to a court cae ncreang the cot of upply. Extendng a payment term y lateral agreement an opton. Such a payment term, y t alty to fnance une, alo referred to a trade credt. Herey the nteret mplctly ncorporated n the purchae prce. Peteren & Rajan (1995) and Wlon & Summer (2002) argue that trade credt a mean to how fnancal health. Demrguc-Kunt and Makmovc (2001) add that n 39 countre around the world, trade credt ue wa hgher relatve to ank credt ue n countre wth weak legal envronment. Later, Fman and Ratur (2003) and Van Horen (2004) argue that trade credt ued a a compettve tool, partcularly for mall and young frm. The extent to whch payment term extenon pole depend on two of the fve force decred y Porter (2008),.e. the arganng power of uyer and uppler. Thee force are ovouly not equal for each tem to e ourced (Kraljc 1983). Depte all th the longer the payment term the more captal the uppler need to fund th payment term. Eentally a payment term ncreae can e een a a hft n workng captal from the uyer to the uppler. II Decreang nventory 28

29 A volumnou ody of OM reearch decre the opton to decreae nventory, whle achevng dered ervce level. Bufferng wth capacty or lead tme ntead of nventory decred y Hopp and Spearman (1996). Wthn the cope of th reearch le the decreae of nventory etween the moment of fnhng a product at a uppler and ung t at a uyer. A revew of the extenve ody of lterature wll e confronted wth the trategy of uppler ntegraton of the GPC n chapter 4 uppler ntegraton. In th chapter the argument for preferrng workng captal on the uppler account from a upply chan perpectve wll e motvated whle developng the uppler ntegraton model, th argument hold for payment/recevale term a well. III Advancng uyer payment Varou method to advance uyer payment gven the cope, from a uppler perpectve - are dcued n th chapter. The mplet opton to decreae the recevale term, oppote to opton 1 (ncreang payment term). Th opton eentally hft workng captal from the uyer to the uppler, whch a wn-loe opton. Three alternatve are avalale: Advancng uyer payment: Dcount on early payment Dcount on early payment are a common practce n B2B payment, whch hold for the centfc company a well. An example 2% dcount for payment wthn 10 day and no dcount for payment etween 10 and 30 day. Frt of all doe th not guarantee payment wthn 10 day nce the uyer can decde to pay on day 30. Smth and Schnucker (1994) argue that the dcount offered provde nformaton aout the uppler fnancal tuaton,.e. hgher dcount, ceter paru, mply hgher uppler WACC. Aumng the uppler would e wllng to offer the WACC rate a a dcount for the recevale term decreae, then equaton 2.3 hould e ale to calculate the uppler WACC. (day per year) x (dcount rate) (term w thout dcount (n day) - term w th dcount (n day)) (Equaton 2.3) In the example aove th mple the uppler eleve 36,5% 14 an attractve fnancng rate. Whle offerng a dcount common, the fnancng rate accordng to the equaton 2.3 not. Followng Kramer (2010) uppler prmarly accept thee term offered y procurement department to wn une. He furthermore tate: It enale the uppler to offer a prce dcount to favored uyer wthout mpactng lt prce. Further, mot procurement department are ncented to otan dcount term ecaue ther compenaton aed on prce rather than workng captal and cah flow. From the uyer fnance perpectve uch term are lkely to e accepted, nce 36% generally approxmately a factor 3 or more hgher than an nvetment grade company WACC rate. Ironcally, a tudy of Bartoln (2009) reveal le than half the compane wth revenue over 1 llon US dollar are ale to pay wthn 10 day. Th mple takng the dcounted early payment nfeale. Ethcally, takng the dcount and payng after the dcount term would not e rght. Concludng, there hould e a etter alternatve for decreang recevale than dcount on early payment. Advancng uyer payment: Factorng 14 Calculaton: ((365/(30-10))*2%) = 36.5% 29

30 Factorng an nteretng opportunty f a frm fnancal dtreed ut ha fnancally healthy uyer. In a factorng arrangement a uppler ell t recevale to a thrd party (the factor 15 ). The factor make an nteret charge (aed on the tme to maturty), may mpoe a tranacton fee and pay the remanng value of recevale n cah. Fgure 8 depct the proce of factorng. Th extent to whch recevale mght e ncluded n a factorng program depend on the cutomer credtwortyne. Factor Suppler 2 1 Cutomer Fgure 8 Factorng 1. The uyer place an order to the uppler 2. The uppler upple good or ervce and ue the nvoce 3. Suppler frm requet fnancng and provde the detor ook (Sale Ledger) 4. The factor nvetgate the credtworthne of the uyer 5. The factor pay the uppler the recevale related to the order mnu charge 6. After the payment term ha expred the uyer pay the factor Factorng can take place ether wth or wthout the tranfer of default rk from the uppler to the factor. If the default rk not tranferred and factor not ale to collect payment from the uyer, then t recoup the payment from the uppler. Th referred to a recoure factorng. Followng Klapper (2006), n Italy 69% of all factorng done on a nonrecoure a. Smlarly, a tudy of pulcly traded frm ung factorng n the U.S. found that 73% of frm ue nonrecoure factorng. However eller wth poorer qualty recevale a well a eller who, themelve, have a hgher det ratng were more lkely to factor wth recoure (Sopranzett 1998). Non-recoure factorng alo preferale from an IFRS accountng perpectve, nce t clafed a a ale of recevale, wherea recoure factorng clafed a orrowng, nce the eventual recoup a lalty to the uppler. Both factorng varant have one apect n common; the fnancng rate depend on the credtworthne of uyer, rather than the frm requrng fnancng. Th drve the ucce of factorng for llqud compane that upply to credtworthy uyer, depte factorng compane can etmate the alternatve fnancng choce efore offerng a dcount rate to the uppler. The Factor generally wllng to fnance up to 99% of account recevale (Soufan, 2002) wherea ank are generally not wllng to fnance more than 50-60% of account recevale. The development of conducve and reponve legal envronment n the egnnng of the twenty-frt century ha contruted to a worldwde applcaton of factorng. Furthermore the ncreae of gloal competton ha contruted to the ncreaed ue of factorng. I.e. uppler offerng trade credt ncreae ther volume of account recevale. Thee account recevale are the market for factorng and have grown conderaly (Wlon and Summer, 2000). In order 15 The term factorng derved from Latn and wa ued htorcally to refer to a mercantle agent who aded a une n t trade y uyng and ellng dtant land, takng good on congnment and advancng money. 30

31 to acce th fnancng frm are ometme prepared to out-ource ther credt management admntraton (Wlon and Summer, 2000). Thee addtonal ervce nclude collecton, credt protecton, cah management and detor admntraton (Wlon and Summer, 2000 and Beuvng, 1996). For elaoraton on the market of factorng product reader are referred to Beuvng (1996). Thee ervce are not jut outourced to otan fnancng accordng to Smth and Schnucker (1992). They argue that econome of cale at factorng compane provdng thee ervce decreae the cot of thee ervce. Partcularly frm wth geographcally dpered uyer and few repeated ale to any gven uyer have hgh cot of nformaton and montorng. In thee ettng factor comne nformaton aout uyer and eller aout product rk and credt rk at lower cot than could ndvdual frm gven the nternatonal experte of factorng compane on rule, regulaton, language and credtworthne nvetgaton (Smth and Schnucker, 1992 and Klapper, 2000). Wlon and Summer (2000) argue that eaonalty and varalty n demand doe not gnfcantly motvate compane to ue factorng. Accordng to them the oppote true. Stalty of demand potvely correlated wth the ue of factorng. Hghly varale demand more utale for ad hoc factorng than contract factorng, nce a factor prefer a tale ncome. Addtonally n low demand eaon the uppler would need addtonal fnancng for fxed cot, ut recevale are on a lower level then when demand hgh and thu the larger the eaonalty effect le enefcal factorng can e. Downde of factorng are the nteret rate and charge from a factor may e cloe to the cot of drect loan or a lne of credt, dependng on the recevale portfolo. Klapper (2004) argue that fraud n developng countre made factorng unproftale n thee countre for factor. Addtonally ome countre allow nteret payment from ank to e tax deductle do not apply the ame deducton to the nteret on factorng arrangement. VAT taxe may e charged on the entre tranacton (not jut the ervce fee), and tamp taxe may e appled to each factored recevale (Klapper 2004) For a dcuon on the legal perpectve on factorng ee (Beuvng, 1996 and Ruddy, 2006). Elaoraton on ngle factorng are account recevale exchange tradng (Schmdt, 2009 and appendx 4) and revere factorng. Account recevale tradng partcularly utale a new ource of captal for SME uppler, partcularly gven that ank are more reluctant to extend fnancng to SME and thoe compane n countre that may e deemed hgh rk. Whle th mght e a oluton to uppler of the GPC, t not enefcal n a drect fnancal ene to the centfc company and wll therefore e dregarded a an opton. Revere factorng wll e decred n the next chapter a part of a roader approach called upply chan fnance 3. Supply Chan Fnance Supply chan fnance (SCF) a road defnton addreng fnancal apect n the upply chan. It can nclude non-current and/or current tem of aet and/or lalte of multple frm n a ngle or n multple upply chan or upply network. All paper tuded y the author have at leat one apect n common,.e. the ue of fnancal related (often credtworthne) nformaton from other lnk n the upply chan than the lnk requrng fnancng. For a dcuon of defnton, ncludng apect of operaton and nformaton management reader are referred to Pfohl and Gomm (2009). In management lterature the road defnton upply chan fnance often ued when a pecfc apect or development wthn the range of fnancal upply chan 31

32 development meant. The cae tuded a pecfc form of SCF,.e. uyer ntated non recoure revere factorng of confrmed payale. Revere factorng can e defned a follow: the electronc preentment of approved payale from the uyer to the uppler wth the uppler havng the opportunty to dcount thoe payale to cah earler than the payale maturty date. (Fnancal Tme Lexcon) Ironcally the keyword for the aove defnton upply chan fnance. In RF program a large corporate uyer an ntegral part of the arrangement. Th concept A g opportunty accordng to Atknon (2008). An onlne portal of RF to whch uppler can ealy connect and decde on the moment of dcountng any nvoce ncreangly adapted. Large corporate uyer have eentally two opton. (1) A mult fnancal nttuton platform wth compettve rate and a relatvely hgh ntal nvetment. Or (2) a ngle fnancal nttuton platform wth a lower ntal nvetment, ut rate are dctated y the fnancal nttuton. The HTM group choe for opton 2. Accordng to a procurement manager, th relatvely mple opton upported a quck tart. The choen RF provder experenced almot a factor 1000 growth of nvoce volume through RF n the pat 17 year from 61 mllon to 43 llon, offerng ervce now to over compane (under whch over 20 from appendx 4), ettlng more than 55 thouand nvoce daly. In a 2006 urvey y Aerdeen reearch group 70 out of 100 compane pread over ndutre and geographe ndcated they had ether mplemented or were evaluatng SCF program. The attenton for RF addtonally hghlghted y a urvey n 2009,.e. out of 1000 Brth and German frm 61% of Brth frm and 43% of German compane are plannng to monetze ther recevale or utlze payale fnancng (Demca, 2009). And md 2010 a urvey among 168 enor fnance executve n U.S. compane wth more than $500 mllon n revenue revealed that 21% partcpate n SCF a a uyer, 9% a a uppler and 35% a oth. Another 17% conder tartng. The remanng 18% had no plan for SCF of whch 65% argued they dd not know enough aout any of t eneft 16. For uppler the eneft of RF are cloely related to the dadvantage. The fnancal nttuton montor only the corporate uyer credtworthne contnuouly ntead of the uppler whole uyer portfolo, whch the cae when normal factorng ued for all recevale of a partcular uppler. The hgh credt ratng and ngle company nvetgaton decreae the cot of nformaton for the factor. Furthermore, y the actve partcpaton of the large corporate uyer factor otan etter nformaton and can releae fund earler (Sefert and Sefert, 2009). The downde that only recevale from uyer offerng RF can e ued a a fnancng ource, wherea n cae of normal factorng the recevale from mot uyer can e ued. For fnancal nttuton RF nteretng nce the amount of payale from multnatonal are utantal and the cot of otanng (credt) nformaton are relatvely low. The downde dependence of the fnancal nttuton on the uyer credtworthne. Th mght nvolve lengthy credt nurance negotaton for fnancal nttuton (Volcke, 2006). Therefore only nvetment grade compane are attractve for fnancal nttuton to etalh a RF agreement wth and SME are generally not. Th hold ovouly only f uppler regularly chooe to dcount ther recevale oon after confrmaton y the uyer. The advantage for corporate uyer, upportng fnancal nttuton ncome the extenon of payment term n turn for offerng the RF opton to uppler. By extendng the payment term the uppler tll ale to dcount the amount drectly after the nvoce confrmed, ut the payment term extenon ncreae the dcount rate to e pad y the uppler. Snce t tll

