Chain Reaction

In the course of his work Albert Hollema deals with a number of issues and one of the most important at the moment is managing the financial supply chain. That means looking at all the elements of the financial supply chain, including working capital management, debtors, inventory, creditors and investments.

Part of the challenge is ensuring someone has ownership. At Danone Schiphol (previously Royal Numico NV, the baby food and medical nutrition company acquired by French conglomerate Danone in 2007), the finance team includes a dedicated financial supply chain manager, responsible for aligning the physical and financial supply chains as well as a project manager for working capital projects. The physical supply chain is managed in-house by the operations department but with a central purchasing team in place there is good alignment between purchasing and finance.

One positive is that Danone Schiphol is not experiencing too much squeeze on margins from its retailers.

"Baby food is a product every retailer wants because it attracts families, and a family will spend more than twice as much as an individual," says Hollema.

"So by attracting more families a good range of baby products will probably enhance overall supermarket sales."

For the last few years, however, Hollema admits that retailers are increasingly squeezing suppliers, like the food and consumer goods companies, to get better margins into their retail operations. Having said that, there are signs of a supplier backlash, with some stronger brands refusing to supply certain retailers and more aggressive supplier consolidation, as seen in the beer market recently.

While it is not Hollema's intention to finance the working capital of suppliers, the company also needs to be careful not to squeeze its own suppliers too hard, especially the smaller suppliers that may not have access to a full range of banking facilities.

"You need to look at two things: maximising value and risk management. You can squeeze your suppliers to the limit, for example, but if it puts them out of business, then you might be left with an even bigger risk than what you save with respect to payment terms," says Hollema.

"It is all very well pushing the weakest link, but if that breaks then the whole chain has a problem. So, we do some supplier analysis, look at their strengths and weaknesses, see how they operate, try to get a feel for their working capital arrangements, and based on that we try to estimate the best position to take."

Reverse factoring

Like most companies Danone Schiphol utilises a number of financial tools to help optimise the financial supply chain. Reverse factoring seems to be popular with many companies at the moment, particularly when dealing with emerging markets and it is something that Hollema is considering.

"We are looking into reverse factoring with some of our main suppliers; we think it looks interesting – the way we look at it, it is a trade off between cost of debt and cost of capital. But we need to fully understand the legal implications," says Hollema.

"So, it would work for us if the reverse factoring is still seen as a creditor and not as bank debt; if it is seen as bank debt then I can easily go to a bank and use my credit lines. If reverse factoring is still seen as a normal creditor it will help my working capital, and my net debt won't be affected by it."

From the suppliers' perspective it is also very rewarding.

"If you structure reverse factoring properly it can be a triple-win for all three parties involved. The supplier gets funds earlier, which is a benefit on the cost of capital side. The banks are in the middle financing the factoring, so they will make some profit. And, for a buyer such as Danone, it is a cost of debt issue because it is able to reduce its working capital and release some funds."

"In terms of the price," adds Hollema, "It should end up somewhere between the cost of debt and the cost of capital, and that is something that needs to be negotiated with the supplier."

He also points out some considerations on the debtor's side. "The trade off between giving trade discounts and factoring is interesting. It brings us back to that discussion about cost of debt and of capital," he says.

"For debtors, paying early is a cost of capital therefore they want a big discount in order to do so. In some countries you see companies needing to give huge trade discounts in order for customers to pay early, within a month, say. Alternatively, it can be more interesting to factor – instead of giving a trade discount as sometimes the cost is lower."

Cash conversion

Another important issue for Hollema is the cash conversion cycle. "That is the moment you start financing the supply chain, to the moment you get the euro or the pound back out of your supply chain again. I would call that a cash conversion cycle. Maybe not every company has the same definition but I think it's an important aspect to understand, so that we know how long to finance the supply chain and how we can shorten that period."

At the moment Danone Schiphol measures its performance on cash conversion by calculating the cash conversion cycle every month and mapping it on a graph over time so it can be used for comparison purposes. In terms of the targets, it has specific targets on the debtors' side, the creditors' side and on inventory.

"It partly depends on the country and the type of business," says Hollema, "For example in Italy we have hospitals buying our products that are paying after one year. Giving them a 30-day target would be nonsense."

"Equally, we sell to retailers, hospitals, pharmacies and other types of business, and each client has their own specific considerations. So if you set targets, they should be achievable and that is something you first need to discuss with the local business, try to find the achievable target, and put it into their bonus scheme."

Looking internally

Finally, says Hollema, regardless of what initiatives or measures you put in place it is important to set the right targets internally if you want to encourage behaviours that will help optimise the financial supply chain.

"If you only give a person a working capital target, then the first thing they do is go to a factoring company, with little regard to the costs. Because the person is measured in terms of operational results, they focus on reducing working capital to get their bonus, rather than the costs of reducing working capital," he says.

"So we made sure that the factoring element is reflected in the operational results; that way there is more weighing up of the advantages and disadvantages of the different initiatives used to lower working capital."