UK government supply chain finance initiative – what could possibly go wrong?
It’s good news that the UK government has recognized the opportunity to utilize supply chain finance as a means of freeing up the availability of credit for small business. Allowing small businesses to borrow money to fund early payment of their outstanding invoices on credit terms that would normally only be offered to their big and relatively powerful customers isn’t just common sense, it could provide a valuable boost to the UK economy. Other governments take note.
But before anyone gets too excited, take a little time to consider what is really going on. It looks great on the surface but lurking beneath is a very ugly reality.
We can cloud this discussion with complex and convoluted terminology. We can talk about the cost of working capital, supply chain risk mitigation an even the opportunity to disintermediate banks. But while the clever lingo might impress some, like most jargon, it only serves to confuse and conceal what is really going on. Supply chain finance is simple and it all boils down to a simple concept. The cost of doing business.
Supply Chain Finance – reducing the cost of doing business
Supply chain finance allows small business to take advantage of their customers’ financial standing. They’re able to stand up to the big banks, wave an approved invoice in their face and demand better credit terms. It works for everyone. The banks mitigate their risk and the suppliers get paid promptly without it costing the buyer anything in terms of working capital. What could possible go wrong?
Here’s what can go wrong.
Supply chain finance reduces the cost of doing business because the middleman takes less money out of the supply chain. In other words, there’s more money to go around. But who decides how to divide up the cake? The buyer could say to the supplier “Yes we’ll pay you 30 days early but before we do, we’d like to extend your standard payment terms by 30 days.” It’s called giving with one hand and taking away with the other and it provides an easy source of working capital for the buyer allowing them to keep hold of the supplier’s cash for even longer. And what about the bank? By securing credit on an invoice approved by the big business buyer, almost all of their risk is mitigated. Will they really pass on the same terms to the supplier that they would offer to the buyer? Dream on! The reality is that by the time the supplier gets to the table, the cake has all been gobbled up.
Supply chain finance and the law of not so unintended consequences
I suspect that David Cameron’s heart is in the right place and that he would see the above scenario as an unintended consequence. But his big business and banker buddies are less naive. This is exactly the consequence they intend. How do I know this? Simple – it’s already common practice.
Look at like this: The banks are supposed to be the facilitators of commerce, making money available, lubricating the wheels of the economy, keeping businesses in business. They provide credit – for a price of course – and they pay interest on cash deposits. How much do they charge for credit? It depends of course but some business who are struggling to get credit – the SMEs that David Cameron is trying to help – pay 20%-30% – sometimes more! And what interest rate do banks pay on cash deposits? In the current economic environment a business with cash surplus would be lucky to get a few percent. Which begs the question – what happens to the difference?
Extracting upwards of 20% of the value of goods in the supply chain isn’t facilitating commerce, it’s sucking the lifeblood out of the economy. Allowing the banks to oversee a supply chain finance initiative would be like asking the inmates to look after the keys to the prison. If the UK government means what they say, that they want to help small business who struggle to get credit, they need to get a little bit closer to these supply chain finance schemes to ensure that they operate in favor of hard pressed suppliers and not in the interests of big business and the banks. That really could give a welcome and timely boost to the UK economy.
Pete Loughlin can be found on twitter @peteloughlin