33 cheaper for the uppler to accept th hgher rate, rather than ung other ource fnancng durng the ntal payment term the uppler lkely to dcount the recevale early. RF provde the opton for the corporate uyer to trengthen the uppler ae or decreae purchae prce. The added value of RF for a company nvetgated n a revew y Sefert and Sefert (2009). They ntervewed 23 large corporate uyer on the ucce of RF. By mplementng RF on average a 12% workng captal reducton for large corporate uyer and 13% workng captal reducton for uppler acheved accordng to large corporate uyer. Addtonal advantage mentoned y the uyer are tandardzaton of payment term, mprovement of uppler relaton, reducton of prce and nformaton gan aout uppler' fnance. Dadvantage are, 44% reported reduced credt avalalty, 31% reported preure to guarantee payment, and 25% reported other drawack. Accordng to them choong the rght ankng partner of conderale mportance. Propoed relevant crtera for the ankng partner are a wde geographc reach, legal experte and fnancal mucle. Th elaorated n chapter 7 mplementaton. RF tll not a common a det, nce one executve reported that uppler would rather accept late payment than e nvolved n a eemngly complcated program that they do not undertand. Applcaton of RF are not n all cae ntated y the uyer. Bede uppler, government alo developed RF platform to upport economc development and export n developng countre (Klapper, 2006) and export va SME n developed countre (Polcell, 2010). Addtonally Hofmann (2005) decre a concept n whch a logtc ervce provder ntate SCF. Multple reearcher am to model SCF a a tool to fnance nventory, ut they lack to decre RF a a polty. Th tatement hghlghted y Pfohl and Gomm (2009). They revew the lterature on RF and conclude that the reearch gap for RF le n the upply chan perpectve on reducng the cot of captal. A a conequence they propoe a model n whch a project (e.g. nventory) of one ter n the chan can e fnanced y another ter n the chan (e.g. wth uyer ntated RF) a an alternatve for external nvetor. They do however lack to decre elaoraton on the fnancng practce for th project, on the mpact on credt ratng and the legal (m)polte. Wthout an n depth nvetgaton of practcalte ther model contrute more to academc rgour than relevance. Buyer ntated RF program cannot e modelled accurately wth th model, nce there not neceary a project avalale. It doe alo lack to model varalty n the freed cah, whch aumed a fxed amount equal to project ze. The next paragraph devoted to modellng RF,.e. an opton that decreae the cot for uppler and uyer n the upply chan wthout any negatve mpact on operatonal factor of the upply chan. In chapter 4 the uppler ntegraton trategy of the centfc company wll e confronted wth lterature and modelled quanttatvely. Thee model wll e teted for entvty and nteracton n chapter Modelng revere factorng The frt tep n modelng a conceptual decrpton a a reult of nvetgaton of RF practce at the centfc company n cooperaton wth the fnancal nttuton and uppler, whch wll e modeled centfcally afterward. Thereafter the centfc model wll e valdated for the HTM group and for the GPC. The nformaton for the conceptual model and verfcaton of the centfc model receved from two procurement manager wthn the HTM group and one fnance manager. The communcaton method ued are nteractve veral,.e. ntervew and telephone converaton, wrtten text, PowerPont and Excel fle y e-mal and ntranet. 33

34 3.1.1 RF concept The HTM group ntated a ngle ank platform prmarly to quck tart mprovng ther workng captal tuaton y ncreang payment term. Smultaneouly uppler can decreae recevale to reduce ther utlzaton of extng fnancng y flexle low cot refnancng. Addtonally doe RF am to trengthen the te wth uppler and decreae the llqudty rk at uppler ncreang upply certanty. Indrect reult are RF drven proce mprovement. The mplementaton tarted wth a ankng partner electon. The ankng partner wa elected for t longet experence wth RF and et experte, the mplementaton proce ncluded the department procurement, treaury, accountng, IT and the followng tep: 1. Ganng CFO commtment 2. Preparaton for and dcuon wth ankng partner 3. Verfcaton of the accountng treatment 4. Invetgaton ytem mpact and fealty 5. Defnton of Plot Suppler 6. Accountng proce re-degn 7. Treaury proce redegn 8. Sytem programmng 9. Suppler communcaton concept 10. Preparaton workhop wth uppler 11. Feedack wth partcpatng uppler 12. Start plot 13. Evaluaton of roader roll out The legal proce tep are (1) A contract etween the centfc company recevng legal entty and the RF ank (2.1) A contract etween the upplyng legal entty and the RF ank (2.2) A contract etween the good upplyng entty and the centfc company good recevng entty. Then applcaton of RF can tart. The uppler and uyer wll only accept RF f the eneft are larger than the cot n trategc, operatonal and fnancal term. Therefore the uppler electon crtera can only e decred f the cot and eneft n trategc, operatonal or fnancal term, ther tructure and talty over tme are known. Frt the operatonal proce and fnancal mpact of RF wll e conceptually decred. The trategc motvaton have een ntroduced n the paragraph Relevance on page 12 and n chapter 2 Workng captal management. The mplcaton of decon wthn the RF framework wll e decred durng the model development and teted for ther entvty n paragraph 6.1 RF entvty. The operatonal proce of RF mlar to factorng a depcted n fgure 8. It compared wth an ntal arrangement n fgure 9. A one can ee the ntal term (t α ) horter than the new term (t θ ). At the uyer, a a conequence of payng later, cah held for a longer perod. The uppler ale to collect payment earler than after t α.e. after notfcaton from the ank (t f ). The RF model aume one can earn a return on th freed cah. The cot of RF for the uppler are at nvoce ettlement efore extended maturty. When the ank purchae the recevale from the uppler the tme value of money and rk of uyer payment default decreae the amount receved y the uppler. 34

35 The fnancal gan for the uyer are the nteret avng on releaed cah, mnu any fxed (IT platform) or varale (negotaton and educaton) cot. The fnancal avng for the uppler are the nteret on releaed cah mnu the nteret pad for the advanced payment. The operatonal mpact wll e dcued n the chapter 7 mplementaton. Suppler Buyer Suppler Fnancal nttuton Buyer Order Order Delvery Delvery Invocng tα Notfcaton Invocng Advance payment requet Confrmaton Invoce ettlement* Full payment Invoce ettlement* Payment at extended maturty t t f tθ Intal arrangement net term Revere factorng arrangement Informaton Product Cah *only once per nvoce Fgure 9 - Intal veru RF arrangement Scentfc RF model for payment term extenon The payment term extenon avng model elaorated on a ank avng calculaton preadheet ung ntervew wth procurement manager at the hgh tech materal department. It verfed wth the calculaton method ued y Deutche Bank, CtyGroup and Santander. It model the annual eneft aed on the cot of captal rate dfference, aumng uppler f dcount payale drectly after t t ung the followng varale. Unle explctly mentoned, the followng ndexe for varale apply. Supercrpt wth,, f 35 where = uppler = uyer and f = fnancal nttuton. And ndexed wth ucrpt j,,, where α for ntal tuaton, β for SMI tuaton, θ for RF term extenon and μ for RF prce decreae. The followng varale are ued. w WACC percentage (ee equaton 2.2) r e Euror rate percentage r f Bank margn percentage t j Payment term day t Invoce confrmaton tme day t f RF nvoce proceng tme day V j Annual purchae volume Euro I Intal nvetment Euro S net avng Euro j

36 D Annual demand unt u j unt purchang prce Euro If the payment term would not e extended, the net avng for the uppler can e calculated wth equaton 3.1, uject the contrant 3.1 and 3.2. Note that V j = D x u. f * e f ( t t t ) S V ( w r r ) (Equaton 3.1) 365 e f w r r (Contrant 3.1) f t t t (Contrant 3.2) If the payment term extended and V V, contrant 3.1 and 3.2 mut hold and contrant 3.3 mut hold a well for the uppler avng n term extenon cae Addtonally for the uyer avng S to e potve. S to e potve, contrant 3.4 mut hold. If contrant 3.3 doe not hold, the uppler pay more nteret to fund the uyer new term ( t ) than he can ave y the releaed cah from the dcounted term. The dervaton of contrant 3.3 depcted n appendx 14. f w ( t t t ) f t t t e f ( r r ) (Contrant 3.3) t θ > t α (Contrant 3.4) Thu n order for RF to yeld avng for the uppler and the uyer, the feale range of t θ ounded y the aove contrant. A method to determne f t θ, approprate for the uppler to expre t θ n the actual uppler fnancng rate equaton 3.2. Note that t θ and f are ndependent of V j. f when RF ued for term extenon ung f e f f ( r r )( t t t ) f t t t (Equaton 3.2) f relevant a wll e explaned n paragraph 3.2.1,.e. ung WACC a a avng rate not that ovou. The feale regon for t wa defned y contrant 3.3 and 3.4. The maxmum extenon wthn the feale regon et y equaton 3.3. m ax f w ( t t t ) t t t e f ( r r ) f (Equaton 3.3) At m ax t, uppler. f = w and S 0, whch referred to a reak even term extenon for the * S can e otaned ung equaton 3.5 ung m ax t. Vce vera ung t t a 36

37 nput, one otan * S and S 0, hery equaton 3.4 reduced to equaton 3.1. For any t, S can e calculated ung equaton 3.4 or 3.5. V f e f f S w ( t t t ) ( r r )( t t t ) (Equaton 3.4) 365 V w ( t t ) S (Equaton 3.5) 365 So far, the model decre a ngle term extenon for a ngle uppler. RF doe however allow for multple payment term extenon per - or at multple - uppler. Therefore every unque comnaton of ( V, t, t, t ) allocated an ndex numer y varale x. Wth = 1,2,3..X. In cae of multple term extenon per uppler the net avng can e calculated wth equaton 3.6, aumng ome t f for each comnaton. X 1 f e f f A V w ( t t t ) ( r r )( t t t ) x x x x 365 x (Equaton 3.6) Addtonally one could calculate the accumulated avng for all frt ter uppler ung an ndex for A e.g. z (wth z = 1,2,3,4 Z) and ue equaton 3.7. Z A, z z (Equaton 3.7) The accumulated avng for the uyer can only e calculated y takng the ntal expene nto account ung equaton 3.8. The (1-T ) tranfer the efore tax expene nto an after tax mpact. The mot mportant argument to do th to otan market value of fnancal mpact. N w V ( t t ) I (1 T ) x x x 365 x (Equaton 3.8) A RF mplementaton doe yeld captal avng for all nvolved uppler and the uyer f contrant 3.3 and 3.4 hold for every x. 3.2 Valdaton The model verfed n three way (1) on ung the rght varale (2) on repreentng the complete mpact of RF (3) on the alty to otan accurate value a nput varale,.e. meaurement method. Thee topc wll e dcued per apect and practcalte are elaorated on n chapter 7 mplementaton. 37

38 3.2.1 The value of freed cah Equaton 3.4 and 3.5 can e ued to calculate the average annual avng for uppler and uyer, aed on ncreae of cah. In order to e ale to acheve thee avng, every euro of freed cah hould e ale to yeld a return at WACC rate level. Bear n mnd that WACC (equaton 2.2) an after tax rate. Snce uppler were not avalale a a reearch ample th aumpton teted wthn the centfc company holdng and lterature. It aumed the reult of the followng dcuon hold for uppler a well a uyer. Intal perpectve from two manager were non convergng (n the ene of a dtncton explaned n th paragraph), therefore the ample wa ncreaed to even ntervewee, pread over four herarche, three ugroup and three functonal department. The queton aked were what the rate for freed cah from workng captal? and after provdng alternatve perpectve would you e ale to comment on alternatve perpectve?. Th yelded eentally two group of anwer. The fnancal perpectve anwer and the operatonal perpectve anwer. Multple manager howed undertandng for oth perpectve. The fnancal orented anwer lnk ack to paragraph 2.6 decreang the cot of workng captal and unlkely to allocate a rate a hgh a WACC to freed cah. Th upported y the RF model from Deutche Bank (Phllpp, 2009), ung the uppler hort term fnancng rate ntead of WACC a a trade off. Volume and varance of freed cah play an mportant role n th argument: Once DPO ncreae and cah freed t can e ued to nvet or to decreae det. The freed cah hould e teted for two crtera: (1) The nflow crteron: the mean cah level mut utantally ncreae (depcted y arrow 1 n fgure 10). (2) The outflow crteron: there mut e an opportunty at hand to ue the cah for wth a return at WACC rate (arrow 2,3,5 and 6) Example of outflow are an nvetment opportunty (arrow 2) or det avalale that can e pad off (arrow 3). If the DPO level decreae (arrow 4), the cah mut e ganed y dvetng (arrow 5) or ncreang det (arrow 6) DPO Cah pool Invetment Det Fgure 10 DPO and cah flow Dvetng or ncreang det when one ha to, a explaned n paragraph 2.6, lkely to e an unfavorale deal. Thu the cah hould e freed for a lengthy perod of tme n order to e ale to yeld nvetment or long term det rate at WACC level. The nflow and outflow crteron wll e taken nto account mplctly n the followng three argument: 38

39 (1) Relatve amount: Gven the end of year cah amount at the centfc company n 2008 wa 2 llon and 2,7 llon n , the cah freed mut e uffcent to e ale to nvet or decreae det wthout ncreang the cah flow rk. I.e. f t doe not ncreae the mean or decreae the varance gnfcantly, then t too rky to ue the freed cah for th opton, ecaue of the cah nflow and outflow varance. At the moment of wrtng th the RF n very early tage (le than a year experence wthn the HTM group). The mpact of RF on varance and average an t utanalty cannot yet e determned wth uffcent relalty. Baed on nformaton avalale md 2010 and takng nto account that the tme length of upply contract uually one year, a comnaton of hort and md term det could e decreaed yeldng a rate lower than WACC. (2) Alternatve: The econd nflow crteron argument mot related to uppler. I.e. mall amount of cah y RF can alternatvely e ganed y offerng commercal paper or hort tme fnancng, nce the amount are mall t would not ncreae the nteret cah flow rk gnfcantly and rate are lkely to e lower than f. If amount ecome larger, whch pole f the amount of recevale from the RF offerng a a percentage of total aet ncreae, then RF ecome more enefcal and can e agned a hgher avng. Th opton doe generally not hold for SME and a drawack, when the amount fnanced va RF ecome utantal the dependence on the uyer credt ratng ncreae. If the credt ratng of the uyer deterorate, than r f wll ncreae. If a cheaper fnancng opton than f avalale, then payment can e taken at maturty or the RF contract can e termnated anytme. Both alternatve do not necearly undo the term extenon agreement. (3) Varalty: Th argument relevant for the uppler and uyer and wll e explaned ung an example depcted n fgure 11. Aumng monthly order and the payment term for the uppler (uyer) would e decreaed (ncreaed) y 40 day ung RF yeldng a utantal cah ncreae a depcted n fgure 11. Then to e ale to decreae long term det or nvet, the current cah level mut e exactly the nvere o that the accumulaton of ntal and freed cah equal a contant cah level. Th very unlkely nce upply decded on y operaton, not fnance. A an alternatve fnancal oluton det can e decreaed y the average freed cah level,.e. 86 n th example. Now th mple a hortage of cah whenever freed cah elow 86. Then only f hort term fnancng avalale when freed cah elow 86, at a rate lower than the return on cah when freed cah aove 86 a rate cloe to WACC can e agned to the freed cah. Th eem hghly unlkely, moreover can the extent to whch th pole only e aeed f accurate cah flow forecat for non RF cah flow are avalale. 17 Source: Annual Report

