Executive summary Financial Supply Chain Management Step into your clients shoes and leverage existing knowledge to optimise working capital across the value chain Amstelveen, 20 maart 2013 (v1)
Executive summary
Executive Summary Financial Supply Chain Management (FSCM) allows companies to manage and optimise cash flows and financing across the value chain. Consistency and cost-effectiveness of liquidity across a supply chain reduce required working capital, cost of capital and operational costs. Lack of available funding in particular amongst mid and small sized companies increases the urgency to further optimise working capital. Opportunities for both companies and banks await, however barriers need to be broken down. So far, only a limited number of banks or other suppliers have been successful in providing attractive propositions. Our survey amongst the purchasing function in companies shows that few companies know the concept, benefits are unclear and solutions too complex. Banks should step into FSCM to acquire a strong foothold across value chains. Not acting means a risk of disintermediation, as a result the role of a bank will be gradually curtailed when being too late or not present at all. Success can be achieved by bringing together different expertise and focus on sample clients in the right industries. Benefits should be clearly explained to companies by a strategic relationship banker who thinks from a client perspective. The relationship manager should provide solutions that enable companies to manage transactions effectively and manage risks in their supply chains.
Contents 1. Introduction 2. FSCM great untapped potential 3. Current barriers for success 4. Banks should step in 5. Road to success
1. Introduction Financial Supply Chain Management (FSCM) has been on the agenda for some years now. This paper focuses on a number of questions which remain unanswered: What are the benefits of FSCM? Why is not a big success yet? Why should banks step into FSCM? What actions should be taken to reap the benefits? Introduction to Financial Supply Chain Management Financial Supply Chain Management allows companies to manage and optimise cash flows and financing across the value chain. Sustainable improvements across the supply chain can be achieved by using commitments in the value chain. Raw materials and finished goods are often financed multiple times through different banks in the supply chain. Debtor positions from all players in the supply chain can be removed, thereby shortening balance sheets and releasing equity. Cash flows are often very inefficient; upstream and downstream cash flows are not aligned which results in cash imbalances. Goods in the supply chain could be financed against the strongest credit rating available within the supply chain. A logical next step Until the 1960s companies focused only on optimisation of their internal processes. Since then, entire value chains have been improved significantly by introducing Just-in-Time processes, standardising pallet sizes, use of containers and electronic data interchange, to name just a few. Recently, focus on financial working capital optimisation has increased strongly. Companies have reduced their own working capital by increasing the number of days payables outstanding and decreasing the days inventory and sales outstanding. In our view, Financial Supply Chain Management is the logical next step after supply chains and working capital have been optimised separately in recent history. Questions remain unanswered Although there has been a lot of talk about it, still FSCM is not as big as it promises to be. In this document the following questions will be answered: What are the benefits of Financial Supply Chain Management? Why is it not yet a big success? Why should banks step into FSCM? What actions should be taken to reap the benefits? Financial Supply Chain Management tries to optimise these inefficiencies across the chain using various, partly existing instruments and solutions. Some example solutions that have been developed in the past few years: Event-triggered financial services like invoice matching, e-invoicing, open account payments and reverse factoring Bank Payment Obligation (ICC BPO) based products that enable supply chain finance in traditional open account streams Tapping into alternative sources of working capital using third party creditors (funders) who pay early on behalf of the buyer Using outstanding invoices to conserve cash & optimise working capital and maintain / shorten payment periods for key suppliers Dynamic payables discounting (buyers and suppliers can dynamically change payment terms)
2. FSCM great untapped potential FSCM is a next step for companies to manage and optimise cash flows and financing across the value chain. Consistency and cost-effectiveness of liquidity across a supply chain reduces required working capital, cost of capital and operational costs. Just in the Netherlands a potential value of over 3bn is expected. Potential reduction of working capital by 5-12bn in NL Traditional working capital solutions focus on optimizing working capital in a single company. However, throughout a value chain same assets are often financed multiple times through different banks; the number of times depends on production and stock cycle times. Debtor positions from some players in the value chain can be removed, thereby shortening their balance sheets and releasing equity. In addition, cash flows are often very inefficient; upstream and downstream cash flows are not aligned, which results in cash imbalances. Banks can finance raw materials and contract upstream