Supply Chain Finance. Theory, Practice, and Perspectives. 20 November 2013

Transcription

1 Focusing on creating value to its members through shared solutions development and implementation Supply Chain Finance Theory, Practice, and Perspectives 20 November 2013 Powered by:

2 Overview / Agenda 1. Introduction to Supply Chain Finance (SCF) Theoretical perspectives. 2. Examples Classic, no SCF: trade credit & EOQ.... short-term financial management, factoring Contemporary, with SCF: reverse factoring (RF). 3. Research Perspectives RF, Purchase Order Financing, and more. 4. Conclusions, Opportunities

3 Introduction to SCF Part 1

4 General Perspective Supply chain finance (SCF) is the inter-company optimization of financing as well as the integration of financing processes with customers, suppliers, and service providers, in order to increase the value of all participating companies. Pfohl and Gomm, 2009

5 ... in order to increase value Value enhancement criteria of Srivastava et al. (1998), Christopher and Ryals (1999), (1) Acceleration of cash flows. (2) Reduction in the volatility of cash flows. (3) Increase of cash flows. (4) Increase of residual value, i.e., the value of free cash flows beyond a given planning horizon.

6 Problem Structure (Pfohl and Gomm, 2009) Project P, firm N, supply chain partner G, financial institution K. 2. Company N funds P by borrowing indirectly via G. K 1. Company N funds P by borrowing directly from K. Return: r P r G, where i N > r G > i G. i G i N Return: r P i N. G P r P N Supply Chain r G

7 Optimization Criterion (Pfohl and Gomm, 2009) 2. Company N funds P by borrowing indirectly via G. Return to N is r P r G, where i N > r G > i G. G knows that P has success probability 0 < p 1. G requires return p r G. N can reduce r G by increasing p, but this is costly. For N, the optimal value of p lies where marginal cost of information transfer to G equals marginal gain from reduction of r G.

8 Key Insight A supply chain finance arrangement reduces informational asymmetries and thus provides financial advantages for all parties concerned.

9 Part 2 Examples: Classic & Contemporary

10 Project Finance vs. Operational Finance Project finance Discrete opportunities. Acceptance may add shareholder value, but rejection will (usually) not reduce it. Operational finance Ongoing requirements of business activity Inventory. Payables and Receivables. Wages.

11 EOQ, Trade Credit, & Net Present Value EOQ model (Harris, 1913) is classic result for theory of inventory management. Trade credit (i.e., period allowed for payment of invoices) is a standard practice in industry. Inventory policy handled by operations managers. Trade credit policy handled by financial managers. What is the interaction between the two?

12 EOQ Model with Capital Costs DT DT/2 Average Inventory 0 T 2T 3T 4T Annual demand D units, order cost S, item price p per unit. Inventory holding cost h per unit, capital cost r. Find T * (optimal reorder interval) and Q * (optimal reorder quantity). Total annual cost: S DT Z ( T ) = + ( h + pr) + Dp. T 2

13 EOQ Model with Trade Credit Rachamadugu (1989): EOQ with trade credit and discounting. DT NPV ( T ) 0 t T T+t 2T 2T+t 3T 3T+t 4T = S + T 0 hd T ( ) rl rt rt l e dl + DTpe + e NPV ( T ). Present value of first period order, holding, and purchase costs. Present value of future period costs.

14 Impact of Trade Credit NPV analysis shows trade credit in principle affects EOQ policy. Longer trade credit period longer intervals between orders, greater order size. In practice, difference between classic EOQ policy and EOQ policy with trade credit is small, unless optimal order interval already large. Are trade credit terms then not very important? Inventory policy does not change much (in this case), but total costs increase due to trade credit.

15 Cash Conversion Cycle (CCC) Cash invested in seller s operations generates delayed return. Order placed with supplier INV Order received from buyer AR Cash received from buyer AP CCC = INV + AR AP Cash paid to supplier CCC Time

16 Source: REL Consultancy / Citibank (2009) CCC Industry Comparisons

17 Working Capital CCC (days) = INV + AR AP Cash conversion cycle is a useful indicator, but cost of operations depends more precisely on (net) working capital. NWC ( ) = INV + AR AP = (INV, AR, AP).(COGS, Sales, Purchases)/365 For opportunity cost r, annual cost of working capital is at least r NWC.