40 Freed cah Tmelne of freed cah Month January order ( 20) Feruary order ( 40) March order ( 30) Aprl order ( 120) May order ( 70) June order ( 80) July order ( 110) Augut order ( 60) Septemer order ( 90) Oktoer order ( 100) Novemer order ( 40) Decemer order ( 30) Fgure 11 tmelne of freed cah (example) Thu not only eem the rate of WACC unlkely hgh, t alo unlkely that the uppler wll advance payment when he doe not yet need the cah, a wll e dcued n the next paragraph, after the operatonal perpectve ha een ntroduced. The operatonal perpectve le comprehenve and cont out of three argument a well. The frt argument germnate out of two calculaton method wthn the GPC and related contency of polce. The econd from a fnance profeon pont of vew and the thrd from a centfc pont of vew. (1) Inter company contency of polcy: Th argument nvolve a decon tool for choong etween a dcount or a payment term, whch ued when a uppler offer a dcount. Th tool ue equaton 2.3 (p 27); f the mpled rate hgher than the uyer WACC rate, then the dcount taken. If the reult lower the nvoce wll e pad at maturty. The econd method concern the calculaton of nventory holdng cot. The workng captal element n thee holdng cot equal WACC 18. Thee two method ugget that f cah ued or freed, the WACC rate apple. Bear n mnd that all accumulated reducton n workng captal y reducng nventory and ncreang payment term are etmated to e permanent and utantal. Tale 2 (p 24) ndcate that t ndeed utantal. Some manager go even further n ther argument and prefer a rate hgher than WACC, ecaue t eleved to encourage reducton n nventory. The drawack of ung a hgher rate than WACC dcourage for project wth an ROI jut aove WACC. (2) Cro company contency of polcy: The RF concept at the centfc company holdng ntended to e a long-term fnancng alternatve. It not etalhed for the next two month ut ntend to mplement RF a a long-term way of payng uppler. Therefore, the relevant fnancng cot whch hould e compared to RF are the total average fnancng cot of the uppler, a the uppler wll e ale to fundamentally change h fnancng. Conequently for the extenon of payment term alo a long term extenon and wth mlar argument the WACC rate hould e agned to freed cah at the uyer. (3) Scentfcally: The operatonal perpectve upported y centt Modglan & Mller (1958) and Schwartz (1959). From an academc perpectve n makng real nvetment decon, all three agree that the approprate dcount varale not the mmedate fnancal ource, ut the overall cot of captal (Guerard & Swartz, 2007). Conequently other captal ue mut on average e allocated an overall cot of captal rate a well, 18 It ue WACC efore tax, ut th topc dcue after tax rate. 40

41 nce otherwe the weghted average allocated cot of captal rate on all aet would not equal the overall corporate WACC. Conequently RF hould e allocated the WACC rate. Concludng, freed cah from RF at uyer and uppler can replace at leat hort and md-term det and mght e ued (n comnaton wth freed cah from other ource) to decreae longer term det or nvet 19. Thu the currently ued rate (WACC) n the RF model mght e too hgh, aed on the argument o far. For the purpoe of contency RF freed cah hould e allocated the WACC rate Completene of the model The econd topc of verfcaton concern the extent to whch the model provde a complete repreentaton of the expected RF mpact n operatonal, fnancal and trategc ene. Ovouly, followng Bertrand and Franoo (2002) a model cannot capture the full extent of realty. Th RF model lack the repreentaton of the followng: a) Accountng-, det ratng mplcaton and the uppler perpectve on the value of off alance heet fnancng. ) The uppler perpectve on the value of knowng when cah wll flow n and havng the polty to ell a recevale on any moment efore maturty to accelerate nflow when requred, nce a company doe generally not notfy a uppler when he wll exactly get pad. c) The extent to whch RF ale to talze the upply ae y avng uppler from ankruptcy d) The tradeoff for uyer and uppler, etween ung RF for a prce decreae and the current model for payment term extenon. e) The nteracton wth uppler ntegraton and n partcular congnment tock f) Implementaton dffculte and econdary mprovement, e.g. decreang the nvoce confrmaton tme (t ), workng captal awarene at purchaer and ale peron, legal awarene and cah flow control at uppler. In th chapter topc a-d wll e dcued n the aove equence. Topc e wll e dcued n chapter 5 and 6. Topc f wll e dcued n chapter 6. Off alance heet fnancng From a uppler perpectve RF a form of off alance heet fnancng (OBSF). Followng Law and Smullen (2008) OBSF a method of fnancng a company' actvte o that ome or all of the fnance and the correpondng aet do not appear on the alance heet of the company. In cae of RF th hold for recevale y whch a uppler can enhance t accountng rato, uch a the gearng rato and return on captal employed. It can furthermore avod reakng any agreement t ha made wth the ank n repect of the total amount t may orrow. Th tructure may enale the uppler to acce more fundng than would e pole on a tandalone a. OBSF ganed a negatve mage nce t ha een pole, y drawng up complex legal agreement, to conduct off-alance-heet fnance and thu mlead the uer of the account. Th hghlghted y the candal urroundng the collape of the energy-tradng gant Enron n Thereafter Standard & Poor updated t ratng crtera for off-alance heet tem 20. Ratng agence would however, not vew a uyer drven recevale program uch a RF a detrmental to other ratng of the uyer o long a the programme doe not 19 Th aume that RF not already part of extng fnancng. 20 Source: Factorng off-alance heet fnancng nto the ratng proce 1-2 (Aprl 15, 2002) 41

42 ncreae ther det capacty or put another way o long a t ued a a trade credtor for upply chan talzng purpoe (Sddal, 2010). Accountng tandard do however requre at leat a note on off alance heet fnancng and dependng on crtera uch a control and rk over aet even captalzaton mght e requred. Depte factorng wthout recoure - a ued n RF decred here treated a a ale of recevale n each accountng ytem dentfed y the reearcher, compane mght tll e reluctant to ue RF. The fact that non-recoure factorng doe not qualfy a lalty for the uppler, ecaue the rk tranferred to the factor that ought the recevale doe not mean t a cheaper ource of fnancng than varant wth lalte on alance heet. Neverthele mght the off alance heet property of RF e valued y uppler, partcularly when ther lalte judgment are not pulcly avalale, e.g. when they are not rated y ratng agence. Sellng a recevale any tme veru tradtonal fnancng A ntroduced n the dcuon of the fnancal perpectve on the rate of return on freed cah, RF can erve another purpoe for the uppler than decreang det and nvetng. Fater nvoce approval enhance cah flow vlty and cah flow predctalty. Th determntc cah nflow replace uncertanty. And the uncertanty uually uffered wth a cah pool or credt lne whch requre nteret payment even f credt lne are not ued, ut only erve a a ackup. Th elmnate a credt lne already, ut addtonally can erve to decreae the mpact of cah flow varaton that are ether expected or not. Thee contnuou hort term addtonal feature of RF provde value for any uppler regardle of ther cot of captal. Addtonally RF can erve to uld up cah n cae of nfrequent exceptonal expene, e.g. for large ond payment due or for uldng up cah for an acquton Strano (2010). Thee three mportant motvate the ue of RF regardle of the cot of captal. Toward quantfcaton of thee feature, alternatve fnancng method (e.g. credt lne or commercal paper) mply an nteret wth a term or value that mght exceed the perod n whch cah requred, mplyng unneceary nteret payment. In cae of RF nteret only pad for the tme to maturty 21. Herey there a tradeoff etween the expected expene y RF from advanced payment on the one hand and contnuou nteret payment of an alternatve fnancal ntrument (e.g. a credt lne or commercal paper) on the other hand. Th prncple wll e explaned ung a metaphor to enhance undertandng of th topc for operaton manager: Cah flow can e compared wth the flow of good throughout a tradng company holdng nventory. The dfference that cah flow n the oppote drecton. Demand and/or upply of good have a certan varalty and o doe that of cah. Cah lke nventory, eentally a uffer and thu requred n maller amount f varalty and/or uncertanty of t nflow and/or outflow decreae. Ung RF the varalty of nflow wll e made vle reducng the uncertanty and controllale reducng the varalty. 22. Th way emergency upple (of cah or good) mght e cotly when ued, ut cheaper n term of total cot than nteret expene of contnuouly holdng large uffer (of cah or good). Takng an operatonal perpectve, th ha no mplcaton on the ntal model. Furthermore nether Deutche ank, nor Santander or Ctank quantfe th argument n ther value propoton of RF toward uppler. However, takng the fnancal perpectve, vlty and flexlty have two mplcaton on the ntal model,.e. (1) not every nvoce dcounted n advance of maturty,.e. nvoce are on average dcounted y the uppler after t and (2) the alternatve for RF ha a hgher value and eventually a longer term d, a n contrant 3.5. e f Conequently f ( r r ) w equaton 3.4 can e replaced y equaton 3.9. Th numer wll only e potve f contrant 3.6 hold. 21 No nteret expene, ut a decreae n revenue 22 Up to the extent to whch RF offered for all recevale. 42

43 RF Alternatve perod t d amount V rate e f ( r r ) Tale 3 varale for RF and alternatve r d t t t t S r V r r V w e f 1 d r V t r r V t t t w 365 e f (Equaton 3.9) d t V (Contrant 3.5) e f d r V t r r t t t w (Contrant 3.6) A mlar reaonng doe hold for the uyer, except that the uyer cannot decde on payng earler or later,.e. the uyer ha to pay later and thu the uyer cannot decde when to free the cah. For the uyer however freed cah except the ntal IT expene for free. For oth the uppler and the uyer any avng are hghly depended on the fnancng polce and alternatve fnancng polte of the fnance and treaury department. An n depth analy of the daly practce of a fnance manager would e requred to yeld a rate to e allocated to RF avng. Followng Mtroff et al (1974) th model extenon mght e an expreon of over valdaton reultng n unneceary complexty for uyer and eller wth lttle fnancal knowledge and decreaed generc contruton. I.e. the frt element of equaton 3.9 would contnuouly vary over tme for a uppler and uyer. Of coure one can evaluate RF wth th model, ut that not the am of th extenon, the am to predct the advantage avng rate and therefore t would e etter to ue one rate for freed cah and the three aove mentoned feature n the ntal model, rather than facng the followng even dadvantage y addng th extenon: (1) Etmatng the weghted average of at leat fve extra varale ( d,, r, t, V ) (2) The model le recognzed y ank and fnance profeonal n the RF ndutry (3) The model ncontent wthn a company over multple polce n department uch a procurement, ale, operaton and upply management and a a conequence, nce thee model ue w (4) Becaue of nternal ncontency the model dffcult to jutfy (5) Becaue of addtonal varale the model le explanale (6) (4) and (5) mght mply a lo of credlty of the employee mplementng RF (7) The prevou x argument lmt the polty of ucceful mplementaton For thee reaon the model extenon not very utale for quck practcal avng calculaton. Neverthele would t e we to ear n mnd that three addtonal feature ext for uppler. 43

44 Suppler talty and lqudty rk The ntal model repreent RF a a mean to decreae the nteret expene. The prevou paragraph dcued RF a a cah flow forecatng and controllng tool. Addtonally there are tuaton n whch crtcal uppler are aout to go ankrupt. Herey a multnatonal lke the centfc company mght e ale to acqure the uppler, whch can e a very expenve and trategcally undered opton. RF mght e an alternatve to ave a uppler from ankruptcy and therey enure upply. The larger the hare of recevale from the RF provdng uyer a part of total aet the more utantal thee mpact can e. The preventon of uppler ankruptcy y RF y enale the uppler to pay t fnancal olgaton. Otherwe ankruptcy proceedng may e tarted y the uppler nolvent detor or y t unpad credtor. In theory a poeon of aet n exce of a frm' lalte mple olvency. Where the aet are ether cah or marketale ecurte t may e ovou that a uppler olvent. If aet are not a lqud a cah or marketale ecurte a uppler may have prolem over meetng t olgaton ecaue, although t eleve telf to e olvent, th vew need not e hared y credt nttuton. The nformaton leadng t to feel olvent, for example confdence n new product, may e prvate and not convncng to credtor. Inolvency however, a ymptom rather than a root caue for ankruptcy. RF not a long term cah generator, ut can once provde an ncreae n cah flow at an average level a can e calculated wth equaton Frequent order of mlar ze and a hgh hare of recevale n RF a part of total aet mply a relatvely hgher lkelhood that RF ale to utantally upport the uppler. Th upport twofold,.e. (1) the freed cah can e ued to pay off any fnancal olgaton and (2) the nteret rate ung RF lower than alternatve ource of fnancng. The latter doe le ncreae the fnancal urden and proalty of default, f alternatve are avalale at all. e f ( t t t ) V (1 r r ) 365 f (Equaton 3.10) But even f the uppler not aout to go ankrupt RF can erve a a mean to decreae rk of the uppler telf, e.g. followng Strano (2010) f a uppler realze that t ha a recevale concentraton rk (affectng lqudty rk) wth one partcular uyer. It can for example do three thng: I. fund at LIBOR plu one to ncreae lqudty II. partcpate n RF at LIBOR plu two III. nure the recevale and pay a premum In cae of (III) t doe not gan lqudty and n cae of (I) t doe not decreae the concentraton rk. Sellng recevale (II) provde lqudty and decreae the concentraton rk reultng n meetng rk management or portfolo alancng ojectve, rather than meetng a pure DPO or cot contanment ojectve. RF for a prce decreae RF can alo e ued y the uyer a a mean to decreae the purchae prce ntead of ncreang the payment term. The tuaton n whch the purchae prce decreaed noted y μ. Arcelu and Srnvaan (1990) developed a model decrng the tradeoff for uyer etween a prce decreae and term extenon for addtonal purchae. Although not explctly tated, ther model aume efore tax nteret rate. Furthermore are the avng generated y econome of cale at the uppler and only the mpact on the nventory value of the uyer ncorporated. The RF prce decreae model aume contrant 3.1 hold. If not, then another tradeoff (a converon of equaton 3.9) hould e made. The decon varale ntroduced ntead of (t θ ) the dcount μ, whch can e calculated wth equaton

