By Guest Contributor, Gerard Chick, Chief Knowledge Officer at Optimum Procurement Group
Businesses still care about managing their spending, but profitability is fast replacing the traditional cost savings focus. In turn this broader, more balanced emphasis on profitability, leaves open the question as to whether supply management concentrates on cost savings or revenue growth.
What happens next is an interesting and perplexing question. Will other SBUs absorb procurement? Will procurement activities be outsourced? These questions remain unanswered but there are signs that a new supply management is emerging.
While these changes in the shape and guise of procurement are going on, we should reflect again on why and how procurement’s strategic scope is widening. Much has been achieved in the past decade to transform procurement from tactical to strategic; but the idea of ‘strategic’ remains hemmed inside the function, the process, or the spend category. With a cultured understanding of the (strategic) value-adding capability of procurement - the meaning of strategic gets much bigger.
One scenario falling out of this is that procurement gets ‘financial’. Whilst the focus on physical supply chains remains imperative, procurement must become more strongly linked to financial supply chains, optimising cash flow and working capital, implementing dynamic discounting and supply chain financing.
There is no question that the principles of supply chain finance (SCF) are strong and that the correspondent benefits are considerable. The perspective to get financed on the basis of a purchaser’s creditworthiness should line up multitudes of companies demanding such an attractive—and apparently low cost—facility.
And yet, the reality is that SCF programs are evolving slowly and are the widespread adoption one might imagine is not there. Financial institutions have invested significant resources in money, time, and staff to develop SCF programs but have so far obtained relatively small returns compared to the initial expectations.
A cursory glance of the market and of its players suggests a few credible reasons for such a slow uptake and these include:
- The level of information within businesses regarding SCF remains low
- Banks are reluctant to change “old-fashioned” credit-checking, risk and collateral management processes and adapt them to the new offerings
- Companies already have financing lines in place and do not want to change
- Some large businesses have developed in-house SCF programs
- Businesses do not include finance specialists in their SCF program teams
- Perennial issues relating to internal disconnects between finance and procurement functions remain a serious impediment.
The break from tradition or perhaps the development of new practice is often slow to catch on. If we look at one of the methods or ‘instruments’ as the world of finance would call it perhaps we could uncover how the disconnect mentioned above can be overcome.
Reverse factoring (or approved payables finance), is perhaps one of the most significant SCF solutions offered today, some might call it the epitome of supply chain finance. That said it would be interesting to explore why this well known and well thought out financial instrument remains pretty much unused.
The bank receives a mandate to approach the suppliers; who typically are based in the developing economies. It will be the bank that will finance these suppliers, so a rigorous review under the principles of ‘know-your-customer (KYC) takes place. All very straight forward you would think.
However current regulatory pressures demand very strict KYC controls and thorough assessments of each company profile. Since the companies are based overseas, the bank must have a physical presence in each of the suppliers’ countries to execute the KYC mandate. Even with a physical presence onsite it will not always be feasible to conduct a compliant KYC control due to lack of primary information from the company. Not all countries have the same levels of control and not all companies are provided with the proper systems to collect and store KYC required data.
Many banks may have a partner in the country, through which the profiling of the supplier company might be facilitated – but only if the KYC ‘norms’ allow for an “on-behalf-of” KYC check. Clearly a lack of KYC information could compromise the bank’s compliance to regulatory requirements and couple this with a practical impossibility to perform the stringent KYC check so regulations essentially prevent banks from running SCF programs.
We can conclude from this that the low adoption of SCF programs does not depend on lack of demand from companies rather the grip of control is in the hands of banks, which are either unable to comply with KYC controls or perhaps unwilling to rework the very profitable income of their factoring business units in the case of domestic demand.
It will be interesting to see with the growth of the strategic importance of procurement and supply management if the banks will cotton on to this as yet untapped income stream.
There is nothing to prevent banks from putting their factoring business under the wider Supply Chain Finance “umbrella”. Perhaps now is the time for CPOs and CFOs to develop some joined-up ideas and take these ideas to boards or perhaps even lobby the banking sector to get some traction in the SCF space!