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
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
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.