45 V V V 1 V V (Equaton 3.11) Herey V can e replaced y u nce D aumed contant. Bede a proft mpact of at leat V V, a prce decreae alo mpact the nteret expene of the uppler and uyer. For the uppler the avng can e calculated y utractng the ntal arrangement net ncome from the new arrangement net ncome, a hown ntally n equaton e f f f V (1 ) r r t t t V w t t t S V (1 )(1 T ) V (1 T ) e f f f r r t t t w t t t (1 ) V (1 )(1 T ) (1 T ) V ( T 1) e f f (1 ) r r w t t t 365 (equaton 3.12) The lat term doe not nclude (1 ) nce there no real change n nteret expene over t t f for any μ. Herey S an after tax fgure lke S. In order to otan th fgure, the pre tax non nteret proft mpact wll e corrected for the effectve tax rate T. Herey the model aume an equal valuaton of net proft after tax va le nteret payment or ncreaed proft of the uppler and uyer. Th way S can e compared for any comnaton of and j. Bear n mnd that n the econd year n cae of a prce decreae o S ( y 2 ) ( y 1) 2S wherea S ( y 2 ) ( y S 1). j S, add up to the frt year avng, In other word, f the contract wll e undone, cah aved y a prce decreae reman, wherea cah freed y a payment term extenon ued agan. In an nfnte tmelne a prce decreae wll alway outperform a term ncreae. The feale regon of dcount μ ounded on the one hand at μ = 0, yeldng S to equaton 3.1. and 0 * * S. On the other hand the maxmum dcount S equal m ax can e calculated ung equaton 3.13 and mple S 0 (reak even for the uppler). Ung the reult of 3.13, * S can e calculated wth equaton m ax e f f w r r t t t e f f (1 T )365 r r t t t (equaton 3.13) From the uyer perpectve one could argue that f a prce over the whole payment term decreae then payale decreae, o doe the DPO rato and a a conequence the uyer CCC ncreaed mplyng ncreaed nteret payment. Th mght appear correct, ut n 45

46 practce t ncorrect, nce a prce change mple no change n nteret expene wth regard to payale perod for the uyer. It mple the oppote effect,.e. a lower purchae prce decreae the real nteret expene over the purchae prce value of nventore and recevale untl uyer payment receved. Suequently the uyer avng can e calculated y utractng the old CCC expene from the ntal CCC expene of a partcular SKU, a n equaton 3.14, ung two addtonal varale. The latter term reflect the nteret avng on nventory value and ncreae n avalale cah after ale (1/2). Tme of holdng a purchaed tem n nventory (n day) Tme of havng an tem a a recevale (n day) ( 2 t ) 1 S V (1 T ) w (equaton 3.14) Tradeoff etween prce decreae and term ncreae It ha een dcued n the prevou paragraph and y ntroducng equaton 3.4 and 3.5 that * S and S cannot e otaned n one agreement. By keepng the fnancal mpact on the j * j uppler equal, the uyer mght wtch from a term ncreae to a prce decreae or vce vera to ncreae h net avng, whle keepng the mpact on the uppler equal. Herey every ha t equal mpact on uppler counterpart extenon t and vce vera. Or formally. Where can e otaned wth equaton 3.15 and S t S t t can e otaned y ung equaton Thee equaton are otaned y equalzng equaton 3.4 and ( t ) e f r r t t e f 1 T 365 r r t t f t (equaton 3.15) e f f (1 ) r r t t t ( T 1)365 f t ( ) t t e f r r (equaton 3.16) A expected doe w not play a role, nce the nteret over t α aved n oth cae. Once the counterpart have een determned the uyer can chooe for h maxmum avng amount, formally: m ax( ) S j.e. () wth j,. In the entvty analy we wll nvetgate the entvty of choong for a prce decreae or a term extenon to nput parameter varaton. Addtonally a comnaton of μ and θ pole n one arrangement, ut not ueful, nce gven the lnear nature of the equaton ether μ or θ wll yeld maxmum avng for the uyer, whle keepng the mpact on the uppler equal. In a cae cloe to ndfference S S, t we to conult a entvty analy to otan an ndcaton of the routne of the avng over tme. Addtonally KPI or trategc conderaton can nfluence th tradeoff. Gven S S f follow that S f S. f 46

47 An alternatve way to ncreae S j f to purchae a payment term va RF, whch only e f enefcal f w r r whch generally the cae. Wthout RF purchang a payment term only enefcal f w w. In cae of ung RF however, uually w w. Purchang a payment term va RF can e done a follow: e.g. the uyer and uppler agree t θ = 45 ntead t α = 20. Now f the uyer would lke an addtonal term extenon of 30 day,.e. t θ = = 75 and compenate the uppler wth a prce ncreae,.e. μ < 0. The requred prce ncreae can e calculated ung equaton 3.15 wth t θ = 30. Ung the negatve μ n equaton 3.11 the correpondng V μ can e otaned for whch t hold that V μ > V α. Depte th yeld a hgher net avng after tax, t an neffcent polcy from a fnance perpectve, nce (1) t decreae fnancal reult of operaton y an ncreaed purchae prce, whch a ad gn for nvetor and (2) uually other mean of fnancng are avalale (e.g. commercal paper) that can e tmed and have a lower nteret rate. Furthermore (3) wth purchang a payment term va RF the uyer would have to renegotate the term when det mut e decreaed. Therefore purchang a term very uncontrollale mean of long term fnancng. And f a relatonhp wth a uppler end, and the new uppler doe not agree to th polcy, the fnance department n a ad poton, nce they then urgently need fnancng. Conequently the GPC ha a polcy that proht purchaer to ncreae the prce n order to pay later. 47

48 4. Suppler ntegraton In the pat decade OM reearch ha focued on how collaoratve nventory program can make nventory commtment more effcent and mprove uyer ervce (Wllam and Tokar, 2008). In an examnaton of the dcplne of logtc and logtc reearch Dav-Sramek and Fugate (2007) revealed that leadng dcplne vonare feel that one area n whch logtc reearcher mut focu coordnaton and collaoraton. Th focu tarted already n the pat decade (Wllam and Tokar, 2008). Collaoraton wth uppler appled to hare accurate ale and producton forecat to decreae repone and lead tme, whle hftng nventory uptream to reduce nventory level (Goldy et al. (2006); Erleacher and Meller (2000) and Dxon (2001)). The reearch method wth regard to uppler ntegraton ha een decred n chapter 1 and depcted n fgure 4. More pecfc, frt the uppler ntegraton trategy of the centfc company wll e analyzed (arrow 1 n fgure 12). Second, the crtera for compenaton accordng to th lterature are verfed wth the cae n the GPC (arrow 2 n fgure 12). Thrd, f lterature and cae do not converge, an explanaton provded y the GPC employee that mplemented the cae. Th explanaton verfed wth lterature (arrow 3 n fgure 12). Thereafter the fnancal uppler ntegraton mpact on the uppler and uyer wll e modeled centfcally and verfed. In chapter 5 the centfc uppler ntegraton model wll e ntegrated wth the RF model. GPC 2 1&3 Lterature Fgure 12 - Suppler ntegraton reearch cycle 4.1 Suppler ntegraton at the gloal pharmaceutcal company The upply chan management trategy at the centfc company am at evolvng the upply chan nto a utanale agle aet lght upply chan, achevng hgh uyer ervce level. Agle refer n th ene to flexle capacty and utanale refer to the endurance of the upply chan tatu n the future. Th trategy upport outperformng competton and company value maxmzaton. Followng Uqulla (2010) there are eentally three lne of development n GSCM: 1) Enaler project, to create tranparency along the upply chan and uld a fundamental a. 2) Inventory optmzaton project whch conder key nventory reducton lever. Thee key lever are: afety tock optmzaton, lead tme reducton, forecat accuracy, and centralzed determnaton of delvery volume. 3) Md and long term optmzaton approach whch ue et practce and leon learned from 1 and 2 to hare over varou unt, the decrement of the portfolo complexty, and ncrement of level of coordnaton. 48

49 Wthn the upply chan trategy a uppler ntegraton trategy ue apect of all three lne of development expreed n one out of four opton per tock keepng unt (SKU): I. Suppler managed nventory (SMI) wth congnment tock (CS) at the te of GPC II. SMI wth congnment tock on an external te III. SMI wthout congnment tock IV. make jut n tme (JIT) to order wth reduced lead tme In academc lterature and practce vendor managed nventory (VMI) and SMI are often perceved a ynonym and congnment tock ometme mplctly aumed. VMI and SMI are ndeed mlar,.e. oth ncorporate management of nventory aed on the demand nformaton exchanged y the uyer. The dfference le n the party that manage the nventory,.e. a uppler or a vendor. The uppler generally more uptream n the upply chan than a vendor. And the word vendor commonly ued for compane upplyng conumer good retaler 23. Pohlen and Goldy (2003) reveal that the eence of VMI and SMI are dentcal and therefore SMI mpact can e derved from VMI model f the aumpton apply to the partcular cae. For an n det comparon etween VMI and SMI reader are referred to Pohlen and Goldy (2003). The other part of the preferred opton, congnment tock, the tock of good at a uyer whch tll the property of the uppler. Payment for thee good made to the uppler at the moment when they are ued/wthdrawn y the uyer 24. The four opton aove are mentoned n decreang order of routne and nventory reducton potental and ncreang order of ntenty of nformaton harng. Clearly SMI wth congnment tock (SMCS) at the GPC the opton that mot rout, ha the larget potental for nventory reducton and mallet ntenty of nformaton harng and therefore preferred f the crtera the followng crtera apply: a) hgh nventory volume, ) low demand volatlty, c) relale uppler, d) a long term future relatonhp wth the uppler dered e) the uppler wllng to partcpate f) there are no lmtaton n the ene that nventory hould e kept on own tock for trategc purpoe. Thee converge wth the adopton determnant from Dong, Xu and Drener (2007). An aggregaton of the fnancal mpact for uyer a well a the uppler depcted n appendx 6. Some uppler argue that the mpact of SMCS on ther proft negatve, nce the addtonal nteret expene on holdng nventory at the uyer te larger than the uppler avng. Conequently they aked for compenaton. Th requet drven y congnment tock expene, not y SMI expene, nce SMI provde accurate demand forecat enhancng uppler operaton and logtc effcency, a depcted n appendx 6. Furthermore, gven crteron a, the annual extra nteret expene for the uppler utantal n relaton to the SMI cot. The nventory value atfyng crteron a multple mllon of raw materal nventory per SKU. Even f the uppler WACC only 5% th would mply nteret expene of per mllon nventory value, annually. Gven WACC often hgher than 5%, nventory level are multple mllon and the arrangement are mplemented to lat multple year the IT hare of total cot not condered an otacle and ometme even unk gven lne of development 1 and 2 Uqulla (2010). 23 The frt VMI arrangement wa mplemented y WalMart. 24 Source: 49

50 The uyer can calculate the extent to whch RF can provde the requeted compenaton. But gven a hgh nventory volume and the explanaton n the prevou paragraph the uppler can argue to requre any level of compenaton, depte SMCS a collaoratve development. In fact oth parte are tempted to exaggerate ther cot component and undertate ther gan component. It therefore mportant to ae the fnancal mpact wth a complete and correct framework of fnancal mpact on the uppler and uyer. And even f the uppler doe not requre compenaton, t we to nvetgate the mpact on the uppler and uyer a a mean to ae the extent to whch the negotated eneft from the arrangement are off from the maxmum achevale eneft y the arrangement. Th maxmum achevale eneft for the uyer acheved f avng are maxmzed wthout fnancally harmng the uppler and therey ncreang the upply rk. I.e. a uppler can e eager to wn a upply agreement (for multple year) y provdng congnment tock wthout compenaton and grow revenue. Th however at cot of ncreaed nteret expene whch mght mply an nteret nowall effect leadng to ankruptcy. The next tep the verfcaton of the conceptual model n appendx 6, a depcted y arrow 2 n fgure 12. Th wll e done n three tep. Frt the fnancal mpact on a multnatonal IT company a decred y Waller, Johnon and Dav (1999) wll e compared wth the realty n the GPC (a modeled n appendx 6) to enhance external valdty. Then other conceptual model wll e confronted wth the realty wthn the GPC and lat quanttatve model wll e confronted wth the GPC realty. Fnally a centfc model wll e ult and valdated wth the GPC. Thereafter arrow 3 tart to provde feedack on emprcal reult. 4.2 Lterature verfcaton of conceptual model Appendx 6 wll e verfed wth reearch on SMI and VMI n two tage,.e. the SMI and the congnment tock tage. Frt the SMI apect (colored lue n appendx 6) wll e verfed wth lterature. Then the congnment tock apect (colored green n appendx 6) wll e verfed. VMI and SMI lterature Waller, Johnon and Dav (1999) provde practcal nght n addton to the SMI apect. Thee practcal nght yeld a concluon that horter plannng term decreae effcency of operaton, warehoung and tranport and ometme even lead to unavalalty of operaton or tranport capacty, except agant very hgh prce. Wth VMI/SMI, however the uppler typcally chedule producton and tranport n advance, hopng to enure more predctale and feale producton and tranport delvery chedule. Th hft from reactve to proactve plannng help to reduce the ullwhp effect,.e. large order fluctuaton can e perceved y ale and producton employee a change n long term average demand, whch led to fluctuaton n order. By replacng percepton wth forecat accurately repreentng demand, there no place for the eence of the ullwhp effect: mpercepton. Addtonally Waller, Johnon and Dav (1999) argue that multple uyer enforce the potve mpact of SMI, nce a non-crtcal delvery can e dverted for a day or two to enale a crtcal delvery to another uyer. Smlarly, a maller than uual replenhment to one uyer may enale a larger than uual hpment to a uyer n dre need. Th alty of alancng uyer need can mprove the upply chan performance wthout jeopardzng any ndvdual uyer. Buyer eneft from the aurance that they are aured that ther mot crtcal need wll get the mot attenton. Wthout the accurate forecat and nventory level nformaton the uppler ha a dffculty n prortzng 50

