22 August 2017

44975

Retired Member

3,100Posts 10,911,239Views 3,374Comments

It’s time to raise awareness about the costs to run SCF instruments.

29 July 2015  |  2358 views  |  3

Supply Chain Finance (SCF) has generated significant interest as a way to optimize a company’s working capital and to strengthen its supply chain operations. Special attention has been dedicated to the positive impacts of SCF instruments. But what are the associated costs?

After a deep research on this topic, thorough interviews with industry experts, Italian factors, banks and international service providers, and after having analysed the costs of the most frequently adopted SCF instruments: Reverse Factoring (RF), Dynamic Discounting (DD) and Invoice Discounting, it clearly emerged that two key factors strongly affect the costs to run these SCF instruments are:

  • The level of digitization;
  • The quality of the relationship among players.

The level of digitization refers to the use of digital information technologies (IT) integrated into everyday business activities to support the automation, the exchange of transactions, communications, integration and visibility into invoice processing (invoices are the main conduit to trigger any of the above SCF instruments), and to access the data of the other involved parties by means of a dedicated IT platform. The more supply chain partners connect, the more benefits they gain: the use of the IT platform impacts the costs and the time to process, approve, and pay invoices. It also helps to reduce the error rate, the reconciliation time, the information asymmetries, granting the possibility to check—when needed— the processing status of the invoices, and to give the flexibility to select which invoices to discount at any point of time before due date.

When reviewing the access to RF through a web-based platform it clearly emerges that the manual equivalent (i.e., paper-based invoice exchange and manual reconciliation) is almost as twice as expensive. This is caused primarily by the time and resources the supplier (i.e., who sends the invoice) spends to set the agreement with the bank. Especially if a small enterprise (SME), it cannot leverage economies of scale due to the low volume of the exchanged transactions and the manual paper-based management of the invoices. An IT platform-based RF delivery model immediately slashes these entry barriers making the SCF solution affordable especially to SMEs, furthermore allowing those suppliers in the long tail to join the SCF program which improves their financial stability. In addition, this creates a new market segment that IT platform-based SCF providers can target and penetrate.

For suppliers that trade regularly with global multinational enterprises on an IT platform, the estimated cost reduction is around 30%. The volumes of invoices transacted on the IT SCF platform play a crucial role by diluting the overall funding and servicing costs. Moreover, the IT platform gives fund providers (e.g., banks and institutional investors) additional visibility of the transactions between trading partners. Once the digitally exchanged transactions result healthy, reliable, and stable, the creditworthiness of the big buyer receiving (and approving) electronic invoices grants the supplier counterpart access to lower funding interest fees.

RF and Dynamic Discounting are currently the most digitized SCF instruments offered through web-based platforms and result the cheapest to run. Although the total costs are quite similar, not so are the costs compositions: in DD the largest cost factor is the discount rate the supplier grants to the buyer in exchange for an early payment, while in RF the predominant cost part are the servicing costs charged by the IT platform service providers. DD is profitable for both parties only when the applied discount rate is higher than the cost of capital of the buyer and lower than that of the supplier.

The quality of the relationship relates to the level of collaboration and the willingness to share information between partners. It doesn’t only depend on the strategic nature of the relationship nor on the frequency of the transactions. It rather depends on the quality, the transparency, and timeliness of the information exchanged. The more accurate and reliable the shared data, the more the forecasts, the operational performance, and the risk evaluations are trustworthy, leading to more efficient and effective SCF solutions. Allowing the supplier to have information about the approved invoices and the agreed rate of discount ensures supplier stability and loyalty.

In general, RF has higher arrangement costs and administrative costs. For Invoice Discounting, as for Factoring, the cost of finance is predominantly based on the supplier credit rating and cannot be improved by the buyer’s creditworthiness. Invoice Discounting has higher funding costs since there is no involvement of the buyer. Once business partners establish well-managed relationships, banks, fund providers, factors, and service providers can rely on the buyer’s ability (and willingness) to pay rather than on the credit risk of the supplier. Our research proves that this alone shrinks the funding fee to less than 2% on annual basis, and avoids the supplier to carry all the risk.

