The cost of doing business

The cost of doing business

Posted by Pete Loughlin in Financial Supply Chain Management, Supply Chain Finance 28 Nov 2012

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

Purchasing Insight logoFor 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

  • Christian Lanng (CEO Tradeshift) November 28, 2012 at 3:57 pm /

    Hi Pete,

    This is old news, just look at this article from May in Fast Company, where we presented this very product: http://www.fastcompany.com/1837782/how-e-invoicing-company-could-disrupt-banking-industry or this article in Wired in April http://www.wired.co.uk/news/archive/2012-04/26/cost-of-money-needs-disruption where we again talk about exactly the same, slicing the risk of credit on a per transaction level rather than a whole company level.

    I’m wishing OB10 all the luck in the world on this one, but I still think they missed one crucial point in their business case.

    How many active suppliers do they actually have in their network where that would be willing to pay those rates? OB10 have so far taken a “onboard the largest 10% get 50% of the volume” approach to supplier on-boarding, those kind of suppliers would never want or need financing at 4% (hell most SME’s wouldn’t want that either if multiply by 12x invoices per year, then it’s closer to 50% AAR).

    The fact is that the supplier paid invoicing solutions is already a tax on your supply chain and by adding something like this you are just adding a new (and much higher tax). So unless you make it price attractive to size of companies you have on your network this won’t work and for the type of suppliers OB10 have we are not talking 4% per invoice to be price effective.

    Real innovation would be to find a way to actually offer mush cheaper cash to the suppliers in a way that both benefited the buyer and the supplier…

    /Christian

  • john November 28, 2012 at 4:42 pm /

    Good comments Christian,
    1, 2 ,or 3% for 3, 5, 10 or 15 day settlement from the date of delivery of good/services not the date of invoice is currently widely accepted with just over 50,000 UK suppliers,typicality these are suppliers that don’t join invoice only networks.
    This type of supplier understands the influence to there business of end to end procurement & payments (payable / receivable), thus increasing there exposure which leads to more customers greater bottom line & margins but most importantly early on time cash flow.

  • Stefan Foryszewski November 29, 2012 at 9:15 am /

    Christian, your facts are way off the mark again: Express Payments is a platform which allows buying organizations to extend financing to their suppliers – either self-funded (dynamic discounting) or through a financial institution.

    For self funded transactions, the buyer determines the discount rate and for third party funded transactions the financial institution sets the rate in agreement with the buyer. There are no plans to charge 4% or anything like that – I dont know why you make these numbers up.

    Initial indications are that around 50 – 60% of targeted suppliers sign up, we think this is a good benchmark for a new service.

    You also know by now that OB10 does not just target the top 10% of suppliers (and we get way over 50% volume!), we are currently onboarding thousands of suppliers each month and most of these are SME’s.

    As Pete points out in his post, the financing is triggered off an approved invoice and backed by the buying organization, thereby enabling what would be considered very attractive rates for most SMEs. The remarkable take-up for Express Payments is clear testament to this fact.

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