51 uyer hpment effectvely. Thee addton do mpact the magntude of the eneft, ut do not change the component or ther tructure n appendx 6. Addtonally Claaen, van Weele and van Raaj (2008) ntervewed purchae manager revealng perceved VMI mpact: cot reducton n admntraton, tranportaton, nventory and materal handlng, mproved uyer ervce level, upply chan control, n term of le tockout and preventon of the ullwhp effect. Depte the mpact on cot reducton weak admntraton cot of the uyer an addton to the model n appendx 6. Th wll e added to the model, o we derve the model n appendx 7. Followng Claaen et al (2008) a reducton n admntraton cot pole nce extenve materal requrement plannng not neceary anymore,.e. wherea ndvdual purchae order are replaced y lanket purchae order and furthermore doe ackorder admntraton no longer ext for the VMI SKU. In addton to management percepton of VMI Vereecke & Muylle (2006) meaure performance y alance heet fgure from collaoraton wth uppler and uyer and fnd only weak evdence of fnancal performance mprovement a well. Peteren, Ragatz and Monczka (2005) fnd evdence of the mpact from effectve collaoratve plannng effort wth uppler on upply chan performance and, only ndrectly, on a frm fnancal performance. Th converge wth appendx 7. Congnment tock lterature The concept of congnment tock ha een explaned n the frt paragraph of th chapter and depcted n fgure 13, where color repreent ownerhp. Corett (2001) provde a theoretcal analy uggetng that congnment tock help reduce cycle tock y provdng the uppler wth an addtonal ncentve to decreae atch ze, ut multaneouly gve the uyer an ncentve to ncreae afety tock y exaggeratng ackorder cot. It can e derved from Corett model that n practcal aence of a central planner wth full nformaton, no party can nduce jontly optmal ehavor from all parte n the upply chan wthout acrfcng h own proft. Suequently followng Corett (2001): f long uppler producton cycle are the key drver of nventory, the uppler hould e made to ear the cot of the reultng cycle tock, e.g., through a congnment cheme. Converely, f uncertanty aout down-tream demand the man drver, the uyer hould ear the cot of the reultng afety tock. Valentna and Zavanella (2003) add that congnment tock alo enale complementary ntangle advantage, e.g. a hgher degree of flexlty, ncreaed ervce level n turulent envronment and renforced relale relatonhp etween uyer and uppler. Thee ntangle eneft from CS are alo recognzed y author argung CS to e harmful for the uppler from an economc pont of vew (Valentna and Zavanella, 2003). The potve effect ncreae more than proportonally when ncorporatng more uyer n the program, a uually the cae n VMI and arrangement (Zavanella and Zanon, 2009). From ther 2009 artcle we can derve that the complementary ntangle advantage mentoned n the 2003 artcle are related to SMI, not to congnment tock. Therefore no addtonal change to appendx 7 are made. Wthout congnment tock Fgure 13 nventory ownerhp: congnment v. non congnment 4.3 Scentfc model The reearch dcued on VMI/SMI o far ha een ale to verfy the component leadng to fnancal mpact a depcted n appendx 7. Some tude provded the magntude of the mpact, 51 Congnment tock

52 ut lack to provde the meaurement and calculaton method, o t cannot e checked f the aumpton hold. Meaurement and calculaton method are neceary to tranlate the conceptual model to a centfc model. The aumpton of the VMI model of Çetnkaya and Lee (2000) do not match the realty of the GPC SMI ytem. Nether do the aumpton of the model of Dong and Xu (2002) hold. Prmarly nce the model aume that the uyer company the leader n ther model,.e. t pecfe order quantty accordng to t own cot charactertc, and determne purchae prce, whch not the cae at the GPC. Some reearcher nvetgated the mpact of pecfc apect of VMI/SMI,.e. the ullwhp effect (Dney and Towll, 2003), tranport (Dney, Potter and Gardner, 2003) or n pecfc upply chan,.e. VMI n the retal upply chan (Kemuller and Broekmeulen, 2010) or oth,.e. atch ze mpact n a uppler jo hop envronment n an OEM upply chan (Nyen et al, 2009). The model that ft the GPC tuaton et from Yao, Ever and Drener (2007). They dcu a ngle uppler and a ngle uyer model, aumng a ngle tock-keepng unt tranacted etween the uppler. Th generally the cae at the GPC SMI cae, depte multple SKU are pole. Conumer demand aumed to e determntc and known to the uyer under normal (non-smi) operatng procedure and known to oth the uyer and uppler under VMI, whch hold, nce producton chedule are conumer demand n th cae and known n advance. Thee chedule are accurate, nce otherwe SMI doe not make ene. In an SMI tuaton the followng varale are ued n the ettng depcted n fgure 13 where they uyer order from the uppler a depcted n fgure 2. q order ze unt j c order cot Euro j y nventory handlng cot per Euro percentage w weghted average cot of captal percentage T repreent the effectve tax rate percentage z j G j the average nventory level unt the nventory holdng cot Euro D annual demand unt q j c j, y, w, T D Fgure 14 SMI varale Wth, where = uppler and = uyer and and j, where α = ntal tuaton and β =SMI tuaton. Furthermore the cot rate of holdng nventory (h ) can e calculated ung equaton 4.1. h w y (equaton 4.1) Yao, Ever and Drener (2007) calculate the avng aumng determntc demand efore and after SMI mplementaton. At the GPC accurate forecat provded to uppler mplemented a part of the arrangement, provdng determntc chedule. Furthermore do Yao, Ever and Drener (2007) not take the congnment tock mpact nto account. Th reearch doe take the congnment tock avng nto account a well a the avng from SMI a far a they are ncorporated n Yao et al. (2007). 52

53 SMI and congnment mpact on the uyer Frt the mpact of congnment tock and SMI for the uyer wll e calculated. For the uyer the cot of holdng raw materal nventory efore SMI 53 G can e calculated wth equaton 4.2. G z u h (equaton 4.2) After SMI mplemented materal tll n the warehoue of the GPC and handled y the GPC employee, ut owned y the uppler. Therefore the holdng cot for the uyer after SMI wll e a equaton 4.3. Snce the handlng cot do not ncreae f the purchae prce ncreae, the ntal purchae prce taken a a multplcaton factor for handlng cot for the uyer. G z u y (equaton 4.3) Where z * q aftety tock(). Safety tock () a requrement y the GPC n the four 2k cae nvetgated, depte determntc demand a reaonale aumpton accordng to Yao, Ever and Drener (2007). Th reult n the total avng from nventory reducton accordng to equaton 4.4. * q G G z u h y u 2k * q u z h y 2k (equaton 4.4) Intally one addtonal avng effect ha een modeled,.e. the nvocng frequency avng (F ). The moment producton requre materal and conequently take materal out of the warehoue gven y producton chedule. The moment of takng a product out of the congnment warehoue referred to a the moment of uage. The nvocng frequency effect ecame apparent after the reearcher wondered what the dfference of mpact on cah flow would e etween (1) eng nvoced and pay every tem drectly after uage and (2) eng nvoced and pay once per year for all tem. It wa hypothezed that the le often an nvoce receved, the longer cah wll e hold, the larger the avng are. For th explanaton we aume t t 0. Now, the average day upply on hand (DSOH) can e calculated ung equaton 4.5, repreentng the average tme etween recept and uage of materal at the uyer te. Herey D repreent the annual demand n unt. 365z j DSO H (equaton 4.5) j D After mplementng SMI, f tem are counted, nvoced and pad drectly after uage then equaton 4.4 repreent the avng. If the uyer would e nvoced once per year, the avng for the uyer are a follow. Aumng one tem ued per day, then the frt tem ued n a year pad 365 day after uage and the lat tem ued pad 0 day after uage. Wth tme etween nvocng a = 365 the nvocng frequency avng can e calculated ung equaton 4.6. av w F (equaton 4.6) If uage not equally dtruted etween two countng perod, then a numer other than 2 hould e ued n equaton 4.6 to repreent the mpact,.e. maller than 2 for kewed to drect

54 after countng uage and larger for kewed to efore countng uage. The exact numer can e otaned ung the materal requrement dtruton from producton. After valdaton t ecame apparent that another avng effect hould e ncorporated,.e. the countng moment avng (X ). Item can e counted drectly after takng an tem out of raw materal nventory a aumed o far, ut alternatvely they can e counted after producton, or even after ale. Ung x for the average tme etween uage and countng, the countng moment avng can e calculated ung equaton 4.7. xv w X (equaton 4.7) 365 The total cot mpact of the arrangement can e calculated wth equaton 4.8. a * x V w q 2 S G G F X u z h y 2k 365 (equaton 4.8) SMI and congnment mpact on the uppler Followng Yao, Ever and Drener (2007) the uppler optmal order quantty efore the SMI accordng to equaton 4.9, whch mlar to the EOQ formula (Slver et al, 1998). In equaton 4.9 m repreent the proft margn on the SKU condered. The proft margn can e utracted from the unt prce n nteret calculaton, nce no nteret pad on the proft margn of nventory. q * 2 c D h u (1 m ) (equaton 4.9) The total cot of the ntal tuaton are a n equaton * * TC h u(1 m ) q 2 c Dh u(1 m ) (equaton 4.10) In the new tuaton the order quantty for the uppler lkely to e an nteger multple of the uyer replenhment quantty,.e. q q k where k β a potve nteger (Slver et al, 1998). Herey the optmal k β and order ze are a follow (Yao, Ever and Drener, 2007), gven c c. k 2 c h u (1 m ) 2c c h u (1 m ) c (equaton 4.11) Equaton 4.11 dfferent from equaton 7 n Yao et al (2007) nce t ue the uppler holdng cot for the uyer tock, ecaue of the congnment tock cae. Smlarly equaton 4.12 correpond to equaton 9 n Yao et al (2007), defnng the optmal uyer order ze decced on y the uppler. 54

55 q * c D h u (1 m ) (equaton 4.12) And the lat decon varale the order quantty of the uppler correpondng to equaton 8 n Yao et al (2007). q 2 * c D h u (1 m ) (equaton 4.13) To calculate the total cot of the arrangement the mpact of the nvocng frequency and the moment of nventory uage countng at the uppler have to e taken nto account a well. Th reult n equaton c D k 1 S 2 c D h u (1 m ) h u (1 m ) q q q 2 * * * 1 * a x V q u 2 w (1 m ) 2k 365 c D 2 c D h u (1 m ) * q 1 * a x D (equaton 4.14) k 1 q * * 2 u (1 m ) h q q w 2 2k 365 The frt term of the equaton equal the total cot of the ntal arrangement, the econd term repreent the uppler orderng cot n the SMI cae, the thrd term refer to the uppler holdng cot on the uppler de n cae of SMI, the fourth term refer to the uppler holdng cot on the uyer de n cae of SMI, ncludng the mpact of nvocng frequency and countng moment (.e. equaton 4.6 and 4.7). Valdaton Th model ha een valdated wth four mplemented SMI cae at the GPC and ftted the cae tuaton. In one cae the GPC take only whole atche out of nventory and doe not ue them to the full extend. In th cae a = 0 can e ued. In many cae S 0, ut accordng to lterature and ntervew wthn the GPC the uppler value the guaranteed future demand, epecally f t face hgh fxed cot. Addtonally ome apect of the conceptual model have not een ncluded n the quanttatve centfc model. Appendx 8 provde an overvew of the tem ncluded and excluded. Only f S ntangle advantage 0, the uppler requre compenaton. In the paragraph 6.2 t wll e verfed f RF can provde th compenaton. 55

56 5. Integratng the model The RF model and SMI wth congnment tock model are developed n a way uch that y ung oth agreement the value for S can e accumulated for the uyer or uppler. Herey j the nput value for varale ued n oth arrangement hould e equal, except for change n thee varale a a reult from an mplemented arrangement. E.g. a decreaed payment term or ncreaed purchae prce after the mplementaton of SMI and congnment tock hould e ncorporated when calculatng eneft of RF. Note that the nventory handlng cot (y ) are ndependent of prce change and are therefore ued n relaton to u α rather than u β n the SMI and congnment tock model. From fgure 20 t can e derved that t we to tart mplementng RF efore SMI wth congnment tock nce compenaton for SMI and congnment tock mght e provded y a decreaed payment term, reultng n le avng potental for RF. 56

57 6. Sentvty analy Th chapter ae the avng related to a partcular contract veru contnung wth the current contract. The current contract nvolve nether RF nor SMI & congnment tock. Herey one nput varale at a tme wll e vared over a range of plaule value, keepng other nput varale contant. Thee plaule value can e etalhed n two way (1) y ntal electon and (2) a a change over tme. I.e. the value for t α etalhed y electon only and the value of r e wll change over tme only, ut the purchae prce u α uject to oth. The mpact of (1) explctly depcted n graph n th chapter,.e. the dfference on the vertcal graph ax etween 0 and the ojectve value S j. The mpact of (2) can e otaned y comparng the dfference on the vertcal ax etween ojectve value for two or more nput value on the horzontal ax. The formula ued n th chapter are depcted n appendx RF entvty In order to ae the mpact from change n nput varale on total avng, a ae cae requred, provdng realtc varale. Th ae cae etalhed ung the average at the HTM dvon calculated from 21 RF contract n Europe. The weght from th average are ued to calculate the weghted average payment term extenon. The value for w and r f are realtc, ut not real for confdentalty reaon. The value for r e made pulcly avalale y the ECB and an annual fgure, converted to nvoce the tme to maturty. Addtonally average for t and t f are otaned from ntervew and nternal HTM preentaton. The ae cae defned a follow: V = 12.7 mllon euro (CV = 0,14) t = 42.4 day (CV = 0,33) t = 63.8 day (CV = 0,31) w = 8.0 percent w = 10.0 percent r e = 1.5 percent r f = 0.5 percent t = 2.0 day (varyng etween 0 and 5) f t = 0.5 day (varyng etween 0 and 1) Gven the nput from the HTM group cae t can e checked that contrant 3.1 tll 3.4 hold. Suequently the potental avng of RF can e calculated. Note that S n th entvty j * analy per contract n thouand euro. Frt, t follow from equaton 3.1 that S 109. Furthermore ung equaton 3.3 t follow that m ax equaton 3.5 t follow that t 200 day and, ung th outcome n * S 439. The cae aove yeld t = 63.8, reultng n S 96 and S 16. The entvty wll e teted per varale or n cae of mlar mpact per et of varale. Herey we treat the weghted average nput varale of 21 contract a were t a ngle contract. 57

