Supply's the Limit

The aim of offering post-shipment trade finance is to enable corporate clients to achieve broader business benefits. For instance, allowing distributors longer credit periods and higher credit limits. Or, financing internal supply chain projects that lead to an improved quality of service, more flexible and reliable deliveries, and more responsive and resilient supply chains.

Providing such a mechanism requires most banks to step beyond their traditional area of expertise. This is because it is not simply the case of offering conventional funding to suppliers and/or buyers. Instead, the key is understanding the corporation’s business model and its components, such as sourcing, manufacturing, sales, and treasury. The participating bank will have to propose itself as a business partner in the corporate’s supply chain, which requires a granular understanding of the basic principles of the client organisation’s business.

Treasurers should look at those banks that prove the ability to add significant value to the relationship only after having fully grasped the supply chain’s working practices, priorities, business strategy, processes, typical credit terms, incentives, and margins.

Banks are organisations that provide liquidity to their clients in different forms and at different stages along their value chain. In determining where such funding would sit best in the chain, they evaluate the various stages in the supply chain, where funding demand naturally originates and where it should get repaid as well as the risk scenarios associated with it. To translate that to the corporate sector, for instance in the procurement area, the attention of the purchasing manager needs to go beyond the understanding how global sourcing impacts the P&L; it needs to encompass also the influence on the balance sheet and on working capital ratios.

Business processes

Rightfully, banks are always careful as to how the client handles the different elements of risk in its supply chain. So far, the best method banks have utilised to mitigate supply chain risks is to attach documents to a trade transaction. The letter of credit is the epitome of this. The availability of such trade documents proves the ownership of goods can be treated as a financial asset totally exchangeable in the market, and securitises the operation.

However, the concept of supply chain management must go beyond invoices, payments, and inventory management. This is supported by the results of a recent survey of supply chain managers of European large companies.

Sourcing, warehouse management, and shipping goods are, indeed, part of the supply chain manager’s duty. Yet there are additional activities, like planning of production, of suppliers, of finished goods, negotiation of purchasing deals and managing returns. These processes all expand the reach of the supply chain manager’s responsibilities, and all trigger equivalent processes from the financial chain. For instance, the planning of shipping finished goods demands the ability to manage letters of credit, get INCO terms financing, or plan for FX transactions.

Planning suppliers triggers a cash forecast capability, while production planning looks at investment and asset-based lending services as the natural counterpart from the financial value chain world. These few, yet punctual examples introduce the notion that SCF must extend its reach way beyond its current positioning. True SCF practices can satisfy the need of corporate users and the appetite of financial institutions only if these ‘think out of the box’ and look at the extended ecosystem of the supply chain business processes to identify areas of opportunities and of value creation.

Make-order and sales-order services

According to our research, banks concentrate mainly on buyercentric, and post-shipment, financing. This is because their perceived level of operational risk from the supply chain has a profile which does not match reality.

In a buyer-supplier relationship, it is usually the buyer who has a stronger power of negotiation and can impose decisions. Especially in internationally globalised trading networks, suppliers often reside in emerging and low-cost countries. The divide between large buyer and small supplier becomes wider. The bank, therefore, prefers to sit on the large buyer’s side, where the risks can be better managed and mitigated. The use of the letter of credit is yet to be dismissed. A bank will always try to attach documents to the physical transactions to reduce the associated risk. The interest of holding commercial paper related to the trade transaction becomes even more understandable when we observe the risk profile that a bank expects, in relation to a shipment.

From the instant the vessel leaves to its destination, the level of perceived risk remains high. Only when the goods are delivered and can be physically checked, the risk drops. Such a Manichean vision of the supply chain world does not correspond to reality. Experience shows that the risk that accompanies the goods diminishes progressively, with no quantum leaps.

The financial player should pursue an activity that approximates the real risk profile of the supply chain trade transaction. The basic foundation resides in approaching the trade flow with the lens of business process management. Practically, this means breaking the generic, and monolithic, ship-to-deliver supply chain process down to its main elements: build loads, load product, deliver product (see Figure 1, below). Each of them carries a level of increased visibility, and consequent possibility of control, that lowers the level of inherent risk. At each of the connecting points between the process elements, the level of risk drops, thanks to the additional information exchanged, that becomes the communication protocol between the process owners.

The concept can be recursively applied, driving a new profile of risk. The profile is still staircase-shaped, but with smaller leaps and closer to the real risk border of the supply chain transaction. The more granular the breakdown of the supply chain, the closer the overlap with the real risk contour.

The key to making the perceived level of risk coincide with its real values resides in the bank’s ability to encompass all the processes that belong to the physical supply chain (PSC). The PSC is made of pre-shipment (procure-to-pay) and postshipment (order-to-cash) processes.

During the ‘buy’ initial stages, the negotiation power of the buyer is sufficiently strong to ensure a controlled risk. The more the physical operations enter the manufacturing and transormation processes, the riskier it becomes to the bank, since there is less visibility – and no supporting commercial papers – to ensure the goods across the supply chain execution activities. When the finished goods are in stock, the hazard of having unsold/obsolete items marks the highest peak of the perceived risk for a bank. That is where the curve connects with the ship-to-deliver profile previously commented.

Adopting the same approach of breaking down the physical supply chain processes in more granular components, the risk curve is smoothened and approaches the real pattern.

Pre-shipment (the buy-to-store leg) is where the bank has less visibility and guarantee. As mentioned, there are no invoices or shipping documents, only purchase orders or sales/manufacturing forecasts.

The real value that a bank sells is tied to its ability to manage risk and turn it into liquidity. There are many elements of risk in the PSC. The corporate buyer expects the bank to take the risk of financing the supplier, once the buyer has confirmed the reliability, responsiveness, flexibility, quality of delivery, and service levels of the supplier. These are all supply chain-related performance criteria, which the bank must be able to translate in risk ratings. The ability of a bank is to break the chain into its components, in order to establish a risk profile for each of the steps. The more granular the segmentation of the chain, the closer the risk profile gets to the real risk curve.

Celent believes that traditonal thinking around trade finance, especially buyer-centric finance, is increasingly being challenged by corporates’ growing expectations of the banking community. We believe that the future perspective of a bank’s SCF offer is, as IBM calls it, an event-driven financial chain.

As soon as the financing institute is able to intercept the instant when the accounting transaction is triggered by the supply chain process (see Figure 2) it will also be able to offer added value services. Again, using the example in Figure 2, from the trigger point of the issue invoice the bank could offer corresponding services, invoice issuance, such as a service of electronic invoicing, of dematerialisation and management of the related paper documents, and of invoice financing.

As can also be noted from Figure 2, there are many trigger points that can activate added value financial services. The bank can intercept them, and therefore increase its offer, integrating the processes of the physical chain upon a technological platform capable of recognising them and, consequently, activate the proper triggers.