Last month David Cameron announced a valiant government sponsored initiative. The primary objective of the UK-backed program is to provide small businesses with much needed access to liquidity – put in simpler terms: to pay small businesses faster. If you’re unfamiliar with the current global economic environment, large organizations are taking longer and longer to pay their suppliers. In many cases, suppliers are paid 90 (or even 120!) days after they provide goods and services to their customers. This has been the case for many years. If you’re wondering why, the answer is money.
Look back to the late 1970’s and early 1980’s when interest rates exceeded 20%. CFO’s around the globe began to hold onto their cash for as long as possible to reap the benefit of the earned interest. One successful tactic to accomplish this has been to take longer to pay suppliers. This is commonly know as Days Payable Outstanding (DPO) – the number of days it takes an organization to pay trading partners. As the practice of extending out DPO became more common, suppliers were forced to find alternative means of cash as they require liquidity to operate – to fund future orders or meet payroll. This has been done in a few ways, factoring their receivables or taking a short term loan from a bank – neither come with attractive borrowing terms. But with the financial crisis came tighter lending restrictions, so many small suppliers are starved for cash – as their customers take longer and longer to pay and credit lines from their banks have in many cases all but disappeared. The irony in all of this is that as small suppliers are starving for liquidity, the largest organizations in the world are richer than ever. Meaning large companies (the Apple’s of the world) are flush with cash and struggling themselves to make a return on this money in this near-zero interest rate environment.
So this brings me back to David’s Cameron’s attempt to help the small guy, the cash-poor suppliers servicing some of the largest companies in the UK to get cheaper and easier access to money. His goal appears to be genuine, but the financial tool he has chosen will limit the effectiveness of the program. Why? Supply Chain Finance (SCF) relies on the culprit of the current lending crisis – the banks. In traditional SCF (also known as reverse factoring), banks acting as an intermediary provide quicker payment to suppliers, but take a portion of the payment (think how banks make money: fees). To accomplish this banks first need to onboard each company into the program, a costly process. Because of this, banks only target large companies that are worth their while – typically organizations that they can finance a minimum of half a million pounds in annual volume. The point here is that small companies aren’t worth the upfront fees a bank will face in bringing them into the program. So while SCF will absolutely help some suppliers, really only those important enough for the banks to finance. But what about the vast majority of suppliers? This program isn’t for them.
The SCF model would be logical if the buying organizations were also strapped for cash — but they are NOT. These companies are cash-rich to the point that gaining a return on this liquidity has become a problem. Organizations with the necessary liquidity can cut out the banks and provide earlier payments themselves directly to their suppliers. There’s no need for a middle-man. Not only would this provide quicker and cheaper access to cash for ALL of an organizations suppliers, but it also provides a better return for the buyer. The technology I’m referring to already exists and is being leveraged by some of the most innovative organizations around the globe. This technology is called Dynamic Discounting and it enables organizations to pay their suppliers early, while taking a discount on the payable that varies based on when the suppliers chooses to be paid. The earlier the payment, the larger the discount – the concept is ingenious in its simplicity. And no middle-man to skim off the top. So while David Cameron had the right idea in helping suppliers, looking to the banks was the wrong approach.
Joe Hyland is VP Marketing at Taulia