58 RF for a prce decreae If RF would e ued for a prce decreae, then gven S S the fnancal mpact for the uyer depend on, nce other nput value are gven. E.g T = 30%, ut wll e vared later n th chapter. If we vary etween 0 and 400 the reultng avng are depcted n fgure 15. Ung RF for a prce decreae wth thee nput varale not more enefcal than ung RF for a payment term extenon, depte S S ncreae lghtly and lnearly a ncreae,.e. S gven the cae nput parameter wth t θ and μ uject to S S. When w vare S doe no longer hold a we wll ee n fgure 21. Therefore the entvty of avng dependng on μ relevant. Furthermore doe varyng μ yeld nght for cae wth other nput value. Smlar to decdng on t, decdng on μ a conflct of nteret a depcted n fgure 16. S S j Sθ S SμS Sμ S S j Sμ S Sμ S SθS ,00% 0,50% 1,00% 1,50% Fgure 15 RF avng and CCC length Fgure 16 RF avng and prce decreae New term (t θ ) RF can e a mean to provde a oluton for the conflct of nteret etween the uyer (preferrng a DPO ncreae) and uppler (preferrng a DSO decreae) nce oth are pole wthn one RF contract. Decdng on t, however a mlar conflct of nteret. For the cae t = 63.8 day, varyng t change the mpact on the uyer and uppler utantally, a depcted n fgure 17. Depte S S ncreae a t ncreae, the uyer purchang a payment term not condered an opton for the reaon explaned n the lat paragraph of chapter 3 Tradeoff etween prce decreae and term ncreae. By ntegratng fgure 16 and 17 ung equaton 3.15, fgure 18 otaned, where the lue lne dappear ehnd the red lne a the cae n fgure 15, nce S S. Fgure 18 alo upport fgure 15 y llutratng S S n the feale regon of t and μ. 58 S j

59 S j SθS Sθ S Fgure 17 RF avng and payment term extenon Fgure 18 RF avng from payment term extenon v. prce decreae From fgure 18 t can e derved that, holdng uppler avng contant uyer avng are more entve to a payment term extenon than a prce decreae. Purchae value (V α ) From appendx 9 we derve that V α ha a lnear effect on S j, whch depcted n fgure 19. Note that the ax cale are oth logarthmc, e.g. V α = 10 6 = 1 mllon euro yeld S 10 3 = thouand euro ( S 4 S ). From fgure 19 t can e derved that hgher purchae volume wll yeld hgher avng. Therefore t we to take V α nto account whle prortzng upply agreement for RF adopton. 1,E+11 1,E+09 t S j S j S j t SθS SμS Sμ S SθS t m ax t 1,E+07 1,E+05 1,E+03 1,E+01 1,E-01 1,E-03 V S Sθ S Sμ S Sμ Sθ S t t Fgure 19 RF avng and purchae value Fgure 20 RF avng and ntal payment term 59

60 Intal term (t α ) From the equaton n chapter 3 we can derve that an ncreae n t α ncreae the maxmum potental avng S * j. To llutrate th effect we depct j S and t α uject to S S S n fgure 20. Herey the reult of equaton 3.4, 3.5 and 3.12 are equal. And ndeed t can e een that larger value of t α yeld hgher avng. Savng rate (w ) So far we aumed the avng percentage to e at the level of WACC. In paragraph the value of freed cah argument have een provded for a lower avng percentage than WACC. A lower value than WACC doe yeld le avng from the ame agreement. The mpact of the rate allocated to freed cah from RF on S S. S j depcted n fgure 21. Th once more uject to S j ,5% 2,5% 4,5% 6,5% 8,5% -40 Fgure 21 RF avng and the rate allocated to freed cah w Sθ S Sμ S Sμ S Sθ S From th fgure two concluon can e drawn. Frt t make ene for the uyer to convnce the uppler of a hgh avng rate, nce th ncreae S an ncreae of S j. Second, f the uyer allocate w r * j e and thu ncreae the chance on r f, then S uyer wll ave at leat a much when he chooe for a prce decreae. S j % 10% 20% 30% 40% 50% 60% 70% -20 Fgure 22 RF avng and uppler tax rate T Sθ S Sμ S Sμ S Sθ S S j S and hence the 0% 10% 20% 30% 40% 50% 60% 70% Fgure 23 RF avng and uyer tax rate T 60

61 Conequently hgher value of γ and ζ ecome relevant, nce they ncreae S. Furthermore e.g f at T = 30% we have w = 2,1%, w = 4,6%, t θ = 63,8 and μ = 0,17%. Then y varyng T whle keepng t θ and μ fxed fgure 23 can e otaned. When T ncreae the aolute dfference etween S and S ecome maller for any value of w. But T wll not caue a preference for ether a prce decreae or a payment term extenon. Th doe not hold for the uyer avng and tax rate,.e. t can e concluded from fgure 22 that hgher uppler tax rate motvate toward RF for a prce decreae. Note that the tax rate a electon varale and moderator varale. Economc change Macroeconomc or mcroeconomc change can mpact S j. Macroeconomc change can mpact the Euro Interank Offered Rate (EURIBOR) at whch the ank orrow. An ncreae n EURIBOR wll drectly ncreae the cot of RF va r e e wth the ame magntude,.e. w r x. In fgure 24 the Euror htory depcted and n fgure 25 the mpact of r e on We can conclude that change n r e wll mpact S utantally and S j depcted. S hardly. For r e a lnear ncreae to 2,6% n 2013 forecated y Bloomerg. Baed on fgure 25 renegotaton ntated y the uppler can e expected n cae of ung RF for a term extenon. Fgure 24 Euror htory S j Sθ Sμ Sμ Sθ S S 0,0% 2,0% 4,0% 6,0% Fgure 25 Rf avng and Euror r e S S On the other hand can mcro economc change mpact change, the mpact on S S 61 S j. If the uppler cot of captal can e derved from fgure 21. If the cot of captal of the uyer f change, then r wll change a well, conequently changng the uppler avng a well a the f uyer avng. Herey the relatonhp etween r and w unknown, therefore two plaule cenaro are depcted n fgure 26, whch oth aume w = WACC of the uyer, ut th aumpton not relevant for the prolem. Furthermore once agan S S. For fgure 26 the relaton of uyer cot of captal and the RF rate wa requred. Two plaule cenaro haven een developed and are depcted y the purple and green lne. We can conclude that f the agreement not changed the uppler avng wll decreae f the uyer credtworthne deterorate and the uyer avng wll ncreae n cae of a term extenon. In cae of a prce decreae there no change n the uyer avng.

62 S j 200,0 150,0 100,0 50,0 0,0-50,00,0% 5,0% 10,0% 15,0% 20,0% -100,0 f r Fgure 26 RF avng and uyer cot of captal change Sμ S Sθ S S1r f f e S2 r w r w r 5 e 1,5 6.2 SMI wth CS entvty At the GPC approxmately forty cae of uppler ntegraton are n varou tage of development. Only four cae are fully mplemented SMI and congnment tock cae. All four cae have een ued to valdate the model. In th chapter one cae wll e ued to llutrate the alty to compenate the uppler wth RF or two alternatve compenaton method and to llutrate the entvty of compenaton. The followng nput varale apply to the cae. z 450 unt D 900 unt u α 2500 euro y 5,5 percent 300 unt Furthermore c 100 aumed. Snce th model doe nclude 15 relevant varale to tet j the entvty t plt up n three paragraph,.e. operaton and plannng varale, fnancal varale and contractual varale. The mpact of varalty n each of the 15 varale on total avng wll e compared over four cenaro per graph: 1. SMCS wthout compenaton S 2. SMCS wth compenaton y RF S 3. SMCS wth compenaton y a prce ncreae S p 4. SMCS wth compenaton y a normal payment S t Scenaro 1 ha een dcued n the prevou chapter. In cenaro two t t and S S S reultng n S S. Scenaro three wa ntated y the uppler, t mple a prce ncreae of 12 month EURIBOR + 5% over the afety tock value 25. Scenaro three and four are formally decred n appendx 8. In cenaro four the new payment term wll e t t 25.e. u u 1 o r D e(12 m ) wth o = compenaton rate, r e(12m) =12 month euror rate 62

63 day. The upply chan avng S S j j are hardly dcued, nce th not a relevant topc of dcuon n negotaton. Epecally nce f a cenaro choen aed on maxmal upply chan avng, then t mght not e optmal for oth the uppler and uyer. A a conequence of a non optmal contract the exchange of cah to plt avng equally wll eventually take place n a cenaro mlar to cenaro 2,3 or 4. The upply chan optmum therefore already mplctly ncluded n the entvty analy. It can e oerved that the tradeoff etween cenaro 2 or 4 veru 3 mlar to equaton 3.15 veru Operaton and plannng varale In th paragraph the entvty of nventory handlng cot rate, orderng cot, tme to confrm an nvoce and ervce & afety tock level on total avng dcued. In the cae dcued t hold that f the uyer would not mplement SMI, then a lnear prce dcount from 0% at D 100 to 25% for D 1200 can e provded wth a ae prce of 2680 euro. The mpact of SMI and congnment tock wthout compenaton depcted n fgure 27. Savng are n th chapter, lke n the RF chapter expreed n thouand euro. RF doe not harm the uyer, ut doe ncreae the avng of the uppler S j 50 0 D S j D Fgure 27 SMI & CS avng and demand level (=300) -300 Fgure 28- SMI & CS avng and demand level (ervce level =0,95) In fgure 27 the afety tock reman 300 regardle of the demand, therefore RF ecome a more attractve opton at hgher demand value. In fgure 28 the afety tock et accordng to Slver et al. (1998) ung CV=0,05. By adaptve level, RF doe no longer provde hgher avng than a prce ncreae to the uyer. Furthermore the avng trend for the uppler negatve. The uppler doe offer a dcount nce, f the uppler margn only 10%, then the proft j a depcted n fgure 29. Furthermore mght there e addtonal avng related to ncreaed utlzaton of capacty enalng a quantty dcount up to 25%. 63

64 j Sm SmRF m p p m t t D Fgure 29 SMI & CS, uppler proft and demand Further n th chapter, demand wll e fxed to 900 and the mpact of other varale on the avng are dcued,.e. the mpact of varaton n orderng cot and nventory handlng cot. Yao et al (2007) how that a decreae of orderng cot ncreae the avng, whch confrmed for the uppler y fgure 30. A a reult of an ncreae n uyer order cot, the optmal order quantty ncreae, th doe not only ncreae the cot of handlng nventory for the uyer, ut alo ncreae the cot of holdng congnment nventory (CS) for the uppler, whch depcted n fgure 32. Furthermore doe each company tll handle nventory on t te, thu a change n nventory handlng cot doe not decreae thee cot when SMI or CS mplemented. When nventory ncreae (decreae) the nventory that ( not) preent the te, doe (doe not) need to e handled wth cot (avng) a a reult. S j S S S j -40 S p S t 0,0% -50 5,0% 10,0% 15,0% 20,0% Fgure 30 SMI & CS avng and uppler order cot c y Fgure 31- SMI & CS avng and uppler nventory handlng cot The extent to whch demand forecat and producton plannng are accurate determne the requred level of raw materal afety tock. If the CV of demand hgh and demand met y 64

65 flexle capacty rather than fnhed good nventory uffer, then fgure 34 ndcate that a prce ncreae doe harm the uppler (uyer) le (more) than compenaton va a term decreae. 150 S 100 j Fgure 32 SMI & CS avng and uyer order cot c S j y 0,0% 5,0% 10,0% 15,0% 20,0% Fgure 33- SMI & CS avng and uyer nventory handlng cot But nce a low CV a prerequte for SMI, compenaton va RF more attractve for the uyer and uppler. Th effect caued the prce ncreae related to afety tock a decred n footnote 24 and the term decreae related to demand level S j ,00 0,05 0,10 0, Fgure 34 SMI & CS avng and demand coeffcent of varance (CV) CV S j Fgure 35- SMI & CS avng and nvoce confrmaton and proceng tme t +t f Another negatve mpact on the uppler created y ncreaed tme pend to confrm an nvoce at the uyer and proce an nvoce at the ank. Durng th tme the uppler lack the opportunty to ue the opton to free cah and ave nteret, a depcted n fgure

66 6.2.2 Fnancal varale The avng for the uppler and uyer are uject to the uppler margn a depcted n fgure 36. If the margn hgh, then the cot of holdng the ame amount of nventory wth the ame purchae prce for the uyer lower than when the margn low. Thu when applyng SMI wth the ame amount of compenaton than at other margn, the total avng for the uppler ncreae. For the uyer a hgh uppler margn not only potve nce the uppler may demand le compenaton. If the margn very hgh then the optmal replenhment quantty (q) ncreae, mplyng an ncreaed nventory level at the uyer te and conequently ncreae the uyer aolute amount of handlng cot. For a decon on the compenaton cenaro the uppler margn doe not play a role. The mpact of the euror on RF the ame a n paragraph 6.1. For SMI & CS compenaton the 12 month euror ued a a ae for the prce ncreae. The relaton etween thee euror rate etalhed n appendx 11. The mpact of the 2 month euror ncreae doe have a lnear mpact on the uyer and uppler avng a depcted n fgure 37. The hft of nventory from the uyer to the uppler account reult n the negatve trend for the uyer and potve trend for the uppler. S j % 10% 30% 50% 70% 90% m Fgure 36 SMI & CS avng and uppler margn S j ,50% 1,50% 2,50% 3,50% 4,50% Fgure 37 SMI & CS avng and euror r e Another fnancal varale the WACC. If the uppler cot of captal ncreae, then a term decreae doe provde more avng to the uppler than a prce ncreae a depcted n fgure 37. The lower the nventory level and the longer the ntal payment term the greater th effect. 66

