The cost of credit to many businesses is so high that it threatens their continued existence – that’s if they can get credit at all. And it’s not just a problem for them – it affects their customers and their suppliers. The full extent of the supply chains within their industry is affected. But it need not be like this. By taking a fresh view of risk, that cost of credit can be reduced significantly.
We’ve taken a detailed look at OB10’s Express Payment offering to understand how this new way of trading can work in practice.
The cost of working capital
For some suppliers, the cost of working capital can be very high. To factor invoices, banks charge up to 4% of the value of an invoice – in some cases even higher. In annual terms, this puts the cost of working capital well in excess of 20%. A buyer that seeks to extend payment terms in order to maximize DPO is putting an excessive cost on to their suppliers. In terms of accounting this might make sense, but in procurement terms it’s crazy. Every bit of extra cost that the supplier incurs lands, in one form or another, in the hands of the buying organization either in terms of increased prices or greater supply risk.
Taking a wider, supply chain perspective, if the cost of doing business (in annual terms) is 20% and the return on cash for the buyer 1% – there is money lost to the supply chain of 19%. That’s 19% of the value of goods and services that could be better deployed.
What is this cost? Is it simply a charge that the middle-man makes and why is this cost justified?
I wouldn’t want to rush to the defense of the banks over their charges but it is sensible to take an objective look at why this cost is so high. Essentially, when banks factor invoices they are lending to suppliers and the banks are charging to cover credit risk – the risk of non-payment. One could argue about the scale of the costs but it is, in principle, a legitimate charge. But it’s a charge that is completely unnecessary. It is unnecessary because the credit risk can be almost entirely removed if it is assessed in a different way. This new way of looking at risk and how it can be mitigated is central to OB10’s Express Payment service.
A new way of looking at commercial credit risk
The traditional way of looking at credit risk is to assess the borrower’s financial standing. Express Payments takes a different view. It assesses risk based on individual invoices – invoices that have already been approved for payment by the buyer. This takes almost all of the risk out of the transaction. By applying this approach pragmatically, Express Payments can facilitate early payment to suppliers without impacting DPO for buyers.
What make Express Payment different?
There are other ways of achieving what Express Payments delivers. Reverse factoring for example, is a buyer initiated approach that allows early payment to suppliers without an impact on DPO. But the reverse factoring services offered by the banks generally require complex supplier on-boarding programmes and are therefore restricted to payments to larger suppliers only.
Similarly, dynamic discounting can deliver very big benefits by disintermediating the banks entirely but it’s only cash rich buyers that can really take advantage of this.
OB10’s differentiator is the ease of enrollment for suppliers and the accessibility for all buyers – even those who choose not to use their own cash.
Express Payments – a compelling opportunity
OB10’s new Express Payment service is amongst a small number of innovative products that are emerging to support business in developing lower cost operating models. The opportunity to use technology driven supply chain finance techniques like this is as compelling now as e-commerce was in the late 90s and we are convinced that businesses that fail to grasp the opportunity now will incur significant costs of delay.
Pete Loughlin can be found on twitter @peteloughlin