Improved quality of relationship between supply chain partners also increases the level of collaboration that leads to competitive advantages. Increased collaboration means additional visibility across the various tiers of the value chain, adding information on the financial and non-financial performance of suppliers beyond the first tier. The possibility to interact with upstream levels of the supply chain augments the quality of information of all involved constituents, allowing all participants to execute more reliable cash forecasts and to better plan for production, inventory, and deliveries. All these factors benefit the provisioning of SCF solutions that—at this point—can practically extend the supply of financial support to all levels of the supply chain. Recent market research, in fact, claims that SCF support will be assigned using innovative credit scoring techniques based on the borrowing company’s operational performance supplemented by fast credit underwriting processes that use multiple financial supply chain data sources.

Last aspect to consider, that runs alongside the two factors explained above, is the variability of the service providers’ revenue models and strategies: one side thinks that it’s better to charge fees only to the supplier to facilitate buyer adoption; another thinks that it’s instead preferable to charge the buyer to on-board as many suppliers as possible. Either solution has significant impact on cost quantification, cost analysis, and cost benchmarks, generating quite different perceptions to suppliers and buyers that must be anticipated once a decision is made and the SCF program is to be launched. 

 

Comments: (4)

Enrico Camerinelli
Enrico Camerinelli - Aite Group - Boston | 30 July, 2015, 06:56

Great article and useful contribution to the SCF "cause". Thank you for sharing.

Be the first to give this comment the thumbs up 0 thumb ups! (Log in to thumb up)
Ganesh Guruvayur
Ganesh Guruvayur - Intellect Design Arena - New Jersey | 30 July, 2015, 17:35

Excellent post. When a buyer onboards a new supplier, it seeks extraneous data on the non financial performance of the supplier, the quality of the goods and services, the timeliness of the supplies, propensity of the supplier to notify in advance on potential delays. Similarly when a supplier on-boards a buyer, it tries to understand the ability of the buyer to pay and pay on time, tendency of the buyer to fault with the goods and services or with the invoice and therefore to delay payments. There is a significant amount of white space from an IT enablement standpoint that can contribute immensely to the risk discovery process. Providers of finance too look to acquire these insights when deciding on buyer sponsored supplier finance and supplier credit rating driven programs. Industry wide sharing of data is lagging in pace and continues to be an important factor in the variations in the cost of finance. The FI that facilitates buyer / seller relationship is probably the only player that is well suited to price the finance. An effective competitive bidding mechansim is sorely missed !!!

Be the first to give this comment the thumbs up 0 thumb ups! (Log in to thumb up)
Aparty Behera
Aparty Behera - ORACLE - PUNE | 31 July, 2015, 07:28

It is rightly pointed out that there are lot of manual process involved at invoice processing level, in some cases even upto the level of buyer's acceptance, matching and reconcilliation etc.
An IT platform that provide end-to-end digitization of SCF platform will definitely improve efficiency and cost control. Few more bottlenecks such as the on-boarding process, KYC compliance and dispute resolution process etc that also hampers adoption of SCF. KYC centralization may be an welcome step.
But the moot point is the investment that it requires to establish such a platform? and what would be the ownership model?

Be the first to give this comment the thumbs up 0 thumb ups! (Log in to thumb up)
A Finextra member
A Finextra member | 01 August, 2015, 20:42

Thank you for your comments.

There are currently in the market Private and Public Service Providers that offer powerful SCF programs. They have customized revenue models but in general they charge a fee to access the platform (it can be pay-per-use or annual subscription) and a servicing fee depending on the transaction volume. Multi-funding platforms can provide efficient and competitive funding at low costs.

 

Be the first to give this comment the thumbs up 0 thumb ups! (Log in to thumb up)
Comment on this story (membership required)

Retired's profile

job title
location
member since 2014
Summary profile See full profile »

Retired's expertise

Member since 2009
3066 posts3,374 comments
What Retired reads

Who's commenting on Retired's posts

Ketharaman Swaminathan
Charmaine Oak
Francis Chlarie
Raymond Lee
Deepthi Rajan
Melvin Haskins
João Bohner
Bob Lyddon
Urs Meier
Steven Hatton
Ahmed Saleh
Barclays Loans Service