Vendor risk management – using supply chain finance to mitigate risk

Vendor risk management – using supply chain finance to mitigate risk

Posted by Pete Loughlin in Supply Chain Finance, Vendor Risk Management 16 Jul 2012

Many suppliers will offer a discount for early payment. The decision to accept the discount is normally based on two factors. Are you in a position to pay the invoice early? (i.e. are your purchase to pay processes efficient enough to do so) and secondly, the size of the discount. What is not normally considered is arguably the most important factor of all – the mitigation of risk.

Purchasing Insight logoIn challenging economic times, there are many businesses that go under – not because they have a poor business model – not because their order book has dried up – but because they run out of cash. This is a vendor risk that is traditionally extremely difficult to mitigate.

Supply chain finance – a critical component of vendor risk management

Mature procurement organizations routinely manage vendor risk. Ensuring that their supplier base is stable is a fundamental procurement function. A vendor risk management strategy will usually focus on financial strength and stability as well as other non-financial factors such as corporate social responsibility, ethics, environmental factors and political risks. However, these risks are nearly always managed reactively or retrospectively.

Financial strength for example will be assessed based on last reported accounts – at best a snap shot of the financial standing 12 months ago and if these reviews are held annually the risk assessment is often 2 years out of date. This is no better than a tick in the box to say the risk assessment has been performed. It does little if anything to alert the business of an imminent financial collapse of a key supplier.

Suppliers will never hold their hands up and declare that they have severe cash flow problems. It makes no sense. Indeed, there is a view that to offer discounts is an indication of problems and suppliers sometimes present this as a reason not to discount and this leaves buyers exposed.

Embedding supply chain finance arrangements such as dynamic discounting into a supplier relationship provides an opportunity for both parties to develop better cash flow. It also provides an important safety valve for a supplier during turbulent times and for the buyer, it helps to mitigate the risk of the supplier failing.

The white paper: “Supply Chain Finance – A Procurement Strategy”, is available for free download here.

Pete Loughlin can be found on twitter @peteloughlin

  • Robert Kramer July 24, 2012 at 2:31 pm /

    Great point, there is a big difference between monitoring risk and doing something proactively to mitigate it. A few quick comments on dynamic discounting, mainly with respect to the direct material supply chain:

    1. I don’t see how dynamic discounting is “an opportunity for both parties to develop better cash flow”. If buyers pay early to gain a discount it will have a negative impact on their cash flow. It still might be a good deal for the buyer if the rates are high enough, but it will hurt their operating cash flow.

    2. Most dynamic discounting solutions tout discount rates charged to suppliers of 10% APR or more. That’s the B2B equivalent of pay day loan rates. Buyers will know if and when suppliers choose to utilize dynamic discounting at those high rates and consider it a vendor risk flag. Similar to your point about suppliers offering discounts, this will make suppliers hesitant to use dynamic discounting.

    Supply Chain Finance certainly should be a component of any comprehensive vendor risk management program. It reduces cost, capital and risk in the supply chain. That said, when the discount rates are high (say more than 8% APR) or the funding inconsistent, I believe these programs become counterproductive. Only when the rates are low enough, say 5% APR or less, can they truly provide meaningful, long term and sustainable value to both buyer and supplier. The challenge with dynamic discounting is that either the rates are so high that they don’t support a healthy supply chain or they’re so low that they are below the buyer’s cost of capital. This challenge does not exist with bank funded SCF programs where a meaningful segment of the supply chain will see discount rates that make sense for both buyer and supplier. At PrimeRevenue we provide both bank funded and dynamic discounting (buyer funded) SCF solutions but bank funded has much wider applicability in the direct material supply chain.

    Robert Kramer
    VP, Working Capital Solutions
    PrimeRevenue, Inc.

  • Pete Loughlin July 24, 2012 at 2:45 pm /

    Thanks for your comment Robert. Your point 1 is well made and I think in strict accounting terms you’re 100% right. But for the buyer cash flow is improved in the sense that they get to pay out less albeit quicker. The point is that it’s a win-win.

    I’m not entirely sure about how universal your second point is. When speaking to the Taulia customers who contributed to the white paper, they shared some insights that were very revealing about the actual costs of some bank funded offerings that make pay day loans look positively attractive!

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