manufacturer(s) against a service fee that covers their value added of finance inventory of distributers until products are sold. Example Applying the concept of FSCM, would mean that the overall bank matches funding needs to the payment schedule of the different parties involved. This way, the own banking facilities of the parties during the entire engagement could be reduced to times when funding is actually needed. Based on this matched funding principle, the cost of all Basel III drivers can be decreased for the supply chain. The below example shows benefits realised of almost 70%. This example doesn t take benefits from different ratings or operational benefits into account. In The Netherlands working capital is about 125bn 1 and short term financing is 81bn. Less instability in value chains might eliminate part of this short term financing. Financial supply chain solutions are expected to release 5-12bn of working capital 23, using an average interest rate of 8% this means reducing financing costs by 400m- 1bn. Reduction of financing costs of about 800m in NL Financing of goods against the strongest credit rating available within the value chain further reduces financing costs. These benefits are based on using relations and commitments from the buyer and supplier in the value chain to buy and sell (finished) goods. These commitments, albeit orders, invoices or long-term contracts can be used to allocate risks to the strongest parties in the value chain or the parties that have most control. Given that short term financing in the Netherlands amounts to 81bn, overall working capital financing costs are expected to reduce driven by lower risk and a lower required interest rate. Less instability in value chains might eliminate part of this short term financing. Calculating a conservative 2% financing advantage over 50% of the used short term funding, this results in an additional 800m advantage in the Netherlands alone. Operational benefits through electronic invoicing of 1,5bn in NL If a company is going to optimize its financial supply chain using digital financial processes and documents, it is a small step towards electronic invoicing. Estimates of annual benefits of e-invoicing across Europe amount up to 250bn. A conservative estimate 4, referred to by the European Commission, calculates savings up to 40bn per annum for an estimated 30 bn invoices. With an estimated 4% share 5 for the Netherlands this results in a potential cost reduction of about 1.5bn. 1 ABN Amro 2 Dinalog Whitepaper Opportunities for Supply Chain Finance in the Netherlands 3 IMD 2009 4 SEPA: potential benefits at stake, Capgemini 5 E-invoicing 2010, Innopay
2. FSCM great untapped potential Case study A number of large corporates have already recognised the opportunity and have started to implement bank-independent solutions. Below a case study. Situation A world leader in healthcare, lifestyle and lighting with annual turnover of 25bn had been stretching payment terms to their suppliers to optimise their working capital costs. The company could realise this from the dominant position in the supply chain, however this also led to growing tension with suppliers to manage their working capital. Set-up of the program To mitigate this and secure supplies, the Treasury department initiated a Supplier Financing program in 2010 together with Procurement. This program had to realise benefits in terms of cash and favourable interest rates for its suppliers. A number of Supply Chain Finance instruments are explored. However, focus is on the Reverse Factoring program as this is most easy to implement and most beneficial in terms of cash. The program is focused on the largest suppliers, who are selected for participation on a case-by-case basis on individual business cases. Getting the suppliers onboarded and connected requires significant time and effort from both Procurement and Finance, in addition to changes in the ERP environment which are sometimes needed. Once a supplier is selected, it is approached by Procurement. The lead buyer initiates the meeting, in which the mutual benefits are explained to the supplier, often supported by a dedicated Program Team member within Global procurement, as well as on-boarding team member from the bank. Once the supplier agrees to participate, procurement and experienced on-boarding teams from the selected banks jointly implement the solution. As soon as the supplier is connected to the program, it is guaranteed to have its invoices approved within 10 days. Thereafter, it can choose to get the invoice paid early by the bank at a preferable interest rate. Benefits At this point in time, 10% of the total 3rd party spend flows through the program which saves the company over 100m working capital per year. Since the principle idea is to split benefits 50-50 with suppliers, the total benefits for the supply chain are double this figure. Another advantage is that the program facilitates a separation of negotiations on price from negotiations on payment terms. Without the program, payment terms and prices are traded off against each other during negotiations. Using the program, negotiations can be purely price/productdriven. Despite the eminent benefits, the company is careful to stretch the program to its maximum capacity as several risks are recognized as well. First of all, credit ratings of the company become critical for the full value chain this might create an unhealthy situation. If a supplier gets dependent on the cash made available through the program. Therefore suppliers who are financed are regularly monitored as part of the Supply Risk Management framework.
