Charles Dickens wrote "A Christmas Carol" as a cautionary tale about the consequences of miserly behavior. The corporate world needs to reread it. Maybe then big businesses would stop hoarding so much cash and help kick-start our flagging economy. In the process, they might even prop up some of their key suppliers.
More than $2tr in cash and other types of liquid assets currently sit idle in corporate coffers. That money could play a vital role in shoring up supply chains during difficult times. Small and medium-sized suppliers, which lack access to credit from more traditional sources, are especially in need of a boost.
In uncertain times, the ordinary rules no longer apply. Business 101 says that you maximize your bottom line by accelerating payment from customers and slow-paying your suppliers. But the latter half of that strategy could have far-reaching effects. How long can you expect to hang on to those customers when you can't furnish them with product on a timely basis, because a critical supplier has gone under?
Drew Hofler, senior manager of working capital solutions with Ariba Inc., is a vocal critic of the cash-hoarding strategy. Suppliers today are being squeezed from both ends, he argues. Their ability to obtain credit has been severely curtailed in recent years. Meanwhile, customers are stretching payment terms to 60 days or longer. (Anheuser-Busch InBev has extended its terms to a whopping 145 days, according to Hofler.) "Suppliers have to fund cash flow somehow," he says, "but their options are slim."
One strategy is for buyers to speed up payment to suppliers, but pay them less. Some might consider that a case of kicking your vendors when they're down, but a good number of suppliers don't see it that way. In fact, says Hofler, recent surveys have found that up to 40 percent are willing to offer early-payment discounts on approved invoices that would otherwise be slow-paid.
"Buying organizations might not be aware of the liquidity risk they've helped to create," says Hofler. "And a lot aren't taking advantage of the opportunity to put some of that cash to work."
Certain suppliers, it turns out, are offering to give up between 2 and 3 percent of their invoices over a 30-day period. With the three-month London Interbank Offered Rate (LIBOR) hovering at well under 3 percent, companies are getting virtually nothing for the money that's just sitting in their bank accounts. Why not put that cash to work? What's more, accelerated payment is a small price to pay in exchange for a more stable supplier base.
The question arises, of course, as to whether struggling suppliers can afford to knock even a small amount off their bills. In theory, says Hofler, bank credit is a far cheaper means of achieving cash flow. But with that option becoming less and less available to the smaller borrower, the alternative becomes more and more attractive. Evidently more than a third of suppliers feel they're able to sacrifice a portion of receivables in exchange for faster payment on the rest. (Others, apparently, consider it too risky a proposition. "I'd say that your really razor-thin suppliers are going to think about it longer and harder," Hofler says.)
The viability of early-payment discounting depends to some extent on the industry. Suppliers of high-tech components and finished goods are in a relatively good cash position and unlikely to accept less than full invoice value, Hofler says. But in construction and other areas of manufacturing involving large numbers of subcontractors, suppliers are often in a bind because they have to pay those subs before getting compensated by customers. Others might be saddled with high capital costs involved in the purchase of materials. They're looking for any opportunity to get early access to cash.
There are, of course, other ways to help out one's suppliers. One involves the buyer guaranteeing financing through a third party, which provides early payment on that basis. The strategy works best when the buying organization is relatively large, and can take advantage of its lower cost of capital on behalf of a smaller supplier. Both sides win because the supplier gets paid more quickly while the buyer can extend its payment terms, with the third party acting as buffer. There's also the option of a receivables exchange, where invoices are posted on an auction site and sold off on a competitive basis.
The practice of dynamic discounting has the advantage of simplicity; it eliminates the bank or any other type of financing middleman and makes the buyer the banker. While the proper strategy depends on the unique requirements of each organization, banks seem generally bullish on the idea. (Perhaps because it frees them having to act like banks - in other words, providers of credit.) A report issued last month by London-based Demica finds that 75 percent of top European banks see "strong" or "very strong" growth prospects for supply-chain finance - that is, the involvement of suppliers and buyers in structured programs. Under such deals, says Demica, "buyers can ensure the financial health of their suppliers and thus secure their supply chains."
So which way to go? Hoard cash like Scrooge in his counting house, or adopt a "we're-all-in-this-together" approach to surviving a tough economy? Global supply chains don't appear to have much choice in the matter - not, at least, until credit thaws and short-term interest rates return to double-digit levels. Frankly, I don't think that Tiny Tim can wait that long.
- Robert J. Bowman, SupplyChainBrain
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