Published: July 01, 2009
The current economic conditions have obviously precipitated many shifts in financial and commercial behaviour, with some of the most intriguing of these changes currently taking place in supply chains. This was readily apparent during the ongoing series of thought leadership forums organised for senior Asian corporate treasury personnel by Standard Chartered Bank’s Transaction Banking team, where participants discussed the increasingly symbiotic nature of their supply chain relationships.
In many cases the change was already underway, but the current market uncertainty appears to be reinforcing corporations’ awareness of their mutual dependence on suppliers and buyers. This has in turn driven a greater degree of transparency and co-operation among organisations within both the physical and financial supply chains. While the ultimate objective remains the prosperity of one’s own organisation, a growing number of treasurers are evidently aware that this cannot be achieved in isolation; therefore the quality of relationships with both trading and banking partners is a major priority for them.
The motives for this emphasis on relationship quality and mutual assistance are entirely logical. For example, a large multinational (MNC) that depends upon suppliers who produce components or services that are not easily sourced from elsewhere has obvious operational risks to manage. If a key supplier fails, the MNC will suffer disrupted production and in the current economic conditions where sales are hard to achieve, being able to deliver on them is clearly imperative. Obviously an MNC will have alternative suppliers, but these may not be able to ramp up production fast enough to plug the gap. As forum attendee Wildrik de Blank, Group Treasurer, Noble Group remarked, “The relationship between supply chain participants is increasingly critical; we need to ensure that no one fails.”
While business continuity risk is already a well-established motive for supply chain financing schemes, its significance is currently increasing. As economic conditions worsen, the probability of supplier failure increases and therefore the need to strengthen the supply chain becomes even more critical.
In certain cases, banks also have a risk incentive to provide supply chain finance. A bank may already have credit exposure to some of the suppliers proposed by an MNC for inclusion in a supply chain financing scheme. Therefore the scheme’s ability to mitigate the risk of supplier failure acts to the benefit of the bank as well as the multinational.
Suppliers (or buyers in a sales chain anchored by a large corporate) have obvious motivation for developing closer relationships; ultimately it could be a matter of survival. This is apparent in the greater level of transparency (see below) that these smaller companies are exhibiting with anchor credits regarding their financial and other data. [[[PAGE]]]
Greater transparency around sharing of information among business partners (including data previously regarded as highly confidential) is increasingly apparent and was remarked on by several participants at the seminars. This represents a major shift from just two or three years ago, when many suppliers in Asia felt that even expressing interest in supply chain financing was an admission of weakness that would have negative consequences.
One attendee pointed out that metrics such as days inventory, days sales and days payable outstanding (DIO, DSO and DPO) were far more than just a matter of financial reporting; they were also a valuable indication of how robust and well run a company was. The sharing of information such as this is now increasingly common in the supply chain - and often mandatory if a company wishes to be considered for participation in a supply chain financing scheme.
In general, it is apparent that corporate credit policies have become far more rigorous. While this is only to be expected in the current economic conditions, there is evidence that these have only expedited a process that was already underway. This process has also been facilitated by the greater transparency now available around financial data.
In a supply chain where there is strong interdependence among trading partners, business continuity risks mean the credit monitoring of suppliers has become as high a priority as monitoring customers. Certain attendees at the forum indicated that supplier credit monitoring might even result in extremis in them offering liquidity directly (as distinct from via supply chain financing) to needy key suppliers.
From a corporate treasury perspective perhaps the most valuable thing that has been lost in the past year is certainty.
Apart from the context of supply chain finance, companies are also making greater use of this data in more general monitoring of their trading partners’ commercial pulses. This allows them to move swiftly to avert potential problems; for example, to arrange an alternative payment schedule before a customer defaults.
According to participants at the thought leadership events, two key themes underlying this approach are thinking outside the box and frequency. Given the extremely fluid nature of the market, many companies are finding historical accounting measures and conventional credit ratings are currently of limited use.
There is therefore a need to be looking at all available data and warning flags, such as changes in payment behaviour and inexplicable/unnecessary maxing out of credit facilities. In addition to financial risks, such data may also reveal reputational risks. (As some large UK clothing retailers have found in the past year, dubious employment practices at suppliers thousands of miles away still have the ability to inflict severe brand damage.)
The fluid market conditions also mean that monitoring has to be undertaken far more frequently than in the past. Checking counterparty stability on a weekly or monthly basis is insufficient; in the case of key suppliers and customers, some treasuries now undertake this on at least a daily basis.
Events of the past year have given corporates cause to keep as close an eye on their banks as their suppliers and customers. In the past it was generally assumed that major banks were not a significant credit risk. With the exception of a tiny minority, that situation has clearly changed. Apart from the credit risk to corporate deposits, other new concerns include operational risks - such as cessation of payment/receivables traffic and withdrawal of supply chain finance support.
Given the degree of government support provided to some banks, the immediate concern of an outright failure is hopefully receding. However, from a corporate treasury perspective perhaps the most valuable thing that has been lost in the past year is certainty. An issue that several forum participants raised was the way in which some international banks that had previously been pushing them hard for business in Asia had effectively withdrawn from the market when most needed. In these volatile economic conditions, treasurers clearly value the dependability of banks that are not going to dramatically revamp their business models overnight and/or suddenly reduce their provision of liquidity. Consistency of banking support and a willingness to commit in the long term is always valuable, but it is absolutely essential in the current conditions. [[[PAGE]]]
In the context of the supply chain, this dependability has huge implications for business continuity. A bank that fails to deliver on supply chain finance can cause massive dislocation; unless the anchor credit immediately steps in with direct financial support, the cash flow shock to suppliers/buyers will inevitably result in business failures and supply disruption. Therefore a particular concern for treasurers is that some banks, which are still loudly protesting their commitment to supply chain finance and even pitching aggressively for business, may not actually be able to deliver. For example, some banks that are now effectively state-owned are having to withdraw or drastically scale back their overseas operations, as they are being obliged to reserve their remaining capital to support their domestic economy.