3. Current barriers for success Despite the potential and initial successes at large corporates, FSCM has not really taken of yet. The most fundamental barrier is the unfamiliarity of most clients with the concept. Extension of the success requires explaining the benefits and simple solutions that enable clear management of risks. Demand perspective: Current solutions are not well understood Results from a study performed by a Deloitter for the Nyenrode Business University show that buyers of many corporates are not aware of supply chain finance (a term often used for FSCM). If asked about the concept of reverse factoring an even larger group indicates to have never heard of it. This shows that although banks and suppliers have been talking about the subject for years, they have not been able to educate most purchasers, an important group of stakeholders since many FSCM solutions are buyer-driven. Only 14% of the interviewed organisations in the Nyenrode Business University study is active in any kind of supply chain finance with their suppliers. Reasons why companies do not consider setting up a reverse factoring program are: The benefits are not clear enough: 31% The need/necessity is not there: 31% Our internal processes are not mature enough: 28% Too complex: 19% Are you familiar with the concept of SCF finance? Supply perspective: Suppliers haven t been able to create success In the arena of FSCM different suppliers try to get a foothold, including platform providers, logistics providers and banks are most significant, each group with their own advantages and challenges. Platform providers lack the network Platform providers offer bank-neutral value chain platforms for corporate clients (e.g. TradeCard, Orbian, CGI, Misys, MaxTrad). These providers can work on FSCM programs with a wide range of bank /service providers, broad choice of products & services and possibility to compare rates for similar solutions. Most important challenge for these providers is to build the company network to create a valuable proposition. Although these providers have been working on this for some time already, they have not been very successful so far. Only TradeCard and Orbian have achieved limited success. TradeCard has the largest customer base, providing support to 4,000 clients in 50 countries worldwide. TradeCard offers an open FSCM platform allowing multiple banks to participate. Orbian has been chosen as the best global supply chain finance provider (non bank) by Global Finance Magazine in 2009. Orbian offers a global proposition in trade payment settlement and finance solutions. Is your organization already active in the use of SCF with / for your suppliers? 19% 4% 10% 81% Yes No 86% Yes, reverse factoring Yes, other solutions No
3. Current barriers for success Logistics providers lack financial knowhow Logistics providers like UPS, offer finance and receivables management services. These providers have access to logistics and transportation information, which allows risk mitigation from lending on in-transit and/or incountry inventory. On the other hand they may lack the required financial know-how. Banks are siloed and fear cannibalization Banks generate money by attracting capital and lending it to their clients at a higher rate. Income depends on the amount of capital that can be lent, the interest spread between attracted capital & lent money and the ability to minimise costs (operational costs and defaults). As total required funding by. corporates reduces through effective FSCM products, this puts pressure on bank interest incomes. Currently payments (attracting capital) and lending are often siloed functions in most banks. On top of that, specialised functions provide derivative products (FX and interest), Trade products (guarantee-type products), Lease and Insurance products. These different functions are often spread across the organisation. Banks try to bring this together via the relationship manger and large transaction banks try to shift their organisation structures to more functional oriented organisations. The importance of lending income in the targets of the relationship manager, brings the risk is that they will not proactively put this topic on the agend
4. Banks should step in FSCM provides an opportunity for banks to gain strong foothold across value chains. If banks do not move, they will see their positions in value chains crumbling and be marginalised to payments only. The current pressure on funding improves the case for both banks and clients to realise the value potential. Opportunity for strong foothold across value chains Banks that are able to provide FSCM to their most relevant value chains, start building relationships throughout the entire value chain. From this position, banks will be able to transfer these new relationships to full banking clients, using their knowledge advantage of the value chain and create operational lock-in. This will increase market share and cross selling opportunities and provide the necessary return on equity. The flipside is that banks that do not move, will see their positions in value chains crumble. Furthermore, their role will be marginalised to payments only, without obtaining a piece of the FSCM pie. Increased need for solutions from clients High pressure on available funding, lagging demand and consequent polarisation between cash-rich and cash-poor companies has increased instability and financing costs in value chains. UK research has shown that companies are increasingly turning to their suppliers for trade credit as need for cash increases, leaving banks empty-handed. In the Netherlands available working capital of SMEs has declined in recent years, while this has grown for large companies. Especially SME retail and car trade have high liquidity needs. This scarcity of funding improves the case for clients and therefore also for banks. help supply chains decrease financing costs. Truly international banks like JP Morgan, DB, Citibank and RBS have initiated supplier finance programs, specifically targeting corporate clients. However, so far only JP Morgan and DB have been successful in launching a Financial Supply Chain Management