After 25 Years, SCF 1.0 Needs A Makeover

For supply chain finance (SCF) to progress and reach the next set of struggling suppliers, the model needs a rethink. We need SCF 2.0.

Getting to grips with late payments is easier said than done. A single purchase from end-to-end involves multiple departments, and often requires a whole host of steps to ensure compliance.

On face value, SCF looks like the late payments silver bullet. It allows a third-party funder to forward the value of an invoice, minus a small charge, on to the supplier just a few days after the invoice has been approved. Then, the SCF provider recoups the money on the back-end of the payment process, perhaps some 120 days later.

But, SCF has been around for some 25 years and late payments, particularly for small suppliers, have gotten worse. Further, banks’ revenues from SCF stand at just $2.8 billion per year, a drop in the ocean of global trade [1] . What is going on here? To answer that, we need to look into the SCF fine print.

For the few not the many

In principle, SCF is a good solution for many suppliers. It is cheaper than other options available to a supplier, such as factoring or taking out credit based on the supplier’s own rating, and it provides a reliable way for suppliers to be paid before the payment terms are reached.

The biggest hurdle to a supplier receiving these benefits, however, is simply access. One hurdle is on the side of the SCF providers offering the programmes. To onboard a new supplier, an SCF provider has to undertake a host of checks including know-your-customer and anti-money laundering checks. For the onboarding of the very largest suppliers, typically around 1% of suppliers by number, these costs can be justified, but for everyone else, it simply isn’t economical for an SCF provider to take on their business.

That isn’t to say, however, that all the suppliers left out are a small matter [2]. Taken on aggregate, small and medium-sized enterprises (SMEs) payables represent about $2.3 trillion in unmet demand for financing. The traditional SCF model just doesn’t have a way to help here.

Given that around two-thirds of global employment and growth comes from SMEs, that leaves a huge number of jobs and a lot of economic activity shut out from SCF.

The devil is in the detail

If you are lucky enough to be a sufficiently large supplier to be onboarded by the SCF provider, you should receive funds a few days after your invoice has been approved. But how long does it take to get your invoice approved? And how long does that take if you are a smaller supplier and not prioritised?

The answer is, often, a very long time.

A supplier’s work doesn’t start the day the invoice is issued. Many suppliers will have started spending on staff, equipment and materials well before it issues its invoice. It then takes the typical large buyer a considerable time to verify and approve an invoice. After all, they have to double check the terms and do all the checks to ensure it isn’t a duplicate or fraudulent payment. That can be a cumbersome process and when a business is dealing with tens of thousands of suppliers it can be time and labour intensive as well.

Many buyers have started using electronic platforms such as e-invoicing to speed up some steps of this process. On the face of it, that is a good idea and where it can be used it has helped speed up invoice processing. For the suppliers, however, adopting any of these platforms requires a significant investment in terms of time and resources that often only makes sense if you have reached a certain minimum scale. And guess who, by definition, does not have this scale? Right, the SMEs. Small suppliers are left out of the equation again, falling further back in the prioritisation queue. All this combined means that a supplier might have been working on an order and incurring expenses for six months or more before an invoice is finally approved by the buyer and SCF can kick-in. Even for quite a large supplier, that is going to put a significant strain on its cash flow.

SCF, the side effects

These traditional SCF, SCF 1.0, programmes are not without problems for the buyers either. Taking an analogy from medicine, certain "unwanted side effects" have been observed in some users of SCF 1.0.

Many SCF programmes have met considerable scrutiny by auditors recently, and in some cases payables under the programme have been reclassified as debt. The fact that SCF 1.0 programmes rely on approved invoices does not help here, since a binding irrevocable commitment to pay may be viewed as a characteristic of debt rather than payables. The accounting concerns can usually be resolved, but require a lot of attention and are often considered a meaningful risk.

In the febrile atmosphere that surrounds the late payment problem, SCF can also fail the “front page test” as it is only used by the select few. In other words, most corporations wouldn’t want to see in the national press the fact that SCF pays other big companies only days after an invoice is approved, while smaller suppliers go under after waiting months for payment.

Information is increasingly easy to come by and consumers are becoming more activist in their purchasing habits. In fact, the treatment of suppliers ranks in the top five reasons shoppers boycott a brand [3]. Being perceived to be treating small, entrepreneurial suppliers unfairly can have a real impact on the bottom line and the share price.

Furthermore, long payment terms can reduce the range of suppliers available to a buyer. If a buyer calls for a tender for certain goods to be delivered in 9 months, very common in for example the fashion industry, then only those suppliers with large enough balance sheets will be able to participate. A host of smaller, and perhaps much better, suppliers simply cannot afford to fund the 9 months of working capital needed to participate in such a tender.

Finally, as large buyers have extended payment terms, and SMEs have not had access to effective funding, the increased financing costs of the SMEs may feed into the price paid by the buyer for the goods or services.

SCF 2.0

None of this is to say SCF 1.0 does not have its place. It works very well for the group of large suppliers for which it is being used currently. But, for the reasons we have outlined, it cannot address the tail of tens of thousands of smaller suppliers - a fragmented but vast and critical market.

That is why we need SCF 2.0. A reimagining of the process of getting businesses paid. Machine learning and data analytics technologies provide us with a route to a new concept of supply chain finance.

The data generated in businesses today can be used to build highly accurate prediction models of payment behaviour which enables a funder to provide funding even before an invoice has been approved, and in a scalable and accessible way, allowing every supplier to enjoy the benefit of being paid early, and in particular the SME’s.

At last, we can move to the holy grail of instant business payments as an option for all.