The revolutionary thinking that is helping the economy back on its feet

The revolutionary thinking that is helping the economy back on its feet

Posted by Pete Loughlin in Financial Supply Chain Management, Supply Chain Finance 15 Aug 2014

It’s not quite a revolution. No-one is fighting in the streets but the world is changing. For decades – indeed centuries, banks have wielded a power over business and the wider economy that was virtually unquestioned. The effect wasn’t always negative of course. It is hard to see how the economic growth of the 20th century could have happened without these institutions. But neither was it all good. There are anomalies in the way the economies of the western world operate  – there are unintended consequences, winners and losers. The fluctuations that occur in our economies are exploited by the banks who have a privileged central position and their actions can amplify the ups and downs in exchange rates, interest rates and stock prices. These accentuated aberrations can be very damaging to economies, businesses and individuals. But there is one aspect of the way our economies have run that hasn’t fluctuated and has always been pretty consistent – you never see a poor banker.

But now there’s a change in thinking. Some of the anomalies that we see – in particular the unfair playing field that exists between wealthy businesses and their smaller suppliers – are now being seen as unacceptable. Extending payment terms in order to optimize cash flow is a good thing only if you take a very isolationist view – if you see self-interest as the only thing that matters. If you take a wider view, you see that delayed payment hurts vulnerable suppliers, it pushes prices up and can damage an economy – at the very least it does nothing to help an economy that is on it’s knees and struggling to get back on its feet. This is why there’s been a change of thinking and ironically, it is the banks we can thank for the change.

Purchasing Insight logoFor many years, the supply chain finance proposition made sense for all parties. Business could improve cash flow by extending payment terms allowing them to earn more on their cash. Using a supply chain finance arrangement, suppliers needn’t actually wait longer to be paid, indeed they could be paid earlier at a moderate cost because credit terms can be effectively underwritten by their larger, more credit worthy customer. Supply chain finance worked because interest rates were high. But when interest rates are close to zero, for improved cash flow to deliver a decent financial impact, a business needs to keep hold of more cash for longer. For it to be worthwhile for the banks, they need to charge a profitable rate of interest and again they need to see their customers extend payment terms as much as possible. This all points to one thing – crippling cost for suppliers with very little benefit in return.

This is why there is a change in thinking and we can thank the banks for the change because it was the global financial crisis, precipitated by the malpractice of the banks that has led to an economic environment where many SCF arrangements are simply no good.

Let’s put things in simple terms and lose the spin on what is really happening. Supply chain finance in its traditional form is a means for a bank to collaborate with its large corporate clients to forcibly lend money to their suppliers at a very profitable rate while only taking the risk of lending to their much more credit worthy client. There used to be something in it for everyone but today, there are more losers than winners and it’s time that governments stepped in and began to influence and rationalize the situation.

Henning Holter wrote recently in the Tungsten blog about the UK Chancellor, George Osborne, and his plans to compel traditional banks to refer businesses to alternative lenders. He describes this as great news for the UK’s 5m SMEs, who, he says “are collectively owed nearly £40bn in late payments, which stifles cash flow, prohibits growth and makes it a whole lot harder to stay in business.” He quotes Business Secretary Vince Cable as saying “It’s good that more SMEs are making use of alternative finance but the big banks still dominate and small businesses often give up if they’re turned down for finance by their bank.”

Welcome words indeed but not quite as impressive as President Obama’s in July this year. His Administration has launched a new initiative called SupplierPay, a voluntary program in which companies commit either to pay small suppliers faster or help them get access to lower-cost capital. SupplierPay is aimed at strengthening the cash flow of small companies by ensuring they are paid within 15 days.

“For the larger companies, joining SupplierPay demonstrates a recognition that a healthy supply chain is good for business,” said the White House in a statement. “For the small business suppliers, benefiting from SupplierPay means having more capital to invest in new opportunities, new equipment, and new hiring.”

This is an approach I’ve been espousing for quite sometime and it is a great endorsement of the efforts of some of the solution providers we’ve covered over the last few years most notably Taulia, Tradeshift and Tungsten. What I like about Obama’s initiative is his no-nonsense approach – “mandating common sense” as I like to put it. According to Mark Felsenthal from Reuters writing when SupplierPay was launched, his approach antagonized congressional Republicans who say the president has overstepped executive branch authority. To my mind, that’s just the icing on the cake. It’s gratifying to see the conservative stick-in-the-muds frustrated by the sight of the little guys playing on a level the playing field for once and I’d like to add my congratulations to President Obama for simply doing the right thing despite his critics.

Pete Loughlin can be found on twitter @peteloughlin

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