18 Factoring A factor acquires the right to full payment by the buyer in return for immediate payment at a discount. Order placed with supplier INV Order received from buyer F Cash received from factor AR Cash received from buyer AP CCC Time Cash paid to supplier CCC = INV + F AP but r NWC Cash paid to factor

19 Problems with Factoring Factor Not a supply chain partner: extracts value from chain. Exposed to possible fraudulent transactions High risk, high prices Seller Erosion of profitability, exacerbating financial difficulties. Potentially harmful to relationship with buyer. Buyer Loss of control over accounts payable. Weakening of key suppliers

20 Geography of Factoring: Fraction of GDP 12,00% Average Annual Factoring as Percentage of GDP, ,00% 8,00% 6,00% 4,00% 2,00% 0,00% Source: Klapper, 2006

21 Improvement: Reverse Factoring Factoring is reversed when constituted as a service for the buyer, rather than for the seller. Implementation Buyer contracts with financial institution (bank) for provision of standardized factoring services to seller. Buyer s approval of invoice serves as collateral for a loan from bank to seller. Seller pays buyer s interest rate on loan.

22 Schema for Reverse Factoring Reverse factoring is enabled by an ICT system linking all parties. In-house or commercial platforms possible. BUYER Invoice Approval Invoice Platform SELLER Invoice Payment BANK Cash on Demand

23 Reverse Factoring Timeline Factor effectively makes loan to buyer, but funds redirected to seller, in exchange for scheduled invoice payment. Order placed with supplier INV Order received from buyer RF Cash received from bank AR AP Cash paid to supplier CCC Buyer pays bank Time CCC = INV + RF AP AND r NWC

24 Relationship to SCF Reverse factoring is a special case of SCF where G knows that P has success probability p = 1. K i G G P r P N Supply Chain r G

25 Geographic Profile Little current research on factoring. Reverse factoring even less understood. Less than 20% of multinationals have SCF already in place (Aberdeen Group, 2008). Update: 41.7% of 145 respondents in the latest survey (Aberdeen Group, 2013). Major banks active Santander, Citibank, HSBC, ING,

26 Benefits of Reversed Factoring Factor Interest/fee income Ongoing relationship with buyer and seller. Seller Liquidity at low cost, reflecting low risk of transactions. Better systems integration with buyer. Buyer More reliable seller, higher service level. Opportunity to share direct financial benefits with seller.

27 Implementation Challenges Buyer credit advantage. RF generally sees buyer to have credit advantage over seller, but upstream supply chain goals can also motivate. Investments required (systems, staff) RF must realize sufficient transactional volume. Capital structure changes, service concentration. RF may change debt profile for buyer, directly or indirectly impacting credit capacity. Commitment to single financial service provider reduces future flexibility.

28 Sharing Direct Benefits Benefits of RF for buyer are initially indirect and difficult to quantify. Buyer can also take share direct benefits Lower cost from seller Longer nominal payment term to seller How do these measures affect benefit to seller? Equitable sharing of benefits requires deeper understanding of RF mechanism.

29 Research Perspectives Part 3

30 Application of Reverse Factoring INITIAL CONDITIONS Seller offers trade credit to buyer: AR = d 1 days Seller finances trade credit by bank financing at cost of r 1 per year. Seller s annual financing cost for trade credit: Sales r 1 d 365 1

31 Reverse Factoring Analysis Financing Cost 10% 9% 8% 7% 6% 5% 4% 3% Change r 1, d 1 to r 2, d 2 : NWC Benefits for Seller and Buyer Initial trade credit period 60 days, financing rate 10%. = Sales 365 ( r d r d ) 2 r 2 d 2 < r 1 d 1 seller gains d 2 > d 1 buyer also gains % 1% 0% Trade Credit Period (days)

32 Further thoughts... What happens if the seller does not always need to accelerate payments from buyer? Perspective of average NWC neglects the capital structure of seller and the possibly variable nature of working capital needs.

