Strategic Treasury

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Rules of the Ecosystem Taking the balance of the ecosystem of the natural world as a template, the Editor identifies four rules that underpin the complex ecosystem of the business world and discusses what these rules imply for how we should do business and interact with other participants in the chain.

Rules of the Ecosystem

Rules of the Ecosystem

by Helen Sanders, Editor


Being fortunate enough to work from home, and watch the full annual lifecycle in our garden, from frosty ground to ripening juicy berries and apples with a reddening flush, the wonder of the natural ecosystem always amazes me. Every plant, insect and organism has its place. It takes what it needs from its environment, and in turn sustains other life forms (“eat and be eaten”, you could say). Apart from wasps, that is: heaven only knows what they’re actually for, except for hiding in the laundry on the washing line, ready to attack. So apart from wasps, the ecosystem is complex but entirely balanced. But what are the rules of an ecosystem that maintain this balance? And what does this mean for how we do business, and how we interact with other participants in our own ecosystems?

There are multiple ecosystems of which we are a part, both as individuals and businesses. Some are quite self-contained, such as a theatre. Every cast and creative member plays their role, as does the audience. Take out the sound or lighting designer, and everything goes quiet or dark. Take out a cast member and the play no longer makes sense. Take out the audience, and there’s really no point at all. From a trade perspective, while we tend to refer to the ‘supply chain’, this is better described as an ecosystem, often comprising a complex – and potentially fragile – network of parties from raw material producers through to suppliers, distributors, dealers, agents, retailers and customers. The financial infrastructure that supports it is, largely, less fragile, but both interdependent ecosystems are placed at risk both by the removal of one or more of its participants, and equally, the impact of external forces upon them.

The supply ecosystem

Looking first at the supply ecosystem, the geographic reach and number of participants are growing in many industries as companies seek lower cost production and invest in growth in emerging economies. As these ecosystems become more complex, a corporation’s ability to identify and manage risk, and maintain liquidity, reduces. Liquidity is critical to a well-functioning ecosystem of every sort, and if liquidity is maintained, it remains more resilient and adaptable. I’ll avoid the obvious example of watering the garden. Using the theatre example instead, all theatres in London were closed in 1642. This ordnance was then repeated in 1649, suggesting it hadn’t been all that successful, followed by another attempt the following year. Even then, they simply went underground. Why did the theatre companies continue to survive? Because there were still private venues, patrons and a paying public to keep them afloat, and as a result, they could adapt very quickly to changing conditions. As soon as the monarchy was restored and life became a little jollier, they almost miraculously reappeared. Without liquidity, they would have packed up their scripts and costumes and quit.

Most major corporations do not struggle to access liquidity and at the very least, they have assets they can convert into cash. However, liquidity across the wider ecosystem is more of a problem. Take this scenario: Supplier A that supplies to large Auto Manufacturer B goes into liquidation due to lack of liquidity. Supplier A’s collapse has serious ramifications for its own suppliers. It also impacts and potentially halts Auto Manufacturer B’s own production, at least while an alternative can be found. However, as Auto Manufacturer B slows production, its other suppliers, Suppliers B, C and D (etc.) that also supply components are also impacted, as are companies that provide goods and services to suppliers B, C, and D. Distributors relying on new stock are disappointed, as are both customers that have ordered new vehicles, and new customers.

Consequently, it is in the interests of every participant, particularly the largest corporations which the rest of the ecosystem surrounds, to make sure that every participant has sufficient liquidity both to sustain its business, and to invest in growth. While there are already supply chain programmes, such as supplier financing or distributor financing, to which corporations can then onboard their suppliers or distributors, these programmes are not enough in themselves to support the wider ecosystem.

Firstly, these forms of financing are transaction-based, linked to specific invoices or purchase orders. Therefore, while a corporation may be confident that a supplier has access to day-to-day liquidity, it does not have the assurance that it can invest in upscaling its operations to support its own growth trajectory.

Secondly, these programmes only address a single tier of the supply ecosystem, ignoring the complex web of smaller businesses beneath them, which may play an equally important, if smaller role. These businesses are effectively left to their own devices, and have to work with commercial and retail banks to seek financing, often at far less preferential terms.

Thirdly, while techniques such as factoring and reverse factoring are relevant to some industries, this is not universally the case, particularly industries with high capital expenditure.

The first rule of the ecosystem is therefore to consider who needs what to survive and grow. From a trade ecosystem, this means assessing and helping to mitigate the risk and liquidity needs of all participants, rather than individual ones. Banks have a key role to play in this, but few have the geographic reach, organisational model or the risk appetite to look beyond their large corporate customers to the smaller companies that make up their supply ecosystems. Furthermore, larger corporations and mid-caps/SMEs are typically serviced by different parts of a bank. As supply ecosystems continue to evolve, and corporate demands to manage liquidity and risk at a broader level increase, banks will need to revisit their financing strategies and the way that they help customers to evaluate and mitigate risk.
 

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