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New Strategies for Financial Supply Chain Optimization

Yesterday, I signed up at the Aberdeen Group website to take advantage of a free report offer that is running through Jan 26th, 2007 to download a copy of the report titled – New Strategies for Financial Supply Chain Optimization. (Apparently at this link, you don’t even have to sign up to get the report) The focus of the report is,

Rethinking Financial Practices with Your Suppliers to Maximize Bottom Line Performance

and the introduction to the report outlines what the folks at Aberdeen think is a glaring opportunity for firms that have gone the route (I guess there are but a few firms that have not either lead or followed their competitors overseas) of global sourcing or offshoring/outsourcing:

Driven by the pressing need to lower the cost of goods sold, companies have embarked on sourcing from emerging markets and have been able to achieve significant benefits when the strategy was executed correctly, including 10%-35% savings on the cost of goods purchased. However, most companies are still leaving money on the table because they fail to take into account the SCF opportunity when undertaking low-cost country sourcing (LCCS). Applying SCF innovations can bring the next wave of cost savings into the corporate LCCS program, helping a buying organization optimize its working capital, reduce product unit costs by taking advantage of arbitrage opportunities due to the higher cost of capital in emerging markets, as well as reduce supply base risk by enabling faster and more predictable payments to emerging market suppliers.

Refer to the box to understand the terms used above.

Working Capital: = Cash on hand + Accounts Receivables (Money owed by customers) + Inventories – Payroll – Accounts Payables (Money owed to suppliers) – Short Term Debt Costs Arbitrage: (At least in the forex/currency world) Arbitrage is the trading of one currency for another with the hopes of taking advantage of small differences in conversion rates among several currencies in order to achieve a profit. Cost of Capital: Cost of capital for a firm is a weighted average (WACC) of the cost of equity and cost of debt. From where can firms raise funds to support their decisions? They can issue stock or take out loans or reinvest their prior period earnings. WACC provides a way to calculate the resultant cost of capital.

The motivation behind the recommendation of urging firms to use Supply Chain Finance aspect of procurement and supply chain operations is that those firms that are considered best-in-class have better performance:

Best in Class companies have notably better performance across key metrics, such as a 10-day advantage in their cash conversion cycle compared to Laggards and longer Days Payable Outstanding.

Now to the meat of the report,

1. Firstly, it is a fact that access to capital (and the cost thereof) is more developed in the developed world than in the developing world. The question of the hour is whether it is a well known fact. However, suppliers in low-cost (cost of material and cost of labor) would not benefit from the “easier” access to capital in the developed world except if there was some way to “transfer” that benefit to them instead of these low-cost suppliers relying on capital that they can raise in their home countries. That’s what the cost of capital discussion is all about. So how does one create such a “financial collaboration” (of sorts)? Enter the Supply Chain Finance (SCF) solution provider! The critical link that the SCF solution provider offers is the following:

Enables access to capital – e.g., early payment discount using a buyer’s own funds, factoring or reverse factoring by a financial institution, inventory financing from a third party, etc. Third-party SCF providers often offer funding to a buyer’s suppliers at a lower rate than suppliers can obtain on their own.

2. Next, what is the extent of collaboration between suppliers and procurement in the global context. Aberdeen reports that those firms that try to understand their suppliers and work together with them in resolving issues that (and vice versa) arise experience:

Buyers have been able to lower the cost of procured goods, extend DPOs, improve supplier relationships and reduce supplier risk.

And on the other side,

suppliers have achieved more predictable cash flows and lower DSOs, as well as have been able to lower production costs and better support their customers’ business growth.

In other words, what has worked stateside in terms of the procurement-supply relationship will also work globally except that there is that initial period of hand-holding and “getting things to work” that has to be done upfront.

3. Take a look at the various calculations on pages 12-13 that give examples of how to quantify the possible savings arising from such collaboration.

4. Lastly, Aberdeen makes three essential recommedations concerning SCF, Within the firm – SCM is a cross-functional activity at a fundamental level and this is true for the procurement side as well. In order to achieve best in class performance, finance and procurement working together amongst others is one of the observations that Aberdeen makes in best-in class performers. SCF processes – Largely about collaborating with suppliers to streamline the financial as well as material flows within the global supply chain SCF technology – Aberdeen recommends that the right SCF technology be deployed across the supply chain in order to gain visibility into financial as well as material flows, bringing on suppliers and getting on board with compliance efforts. Well, easier said than done. Personally, I have not come across any SCF technology (and I have a hunch that a lot of spreadsheets are being emailed back and forth if at all) but I’ll be keeping an eye out for one. Nevertheless, I will direct your attention to the report which is available free online until Jan 26th.

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Category: Supply Chain Management


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January 2007