solution. Smaller banks could start by connecting existing solutions and potentially use solutions from larger banks, thereby ensuring to stay in the game. Example JP Morgan uses a global, proprietary web-based platform which connects over 10.000 buyers and suppliers worldwide. The bank differentiates itself as a market leader in global trade: Best Trade Bank in the World (2010, 2011) and Best Supply Chain Finance Bank (2010). Their FSCM solution combines trade services, end-to-end supply chain finance and payment solutions and logistics consulting. It helps clients fund, manage and mitigate the risk of their end-to-end trade activities and customers can fully outsource the entire life cycle of a trade transaction from order to payment. Example DB offers FSCM solutions to corporate customers based on a global, proprietary web-based platform which combines supply chain finance and advanced cash management. DB offers both standard FSCM solutions, but also customized services. They take advantage of partnerships with web-platform providers which offer multibank capabilities and with local banks to offer flexible, customized and highly localized FSCM solutions. DB established local partnerships with banks (e.g. RBS, Garanti Bank, Standard Bank South Africa, RBC Canada) to expand trade services and participates in multi-bank SCF platforms. Banks can be successful Banks already have many customer relationships, an international network of interbanking partnerships and access to credit. Banks are highly regulated (compared to logistics and IT firms) and therefore more trustworthy. These assets can be re-used to
5. Road to success The road to success requires focus, driven by a clear vision. The three most important conditions for success are getting executive buy-in, creating success cases and focusing on the right industries. Benefits should be clearly explained to clients by a relationship banker who thinks from a client perspective and provides solutions that help companies manage transactions and risks effectively. Get executive buy-in Currently payments (attracting capital) and lending are siloed functions in most banks. Specialized functions provide derivative products (FX and interest), Trade products (guarantee-type products), Lease and Insurance products. As total required funding by corporates reduces through effective FSCM products, Relationship managers are often very hesitant to put this topic on the agenda. And, as involved products can often replace each other, product managers are often very hesitant to pick this up. Strong leadership and executive buy-in are therefore essential to transcend the siloes. Leverage success cases Development of FSCM products and propositions is often a technological challenge. Furthermore integrated risk management is needed to determine effective pricing. Implementing a full solution across the bank requires substantial investments. In order to get ready for offering FSCM propositions it is essential to present successful cases. Through this, product managers learn what attracts clients and help optimise internal processes. Also, proven propositions help in getting executive buy-in for further investments. Focus on the right segments The potential of Financial Supply Chain Management depends on the degree to which actors in a value chain will align on this topic. This depends on the potential to reduce (value chain) risks and financial impact. Examples of the latter include the share of purchasing costs as part of Cost of Goods Sold (COGS) and strength differences in the value chain in order to benefit from interest advantages. Retail, Food & Agri, Automotive, and unique Industrial processing and electronics value chains are expected to get most benefits due to close co-operation, power differences in the value chain and large value of certain COGS. Within these value chains focus should be on strategic and bottleneck items as supply chain risks for these products are largest and stability in the value chain is most important. Educate clients and staff As explained in Chapter 3, companies need to have benefits explained and must be offered a simple solution that fits the maturity and complexity of their organization. Traditionally, relationship bankers focus on events and their lending relationship with their clients. Given the current need for funding, many banks shift the attention to payments and flow products as well. The next shift will be to really step into the client s shoes and advise on the total set of working capital, asset financing, company risks and finance operations. Relationship managers need to educate clients and put client conversations on a more strategic level. This requires new skills and training. Develop modular propositions FSCM solutions can span multiple parts of a company s process, e.g. purchase-to-pay and order-to-cash processes. As much as banks will need to change internal operations, clients will have similar challenges. Successful propositions will therefore need to be modular to fit the client s needs. Apart from the selected process elements, propositions should also enable effective management of risks that a client may or may not wish to mitigate. This could encompass macro environmental, supply chain specific (e.g. pricing), operational (e.g. bankruptcy) or functional risks. Specific clients will have specific needs with respect to the risks they are willing to take, and thus on which banks should tailor their offering.
5. Road to success From a bank perspective this requires a central client risk profile and limit management and insight on value chain risk and limit positions. Act now Banks that see the opportunity first will be able to seize the most profitable value chains. If banks do not move, they will end up only losing financing income, without obtaining a piece of the FSCM pie, probably seeing their role being curtailed over time.
Contact Hans Honig Partner HHonig@deloitte.nl +31 6 2078 9901 Roeland Assenberg van Eysden Senior Manager Rassenbergvaneysden@deloitte.nl +31 6 2078 9871 David van den Hengel Manager DvandenHengel@deloitte.nl +31613127501 Daan Poelman Senior Consultant DPoelman@deloitte.nl +31 610042742