Fluctuating lockdowns and volatile demand have strained supply chains to the limit over the past year.
The pressures of the pandemic have led organisations in the private sector to be hypervigilant with their cash flow and more reluctant than ever to pay suppliers quickly. Payment terms have been pushed increasingly upwards as companies manage their cash reserves, and suppliers downstream have borne the brunt.
Although these structural issues have been exacerbated and exposed by the pandemic, they have been embedded within supply chains for a long time. And perhaps the biggest symptom is the emergence of supply chain finance as a solution.
The revelation of Greensill Capital’s presence at the heart of Government therefore highlights some fundamental structural risks in its supply chains.
Why is supply chain finance needed?
Every organisation in a supply chain wants to manage their cash flow as tightly as possible.
But buyers and suppliers are coming from a position of essential imbalance. To maintain control of cashflow, the seller is motivated to negotiate shortest possible payment terms, while the buyer wants the longest possible payment terms.
The buyer most often holds the position of power and thus this results in suppliers negotiating a range of different arrangements with their customers, and having to navigate inconsistent cash flows as a result. This is particularly prevalent amongst smaller and medium size firms.
Supply chain finance is used to create consistency, liquidity, and certainty for suppliers by providing loans while they wait for their invoices to be paid.
It sounds like a win, win?
Used well it could be mutually beneficial. But critics have long argued that some supply chain finance programmes gain good adoption with larger vendors but do not get the intended penetration amongst the smaller suppliers that they are often intended to support.
Often this may be because the benefits and implementation are not well explained; the software requires a change management effort. It can also be because smaller suppliers, pressed to accept multiple financing deals from different customers, reject the admin complexity and seek their own consolidated financing facility.
What is the risk?
Supply chain finance is a symptom of payment terms imbalance. It is positioned as a solution to a problem brought on by suppliers having to deal with a complex range of lengthy payment terms that wreak havoc on their cash flow.
Suppliers therefore come to rely on lenders to effectively pay their bills, and when that lender is unstable, as in Greensill Capital’s case, the supply chain and the businesses within it are compromised. Of course, there are many other supply chain finance vendors, who should not be viewed through the same lens as Greensill, but it does emphasize the need to see beyond the benefits and know your partner.
How can Government address this risk?
Government benefits from a higher liquidity than any supplier within its supply chain. In short, greater transparency and less inconsistency of payment terms is needed down the entire supply chain – therefore removing the requirement for supply chain finance. The procurement Green Paper sets out some possible measures to help achieve this.
Crucially, where Government is the customer, it suggests harmonising payment terms down the supply chain. Traditionally in a business supply chain, each supplier will look at the contract with the supplier below and negotiate payment terms with the buyer above that shifts risk downwards and gives their own business commercial advantage. Standardised payment terms will remove this imbalance and offer greater fairness across all suppliers.
The Green Paper is also proposing putting more power into the hands of its suppliers down the chain when these terms are not adhered to. It proposes to will allow sub-contractors to lobby Government directly if they feel they are being treated unfairly by the major contractors above them.
What steps can departments take now to reduce payment complexity?
While the procurement Green Paper is under consideration, there are some key practical steps that Government departments can take to begin addressing risk and reducing payment complexity in their supply chains:
- Understand the current state of payments in your department - Supply chain managers need to ensure how their payment behaviours map to their current contracts, and understand whether there are payment inequalities within their supply chains. Departments should undertake analysis of payments data and engage with their suppliers to understand whether there are existing unbalanced payment terms and how they can create fairer and ultimately more stable relationships throughout the supply chain.
- Ensure that teams understand financial engineering – Government departments need to ensure that those negotiating the deals with suppliers understand their financial make-up and the relationship between levers such as price, payments terms, and cashflow. The teams in control of supplier relationships should be able to create supplier relationships which focus on real financial value for both parties.
- Get ahead of the curve – Government departments should start to plan for the changes set out within the Green Paper and begin taking steps to get ahead of it. Departments need to start implementing the right sort of behaviours, controls, and contracts with their existing suppliers to make sure they are not playing catch up later this year. This could include a supply chain payments role to oversee, understand and liaise with a department’s network of suppliers and make recommendations and adaptations accordingly
With the correct controls in place and the right standards implemented across the supplier base, Government departments should have no need for supply chain finance. The onus is now on them to make that situation a reality.
Simon Payne is client director at Proxima.
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