Detecting this behaviour is not easy and ties back to the earlier theme of unconventional thinking and gathering information wherever possible. Rather than taking the banks’ protestations at face value, treasurers are looking at other signals. For example, is the bank still making a substantive and ongoing investment in people, network and technology to support the supply chain?
In the context of the supply chain, a bank’s network commitment is particularly important. Banks that lack comprehensive physical presence in regions where they offer supply chain finance are effectively hamstrung by lack of local market intelligence. This information gap means that they:
Strength
One of the strongest themes to emerge from the forums was the importance of relationships. In the past, larger organisations would typically have regarded the current market conditions as an opportunity to increase their DPO at the expense of smaller suppliers as well as squeezing them on price.
From the perspective of MNCs attending the forums, this behaviour is clearly yesterday’s business model. In the interests of maintaining the most efficient production system, their attitude is very much one of developing and nurturing relationships with key suppliers and customers. “While I think we are seeing automation increasing at a lower level (such as around STP), the reverse now applies when it comes to relationships with key banks and trading partners,” said Andrew Lo, CEO of Crystal Group, the owner of clothing retailer Giordano. “Here the approach is far more hands on.”
However, it should be emphasised that there is a point where the love tapers off; the strong focus on relationship is reserved for key partners. Suppliers on the periphery, such as those providing small percentage volumes or basic commoditised items are unlikely to receive such treatment. This implicit categorisation of suppliers is obviously a critical component in assessing the ‘stickiness’ of a supply chain and in the context of supply chain finance determines whether a supplier/buyer is worthy of inclusion.
Recourse
While this categorisation obviously changes as trading and financial relationships evolve, some anchor corporations may find themselves having to revisit it for another reason. Given the high level of economic uncertainty, some banks may start looking to anchor firms to do more than shed the light of their credit rating on supply chain finance deals. While this is unlikely to apply to the largest and most creditworthy anchors, some smaller anchors may find themselves asked to participate on at least a partial recourse basis, if not immediately, then perhaps contingent upon a rating downgrade.
This significantly changes the dynamic of supply chain relationships. If there is risk of direct financial loss to them in the event of a supplier’s failure, then these anchors will be looking to re-evaluate their relationships. In effect the anchor will find itself having to balance two risks – the operational risk of suppliers failing if they are not supported by supply chain finance and the risk of financial loss to the anchor if they are supported, but still fail anyway. Ironically, this conundrum may actually drive even closer relationships, as anchors look to trading partners for greater disclosure and transparency so that they can more accurately evaluate these risks.
Apart from the various risks already mentioned, the motivation for most anchors to participate in supply chain finance includes an element of goodwill; if they support suppliers/buyers now, they will benefit later in terms of loyalty. There is also a pecuniary opportunity; supply chain finance reduces supplier/buyer financing costs, so the anchor has the opportunity to share some of that saving and/or extend its payment terms. (Or reduce its credit terms in the case of buyers.) However, to judge by their comments, forum attendees from anchor companies did not feel their organisations wanted to push this too hard at present; supplier stability was the bigger priority. [[[PAGE]]]
The emphasis among forum attendees was very much on taking the long-term view on trading and (as mentioned earlier) banking relationships. In some cases this had a business-specific motive. For example, one company attending has to install a significant amount of plant at customers’ premises to deliver its product; it is therefore vital for it to sustain a long-term relationship with customers in order to amortise the cost of this plant.
Business-specific reasons aside, the more general impression is that corporations increasingly value the business continuity benefits of a robust supply chain. A further value-add is that long-term, trusted relationships also facilitate future change and innovation that can benefit all chain participants.
Despite the benefits of strong relationships in the supply chain and the opportunities to leverage these with financing, companies are still keen to accrue substantial cash buffers. As one forum attendee put it, “Cash is king, queen and prince.”
In the case of anchor companies, one of the reasons for stockpiling cash is in case a key supplier suddenly needs urgent direct financial support. Elsewhere, motives range from general contingency against further sales decline, to having cash available to use as a discount lever.
A measure of corporations’ sharp focus on cash is the growing tendency for them to draw on bank facilities that they do not immediately require. They have realised that with their balance sheets under pressure some banks are withdrawing inactive credit lines to reduce exposure. A further concern is that this trend will be exacerbated by banks merging and lending facilities being consolidated.
While the current economic environment is hardly welcome, there are signs that it has accentuated the importance of strengthening bonds in the supply chain. There is evidence to suggest that it has also imparted a sense of urgency and focus to companies’ deliberations in identifying and cultivating key trading and banking partners. At the same time, the present market situation has been a rigorous stress test of existing and putative relationships; a test that some banks in particular have regrettably and decisively failed.
Looking to the future, the feeling of mutual dependence and support now inherent in many supply chains also bodes well. As and when economic conditions recover, supply chains that have forged strong links between tried and tested partners will be in the strongest position to benefit.
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