67 S j 20 0 w -20 0% 5% 10% 15% 20% Fgure 38 SMI & CS avng and uppler WACC S j % 7% 12% 17% -100 w Fgure 39- SMI & CS avng and uyer WACC If the cot of captal for the uyer ncreae, the cot of RF ncreae 26 and the uyer avng wll ncreae, ecaue nventory hfted to congnment tock a depcted n fgure 38. In th fgure t can e oerved that the uppler avng ung RF decreae f the uyer cot of captal ncreae. Other compenaton method than RF do not mpact the uppler avng f the uyer cot of captal change Contractual varale Th paragraph wll dcu the mpact of the ntal term, frequency of nvocng, moment of nvocng, level of compenaton and product prce on annual avng. S j Fgure 40 SMI & CS avng and ntal purchae prce u S j t Fgure 41- SMI & CS avng and ntal payment term 26 Ung r f w r 5 e 67

68 The hgher the ntal purchae prce the hgher the uyer avng and the uppler loe a depcted n fgure 40. If the ntal term large and acrfced a compenaton y the uyer then longer ntal term decreae avng for the uyer, ut ncreae avng for the uppler. In cae of RF there no lo for the uyer, ut the uppler eneft le than n cae of a normal term decreae, nce the cah not otaned for free ut at a rate a depcted n fgure 41. When etalhng an agreement on SMI and CS four mpact hould e ncorporated: (1) The uppler and uyer agree on the frequency of recevng nvoce (equaton 4.6) (2) a well a the moment n the producton proce at whch wll e counted (equaton 4.7) (3) The tme etween countng and nvocng (4) A change n the payment term The accumulated mpact of 2,3 and 4 are repreented n fgure 42. Impact 1 ha a mlar effect wth approxmately half the magntude of mpact 2,3 and 4. Increang thee tme doe have a potve effect on the uyer and a negatve effect wth a maller magntude on the uppler. The magntude maller nce the uppler doe need to nvet only (1-m )u α, where the uyer nvet u α n thee term. On the other hand, f 1,2,3 are equal to 0 and 4 negatve, then the uppler ave u α when gettng pad earler. Therefore t α ha an mportant role. S j x S j ,0% 5,0% 10,0% o -200 Fgure 42 SMI & CS avng nvocng effect -100 Fgure 43- SMI & CS avng and compenaton 68

69 7. Implementaton Th chapter decre recommendaton for mplementng SCF. Note that SCF a roader term than RF, e.g. t can alo nclude fnancng of nventory or recevale fundng efore an nvoce confrmed. Implementaton of SCF cont of three apect. Frt etalhng the nfratructure that enale SCF whch refly decred n paragraph for the HTM group. Second the uppler on oardng,.e. the frt contact up to a atfactory uppler ung SCF. And thrd the reult and atfacton of nternal and external takeholder mut e montored on a contnung a and acted upon. 7.1 Enalng SCF The team that lead and manage the SCF the lever to t ucce. Followng (Kramer, 04/2010) the CFO take the lead n algnng ncentve etween functonal group and procurement take the lead n electng the technology/ervce provder. Sefert & Sefert (2010) argue that mplementaton are two tme a ucceful when the CEO rather than the CFO lead them. Addtonally functonal group memer of treaury, IT and nvoce proceng hould e preent n SCF team. Sefert & Sefert (2010) add eventually legal and SCM to the functonal team, ut addre that team extng out of fnance and procurement only are almot a ucceful. See furthermore appendx 14. Accordng to 3 ntervewee at the GPC uyng employee are tradtonally extrncally motvated to acheve dcount, not to ncreae DPO. If workng captal mprovement a goal, th motvaton eental. (Kramer, 05/2010) Before mplementaton tart the goal that eventually to e acheved wth SCF to e et, e.g. (a) workng captal reducton, () reducng upply chan rk or (c) upportng low cot country ourcng. The next tep etalhng the SCF crtera that enale achevng the goal, e.g. followng (Kramer, 2010) a quantfcaton of eneft and tme frame, the type and numer of uppler nvolved, geographe (.e. there are ank that do not fund uppler elow a certan credt ratng, n certan geographe or wth a hgh concentraton of revenue wth the uyer legal and accountng tandard n many countre do not recognze e-nvoce and other electronc document a legally ndng (Mckney, 2010) And addtonally followng Rchman & Schmand (2010) tructurng and on-oardng experence, rk management, extended ervce (e.g. analytcal tool for credt corng, uppler rk aement, and the analy of how ung trade dcount and recevale/payale fnancng can mpact the workng captal alance (Aerdeen, 2007)), technology and operaton nfratructure. Addtonally currence, alty of handlng credt/det memo and length and flexlty of fnance tenor are crtera. In 2007 the mot dered feature & nformaton were a depcted n appendx 12. Once the crtera have een etalhed the type of product can e choen. The tradtonal ngle ank confrmed payale program are utale when there are no plan to expand or change ojectve 27. The requrement for larger corporate uyer wll often exceed the capacty of any one ank or even a few g ank put together. Th unlkely to change n Europe,.e. there are approxmately 7500 ank, where 200 would e uffcent, ut the European regulator would perceve uch a declne a a tread to competton. In many cae, large corporate look to a few ank to et up a larger and more flexle open technology platform wth multple ank. Snce multple ank jon n an open platform competton decreae the offered nteret rate, enhancng the potental avng. Once the type of product determned a provder can e choen. Heren the on-oardng tme and effort play a conderale role a well a the ntal nvetment cot and tme to value. 27 A propretary ank platform that yndcate the amount of credt not condered a mult ank platform 69

70 Followng Sefert and Seftert (2010) 44% of ther ample reported reduced credt avalalty. Kramer (2010) explan, credt provded to uppler wll reduce the ank credt capacty wth the uyer. Appendx 4 nclude a lt wth SCF provder n oth categore. Once the provder ha een choen the mplementaton can tart. A topc dcued only refly o far are the cot of a program. Three cot factor are mportant (1) the ntal technology nvetment. Second (2) the program management (0.5 to 2 fte ) y the SCF team. And (3) the fte of mplementaton n each department, e.g. tme of nvoce proceng, the uccefully ntroduce RF to uppler and uccefully negotate wth uppler. The Aerdeen group (2007) meaured SCF ucce y everal performance metrc. Laggard performer nveted on average $ and et n cla performer nveted on average $ Bet n cla performer proce twce a much volume y three tme a many nvoce trough SCF than the ret of the repondent reultng n a DPO advantage of 9 day and DSO advantage of 22 day. The addtonal reward accordng to Sefert and Seftert (2010) mprovement n Purchae-to-Pay, Order-to-Cah and Record-to-Report procee. Followng McKney (2010) the next generaton SCF wll provde full tranparency nto each tranacton. Th enale lqudty provder to apply dynamc prcng n purchang outtandng nvoce (e.g., the cloer the good to detnaton, the lower the prcng) allowng corporate to unlock trapped lqudte through automated fnancng at lower rate and attract the crtcal ma. Next generaton ndeed, nce a of today, no ank ha acheved uch a fully ntegrated upply chan oluton. Mot are tll uy mgratng ther tradtonal dometc platform to croorder tandard, a far cro order tandard ext, nce there no common tandard to enale the exchange of data among dfferent technology platform (McKney, 2010). In the long term, a SCF workng group thought of aet (recevale) acked commercal paper a a tandard tradale ntrument (Sddall, 2010). 7.2 On oardng uppler Onoardng uppler ha proven to e dffcult, leadng to ome low adopton rate (Sefert & Sefert, 2010) and frm pecalzed n on oardng uppler (See appendx 4). It therefore mportant to prortze uppler aed on the goal, e.g goal () motvate a rankng aed on comnaton of trategc mportance, nolvency rk and the mpact of workng captal on demand reponvene. Goal (c) jutfe prortzng aed on geography and payment methodology. Goal (a) jutfe a rankng aed on potental for term extenon and prce decreae. The remander of th chapter focue on achevng goal (c). Sefert & Seftert (2010) argue that ucceful mplementaton nclude at leat 60% of the upply ae n the frt wave, ut compane face dffculte n convncng uppler to partcpate n SCF program. Kramer (2010) explan the rght value propoton to uppler eental to convnce the uppler. Th nvolve preparaton of procurement,.e. payment term enchmarkng and uppler negotaton tratege tranng. Payment term are enchmarked nce the ntal term t α not neceary the maxmum workng captal amount a uppler can or wll e provdng to the uyer y payment term. Inventory day, ndutry average and commodty cla average mght yeld nformaton aout the potental. The European Payment Index and Factor chan Internatonal are ource that can e ued. Depte enchmarkng payment term done y only 20% of the large multnatonal n the U.S. t can yeld valuale nformaton aout the potental, epecally n negotaton

71 71

72 Concluon In order to provde an anwer to the reearch queton, an n depth analy of RF and SMCS conducted. It can e concluded that tradtonally operaton management (OM) and corporate fnance are dtnct dcplne focung on a ngle corporaton. Gradually attenton for nteracton etween (OM) and fnance ncreaed and upply chan management ganed attenton, upported y IT development. Operatonal and fnancal apect nteract wth one and another. Adequate management of ether apect requre undertandng of the nteracton wth the other apect. A decreae n lalte or ther tructure can affect the allowed WoC level and vce vera. RF a well a SMCS decreae the requred WoC n the upply chan y ncreaed vlty and flexlty n controllng nflow and outflow of cah and good. By comnng practcal and theoretcal nght two model have een formulated and valdated a a a for anwerng the reearch queton. A entvty analy ha een conducted to nvetgate the uppler electon crtera and ae the nteracton etween RF and SMCS. By revewng the nght ganed RF knowledge can e allocated to relevant poton n a the GPC. Reearch queton one can only e anwered after the model ha een etup and wa tated a follow: What uppler electon crtera hould e adopted for a RF agreement? Wthn the range of upply chan fnance ntrument RF a popular upcomng ntrument ued y varou multnatonal. It can e ued to ncreae fnancal performance, talze the upply chan and to enale low cot country ourcng. The potental fnancal performance mprovement of RF promng, partcularly f ntal payment term are long, purchae value are hgh and the tme to confrm an nvoce hort. The extent to whch uppler wll accept the value propoton depend on the utalty of the value propoton to the uppler. SME wth hgh cot of captal wll partcularly value the low cot of captal, provded that the demand to the GPC a utantal hare of ther total demand. Larger and credtworthy corporaton wll value the addtonal ource of off alance heet lqudty. Reearch queton two can et e anwered after reearch queton three. Reearch queton three wa tated a follow: How can uppler ntegraton (SI) and RF nteract? Suppler managed congnment tock a form of uppler ntegraton that requre the hghet expene y the uppler, whle t generally the mot enefcal form for the uyer. Except f the uppler doe not value the ntangle eneft ndrectly leadng to ncreaed uppler frm value and the uppler receve utantal amount of compenaton. Mnor compenaton y a prce ncreae or term decreae ha a negatve mpact on the uyer, ut t wll leave the arrangement generally tll enefcal for oth. Alternatvely compenaton mght e provded y RF, whch enefcal for the uyer, nce RF nvetment can e perceved a unk cot. RF can only provde more compenaton than a prce ncreae or term decreae f (1) the prce ncreae mnor, e.g. ecaue uppler recognze ntangle eneft, f (2) varalty of raw materal requrement low mplyng low afety tock and accurate forecat, f (3) the uppler cot of captal very hgh or f (4) ntal payment term are very long. 72

73 In the cae tuded, ether the payment term decreaed or the prce ncreaed. In the frt cae the potental for RF decreae and therefore RF hould not e mplemented after SMCS, nce a term decreae decreae the potental avng to hare etween the uppler and uyer. The fnal reearch queton addree the allocaton of knowledge over varou poton to enale RF and tated a follow: What knowledge hould e preent at whch poton n the organzaton n order to mplement RF effectvely? Many reearcher commented on the mportance of commtment y multple department to cooperatvely mplement revere factorng. Frt of all hould purchaer e aware of the new performance metrc related to WoC. Addtonally purchaer hould have a ref undertandng of the eneft of RF n order to e ale to get fnance expert of the uyer and uppler at the tale. Suequently fnance expert hould e aware of the value of feature they can offer y RF dependng on the uppler fnancal tuaton a dcued y anwerng the frt reearch queton. Addtonally cah flow vlty and control can play an mportant role, whle payment term enchmarkng an mportant preparaton. If the Euror ncreae a expected or the uyer credtworthne deterorate, the avng for uyer and uppler decreae. If th doe happen, than tll the prncple doe reman vald and avng can tll e acheved. In the cae tuded a payment term ncreae generally more enefcal for the uyer than a prce decreae, whle leavng the mpact on the uppler equal. Only f the uyer value the freed cah wth a rate le than the cot rate of RF t ecome enefcal to ue RF for a prce decreae. Compane that nveted more n SCF generally acheve etter reult up to utantal cot decreae and workng captal reducton. Partcularly nvetment n an IT enaled roader range of feature (.e. nventory and pre-order fnancng), eaer ue and mult ank platform can motvate the crtcal ma of uppler to ue SCF, whch eneft the uyer n return. Addtonally legal knowledge uch a valdty of dgtal data, maxmum payment term n France, Span or even the EU a prerequte. Furthermore accountng hould e aware of the extent to whch payment term whle not eng perceved a corporate det y credt ratng agence and accountng tandard. Roughly tated, f RF ued to upport the upply chan talty t not perceved a det. Fnally, oth tool replace uncertanty wth certanty from a uppler perpectve. Th doe not decreae varalty, ut provde the opportunty to act adequate upon varalty. The further n advance nflow and outflow can e controlled, the more tme to act and the etter the qualty of decon. In th ene oth RF and SMCS are eentally tool to mprove cooperaton wth uppler. 73