33 Working Capital: Aggressive Policy Cumulative assets Fluctuating current assets Type of funding Short-term financing Permanent current assets Fixed assets Long-term funds Conservative policy

34 Working Capital: Conservative Policy Cumulative assets Fluctuating current assets Type of funding Short-term cash surplus Permanent current assets Fixed assets Long-term funds Conservative policy

35 Working Capital: Conservative Policy Cumulative assets Fluctuating current assets Type of funding Short-term cash surplus Permanent current assets Fixed assets Long-term funds Conservative policy

36 Working Capital: Conservative Policy Cumulative assets Fluctuating current assets Type of funding Short-term financing Permanent current assets Long-term funds Fixed assets Conservative policy

37 Working Capital: Conservative Policy Cumulative assets Fluctuating current assets Type of funding Short-term financing Permanent current assets Long-term funds Fixed assets Conservative policy

38 Policy Implications Aggressive case Company always has short-term debt outstanding. Replacing some or all of this debt at lower cost is desirable. Conservative case Company may or may not have short-term debt. Increasing payment period may increase duration AND size of financing requirements. Greater likelihood of discounting receivables!

39 Intuition Increasing AR period has compounding effects Increased likelihood of using RF mechanism Increased cost of using RF mechanism Consequence: non-linear relationship. If r 2 (d 2 ) 2 is less than r 1 (d 1 ) 2 then seller has a gain. Much harder to satisfy this requirement than the linear trade-off. Sellers and buyers must be aware of such details when negotiating RF terms.

40 Participation Constraints Financing rate vs. Payment Period Initial trade credit period 60 days, financing rate 10%. 10% 9% 8% Case 1: Linear Costs Case 2: non-linear Costs Financing Cost 7% 6% 5% 4% 3% 2% 1% 0% Trade Credit Period (days)

41 Operational Enhancement Increasing AR period is always costly to supplier SCF reduces costs; savings can be invested in operations. For example, in a make-to-stock setting, supplier with lower costs will have higher optimal stock level. Consequence: buyers should also consider such operational benefits when designing SCF contracts with suppliers. Operational benefits depend on demand volatility and supplier working capital policy.

42 Source: Crimson Capital, 2011 Purchase Order Financing

43 Purchase Order Financing With pre-shipment financing, P generally has success probability p < 1. K i G G P r P N Supply Chain r G

44 Model of Purchase Order Financing Commitment ω expands supplier s debt capacity. Lender s claim settled from supplier s account receivable.

45 Findings Total expected supply chain profits increase when purchase order funding is employed. Relative margins play a key role in the solution. Retailer s expected profit is increasing in supplier s debt capacity and retailer s own creditworthiness. Not so straightforward for supplier Very creditworthy retailers can their purchase order guarantees, forcing suppliers to bear more risk. If supplier s debt constraint is tight and retailer s creditworthiness is low, supplier will benefit from an increase in retailer s creditworthiness.

46 Summary of Research Perspectives Reverse Factoring Payment period vs. financing rate not always a simple trade-off. May depend on capital structure, cost structure, demand variability. Operational and/or long-term benefits may sometimes be greater financial and/or short term gains. Pre-shipment Financing (including purchase orders). More risk, more return and sometimes the only way. The future of Supply Chain Finance? Others Changing interest rates, contract design, sharing benefits, sustainability

47 Conclusions Part 4

48 Conclusions Supply chain finance aims to reduce the inefficiency of separated financial and operational management. Reversed factoring and purchase order financing are important and promising SCF applications; all parties may benefit. Participants have see possible pitfalls, in order to avoid hurting partners instead of helping them. Many opportunities for researchers, supply chain. and finance professionals to help realize the promise of this field.

49 Project Opportunities Pre-shipment Financing (funding: Dinalog) Project approved July 2013 Aim(s): develop/extend pre-shipment financing applications to facilitate supply chain investment and risk management. Current consortium includes Philips, Heineken, ASML, ASYX, Sustainable Logistics (funding: NWO) Pre-proposal November 2013 Aim(s): develop/extend Supply Chain Finance applications in order to remove impediments to and/or provide compensation for increased sustainability. Envisioned consortium: large and SME logistics service providers; corporation with high consumption of logistics services.