74 Lmtaton & further reearch The revere factorng model ha een ued y at leat three major ank and accepted y many uppler and uyer. The model ha een ued to etalh contract of 21 cae ncluded n th reearch. In order to comment aout the development of RF wthn the European market of the HTM group th provde an ndcaton. In order to tet f thee reult, the fndng of Sefert & Seftert (2010) or the Aerdeen group (2007) converge n other ndutre and geographc regon the ample hould e dverfed. Addtonally qualtatve and quanttatve evdence for hgher return form more comprehenve SCF platform would e valuale nformaton for ndutry profeonal n ther conderaton for a SCF platform. Addtonally to e ale to expand the knowledge and gan from SCF, reearch from the fnancal perpectve of a uppler on epecally the feature cah flow vlty and cah flow control would e valuale. Expandng and dverfyng the ample can alo provde valuale nformaton aout quantfcaton of thee feature and/or aout the rate that can e allocated to freed cah. If SCF reman to e enefcal a a contract over the comng year, than a hgher rate can e agned at leat from the uyer perpectve. Regardng SMCS four cae a rather lmted numer. The model hould therefore e valdated ung more and dverfed SMCS cae. Th hold epecally for the countng/nvocng frequency and moment effect nce no reearcher ha commented on thee mpact. For oth SCF and SMCS a corporate and/or upply chan valuaton model would e valuale, nce th can provde nght n the long term eneft n term of added corporate value. Th hold epecally for the choce etween a prce decreae and payment term extenon wthn revere factorng. Mot recommendaton hould e feale and valuale, nce the centfc development on the area of SCF pecfcally are recent and lmted. The practcal development are neverthele aundant. 74

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80 Index Agle, 46 cah converon cycle, 21 Commodty nventory fnancng, 93 congnment tock, 9 Congnment tock, 47 Credt nurance (CI), 93 Documentary collecton (D/C), 92 Export fnancng, 92 Factorng, 92 fnancng decon, 19 Forfatng, 92 Letter of credt (L/C), 92 Letter of guarantee (L/G), 92 market mperfecton, 19 Open account, 92 Operatng workng captal, 20 operatonal decon, 19 revere factorng, 9 Supply chan fnance (SCF), 93 utanale, 46 trade credt, 26 Trade-recevale-acked fnancng, 93 WACC, 23 Workng captal, 20 80

81 Appendx 1 Reearcher v. practtoner 81

82 Appendx 2 The centfc company annual KPI 29 Cah converon cycle (CCC) = 0.4*DOH + 0.4*DSO - 0.2*DPO D ay nventory on hand D O H = N et nventore end of year E xternal C og S x360 T rade account payale end of year D ay payale outtandng D P O x360 E xternal annual C og S T rade account recevale end of year D ay ale outtandng D S O x360 E xternal annual net ale W eghted A verage P aym ent T erm W A T = paym ent term A nnual value of nvoce * paym ent term A nnual value of nvoce receved 29 Source: the centfc company manual for operatve plannng

83 Appendx 3 Scentfc company tandardzed and condened alance heet 2008 and Data from the centfc company annual report 2009, fgure n Euro. 83

84 84

85 Appendx 4 elected compane nvolved n RF SCF uer 1. Arlqude 2. Alcatel Lucent 3. Altom 4. Bg Lot 5. Carrefour 6. Cemex 7. Ead 8. Henkel 9. Holcm 10. Honda 11. J Sanury, 12. Kngfher, 13. Kohl, 14. Llly 15. Lowe, 16. Mark & Spencer, 17. Metro 18. Mcheln 19. Netle 20. Netlé, 21. Rect Benkcker 22. Sant goan 23. Sanury, 24. Seat 25. Semen 26. Sodexho 27. Syngenta, 28. Teco, 29. ThyenKrupp 30. Unlever 31. Volkwagen 32. Volvo 33. Wal-Mart SCF provder Bank 1. Banco Santander 2. Ctyank 3. Deutche Bank 4. HSBC 5. Standard Chartered 6. UnCredt 7. SEB 8. RBS 9. Bank of England 10. ING KBC 11. JP Morgan Chae - Wachova Non ank oluton On oardng uppler - ARIBA Onlne acce to fnance provder - Prmerevenue - ORBIAN - Demca Other The Recevale Exchange - UPS Captal 85

86 Appendx 5 Intervewee Functon Suject Communcaton* Important topc Payment department manager and atant manager Payale proceng Intervew Invoce confrmaton tme HTM, procurement manager & SCF coordnator HTM SCF cae 3 Intervew, Multple e-mal, phone call & exchange of fle Strategy, coordnaton, percepton, model and reult GPC, API Sourcng Predent Suppler ntegraton and compenaton 2 Intervew, Multple e-mal, phone call GPC, API ourcer Supply Chan fnance Two ntervew Multple phone call, e- mal Negotaton and reult n the long term GPC, Procurement payale performance Varou Daly contact, exchange of fle GPC, Suppler Integraton Polcy coordnator Suppler ntegraton and Revere factorng +/- 10 ntervew, Multple e-mal, phone call, and exchange of fle Compenaton, focu, cae avalale, valdaton of model GPC, Procurement performance coordnator, payale performance functonary, predent of GSCM and unverty upervor Progre meetng Monthly meetng Focu, drecton and plannng GPC, four SMCS cae expert 4 SMCS cae 1 4 ntervew each, Multple e-mal, phone call, and exchange of fle detal, Compenaton, valdaton of model CEO Culture, language and SCF Short general converaton n nformal ettng GPC Procurement predent Progre and SCF +/- 5 ntervew reult GPC Procurement communcaton SCF communcaton 1 Intervew Multple e-mal, Communcaton 86

87 PGC, GSCM accountng and reportng functon phone call, and exchange of fle SCF and SI Multple ntervew, e- mal, phone call, and exchange of fle Scentfc modelng and valdaton of model Holdng payale manager SCF and SI Multple e-mal, phone call, and exchange of fle Sourcer motvaton, valuaton, percepton and reult Holdng workng captal manager and atant SCF and SI Multple e-mal, phone call, and exchange of fle Sourcer motvaton, valuaton, percepton and reult Holdng treaurer SCF Multple e-mal, phone call, and exchange of fle SCF model, Valuaton, percepton and reult Fnancal market forecat employee Economc development and rate Euror Procurement accountng SCF Two converaton Negotaton, SCF mplementaton cot GPC packagng ourcer Suppler ntegraton and compenaton Multple ntervew, e- mal, phone call GPC contract manufacturng ourcer Suppler ntegraton and compenaton Multple ntervew, e- mal, phone call Former CEO Ctank, Currently at PrmeRevenue SCF Phone call, e-mal, exchange of fle Goal, negotaton preparaton and SCF reult Holdng repreentatve for SCF mplementaton coordnaton SCF, mplementaton Multple phone call, e-mal, exchange of fle Nutrton, SCF mplementaton repreentatve SCF, mplementaton Intervew Negotaton *Phone call are non-phycal ntervew varyng from 5 mnute to multple hour. Th lt an approxmaton, t need not e complete, ut provde an ndcaton. 87

88 Appendx 6 SMI & Congnment mpact 88

89 Appendx 7 SMI & Congnment mpact reved Impact on uppler Impact on cutomer congnment tock SMI Shft of nventory ownerhp to uppler Sharng accurate forecat Le nventory n own warehoue Optmzed tranportaton plannng Optmzed producton chedulng Long term trategc partnerhp Improved ervce level Decreaed lot ale Increaed ale Proft More nventory n uppler warehoue Decreaed nventory handln cot per unt Decreaed nventory holdng cot Decreaed tranportaton cot per unt Optmzed capacty plannng Other product and ervce ncluded n portfolo Increaed nventory holdng cot per unt Decreaed Inventory on Balance heet Decreaed producton cot per unt proft Decreaed MRP and order effort Decreaed admntraton cot per unt Decreaed workng captal requrement Congnment tock mpact Mxed mpact Increaed ale Decreaed nteret payment Compenaton? SMI mpact Negatve congnment tock mpact Negatve mxed mpact 89

90 Appendx 8 Scentfc veru conceptual model Impact on uppler proft Impact on cutomer congnment tock SMI Shft of nventory ownerhp to uppler Sharng accurate forecat Congnment tock mpact Mxed mpact SMI mpact Le nventory n own warehoue Decreaed nventory handln cot per unt Improved ervce level Decreaed lot ale Increaed ale Proft Decreaed nventory holdng cot Optmzed tranportaton plannng Decreaed tranportaton cot per unt Optmzed producton chedulng Optmzed capacty plannng Long term trategc partnerhp More nventory n uppler warehoue Decreaed Inventory on Balance heet Decreaed producton cot per unt Compenaton? Other product and ervce ncluded n portfolo Increaed nventory holdng cot per unt Decreaed MRP and order effort Negatve congnment tock mpact Decreaed workng captal requrement Decreaed nteret payment Increaed ale Excluded n quanttatve model Negatve mxed mpact Decreaed admntraton cot per unt Included n quanttatve model Partly ncluded n quanttatve model 90

91 Appendx 9 Savng calculaton per agreement RF term extenon (j = θ) TF prce decreae (j = μ) V V 365 Suppler mpact f e f f w ( t t t ) ( r r )( t t t ) ( T 1) (3.4) S j Buyer mpact S j e f f (1 ) r r w t t t (3.12) 365 V V w ( t t ) 365 (3.5) w ( t ) (1 T ) 365 (3.14) SMI & congnment tock (j = β) a * x D c D k 1 q * * 2 2 c D h u (1 m ) u (1 m ) h q q w * q 2 2k 365 (4.14) u a * x V w q 2 z h y 2k 365 (4.8) SMI & congnment tock (j = β+p + ) 1 S u u D T (A8.1) t S u u D w T (A8.2) SMI & congnment tock (j = β+t - ) S t V w 365 (A8.3) S t V w 365 (A8.4) 91

92 Appendx 10 Credt ratng compared Moody' S&P Ftch Long-term Short-term Long-term Short-term Long-term Short-term Aaa AAA AAA Prme Aa1 AA+ AA+ A-1+ F1+ Aa2 AA AA P-1 Aa3 AA- AA- Hgh grade A1 A+ A+ A-1 F1 A2 A A Upper medum grade A3 A- A- P-2 A-2 Baa1 BBB+ BBB+ F2 Baa2 BBB BBB Lower medum grade P-3 A-3 F3 Baa3 BBB- BBB- Ba1 BB+ BB+ Non-nvetment grade Ba2 BB BB peculatve Ba3 BB- BB- B B1 B+ B+ B B2 B B Hghly peculatve B3 B- B- Caa1 Not prme CCC+ Sutantal rk Caa2 CCC Extremely peculatve Caa3 CCC- C CCC C In default wth lttle Ca CC propect for recovery C C D / DDD / In default Source:

93 12 month euror Appendx 11 2 and 12 month euror 0,060 0,055 0,050 y = 0,9218x + 0,0069 R² = 0,9922 0,045 0,040 0,035 0,030 0,025 0,020 0,015 0,010 0,000 0,010 0,020 0,030 0,040 0,050 0,060 2 month euror Source: ( daly rate 2008, 2009 and 2010) 93

94 Appendx 12 Dered SCF nformaton and feature 94

95 Appendx 13 The trade fnance gloary y McKney (2010) Trade fnance ncorporate hghly pecalzed ntrument to mtgate rk etween tradng partner. tradtonal trade ntrument uch a letter of credt are document-heavy and requre extenve manual proceng, and cot-to-ncome rato of 50 percent are typcal n the trade fnance une. Conequently, a mall numer of large ank (varyng n cope from local to gloal) domnate trade ervce, leveragng cale to etalh centralzed proceng operaton. The followng gloary of trade fnance term provde an overvew of tradtonal tranactonal and newer workng captal oluton. Documentary collecton (D/C) The uppler entrut collecton of payment to the remttng (uppler ) ank, whch end document and ntructon for payment to the collectng (uyer ) ank. The uyer pay the face amount ether upon acceptance of documentaton or at a pecfed future date to the collectng ank, whch tranfer fund to the remttng ank. Letter of credt (L/C) The uyer (ung) ank make payment to the uppler' ank, wth the uppler preentng document confrmng the hpment of good wthn a gven tme frame. L/C reduce the rk of nondelvery for the uyer and guarantee payment to the uppler upon hpment. Letter of guarantee (L/G) Prome y the ank on ehalf of a uyer to compenate a uppler for any detrment uffered on the a of the non-fulfllment of olgaton. L/G protect the uyer agant the commercal rk of non-fulfllment of the uppler olgaton and reduce non-payment rk for the uppler. Open account A tandard arrangement wth no thrd-party or guarantee nvolved. The eller preent an nvoce to the uyer for good delvered. Suppler are ncreangly otanng credt nurance to mtgate the non-payment rk. Factorng The uppler ell t hort-term account recevale to the factor (a ank or pecalzed trade fnance company) for cah at a dcount on the face value. Factorng allow the uppler to offer open account term and reduce day ale outtandng. Forfatng The uppler ell a large, medum-term recevale at a dcount to the forfater wthout recoure. The uppler hp good to the uyer and delver document to the forfater, who aume the rk of non-payment and handle collecton. In dtncton from factorng, forfatng contract are made on a tranacton a wth uppler (uually exporter) that ell captal good, commodte or large project wth medum-term credt need rangng from 180 day up to 7 year. Export fnancng In pre-hpment export fnance the ank provde a loan to the uppler (exporter) to fnance the proceng of good to e delvered to the uyer (mporter) on the a of a confrmed purchae order 95

96 and/or L/C. In pot-hpment export fnance the ank provde a loan to the uppler agant ther export recevale for the perod etween hpment of good and recept of payment from the uyer. Credt nurance (CI) CI protect an exporter of product or ervce agant the rk of non-payment. CI generally cover commercal rk uch a uyer nolvency, ankruptcy or protracted default, and certan poltcal rk, a well a currency nconvertlty, expropraton, and change n mport or export regulaton. Supply chan fnance (SCF) SCF program generally refer to ank-ponored uyer-centrc ntatve ung open account and provdng lqudty to uppler through revere factorng. Trade-recevale-acked fnancng The uppler tranfer account recevale aet, uually on a revolvng a, to a pecal purpoe vehcle, whch ue note old to nvetor through econdary dtruton. Th form of tructured fnance can e enefcal to non-nvetment-grade medum-ze uppler, a the ecurtzed aet are rated accordng to the credtworthne of the uyer, provdng the uppler wth lqudty at a lower cot of fund. Commodty nventory fnancng A form of tructured fnance n whch the pledge of a commodty ued to mprove credt term. Fundng technque nclude preexport fnance and nventory fnance, and 96

97 Appendx 14 SCF role per department Source: Sddall,