High level executives, often at the CFO level, are trying to extend payment terms to increase cash. Longer payables equal more cash on-hand. It sounds like a great concept to some in the organization (mostly in the finance world). Wal-Mart, for example, has popularized the idea of not owning goods until they actually sell them. On the other side, the supplier produces and delivers the goods, but doesn’t get paid until the items are purchased by a consumer. But procurement thrives on pricing - beating down prices on piece parts. As the back office maximizes cash by extending terms while procurement wrings out every dollar it can, suppliers are being squeezed to the point that their viability is at risk. Adding to this, suppliers today are coming from even further places beyond the BRIC countries. Many suppliers in emerging markets can’t handle payment terms that have grown as high as 120 days, especially when they are getting pressured on price.
Bridging the Divide
There’s an interesting trend developing within manufacturing organizations these days as a result of the varying outlooks regarding how to manage suppliers. Here’s how it is playing out:
- Finance departments are extending payment terms when they can – sometimes forcing suppliers to shift from 30 days to 120 days.
- Procurement departments are getting the lowest possible part price, shaving the margins of suppliers.
- Supply chain departments are developing supplier risk task forces designed to assess supplier viability and risk. Their goal: identify suppliers that are at risk – often financially – and find ways to reduce it.
Manufacturers recognize the cost associated with a supplier failure. The repercussions impact the entire supply network like an immediate domino effect where nobody wins. When a supplier fails, there is also the added cost of changing out or replacing the pieces being supplied. When you consider the impact across the business, all three departments need to recognize the urgency to partner with suppliers. Here’s a few ways to start down this path:
1. Let suppliers know when they will be paid. The ability to automate reconciliation, match documents, and deliver a self-service model for suppliers to know when payment is coming is a huge advantage. Consider the hundreds – if not thousands – of phone calls manufacturers receive from suppliers inquiring about payment. How much time and money is spent on the manufacturer’s side? And how much impact does this have on the supplier, who is struggling to get paid and keep its business afloat? A self-service model eliminates these issues. We’ve seen those who attempt to outsource this part of the business and it simply does not work. Instead, investing in procure-to-pay technology based in the cloud allows suppliers to have real-time visibility into when they will receive payment and manufacturers can enjoy real-time visibility into where their part currently sits in the supply chain.
2. Assist supplier risk managers in developing programs to lower risk. Supplier risk managers measure the financial health of a supplier and predict if they are in trouble. Usually if they are, it means they are experiencing trouble with payments, but there’s a way to assist. Manufacturers can run their own invoice discount programs by offering payment earlier than 90 days, in exchange for a discount on the invoice. This eliminates the cash risk, but it also creates a win for the treasury department. Considering the minimal returns the manufacturer would get in an overnight money market fund, the invoice discount generates a stronger return.
3. Provide suppliers access to supply chain financing based on the buyer’s strong credit rating. Manufacturers with strong financial health can remove capital burdens and costs by enabling financial institutions to have visibility into both parties. Automated trade platforms that connect all parties in the cloud can make this happen. The result: capital costs incurred by the supplier overseas, which end up rolled into the cost of goods sold, are eliminated. Shaving off several percentage points from financing rates has a big impact on margins.
It all comes back to the basic “karma” premise that the supply chain is interconnected and interdependent so harming a supplier means harming your own business. As more companies recognize this reality, more companies are trying to build partnerships instead. Manufacturers who support and assist their trading partners find that it comes back to them in the form of better supplier performance, less delays, and higher margins.
A tier-one auto manufacturer has established a supplier risk manager role, tasked with identifying single source suppliers and other at-risk trading partners facing financial constraint and liquidity issues. This manufacturer launched a program to help suppliers access capital and design back-up plans, if needed. The program works with suppliers to deliver access to payments early, along with events-triggered financing to deliver capital when it’s needed. The supplier risk manager then sets out to develop win-win programs for the manufacturer and supplier. One such instance is a self-funded early payment program that eliminates financial institutions from the mix and allows the manufacturer to get a better return on cash while removing finance- related risk and cost from the supplier’s world. The manufacturer uses its own cash and pays its supplier invoices within 10 days, instead of 45, in exchange for a discount on the invoice. The discount is greater than any return that could be obtained in an overnight account. More importantly, the supplier has the cash it needs to run its business and deliver goods on time. It also eliminates the need to borrow elsewhere. And for factories in emerging regions, this can be a significant added cost that gets factored into the cost consumers will pay for goods sold.
Manufacturers have created most of these programs in reaction to suppliers going out of business. It can impact a supply chain for a year if someone goes out of business. In fact, a supplier suddenly falling out of the supply chain can be as traumatic as a tsunami or hurricane. Just consider how often inventory is scattered throughout the supply chain, being maintained or owned by another trading partner.
Deconstructing Internal Barriers
Manufacturers need to adjust their focus – not only on the external part of their business – but the internal business has to come together to successfully address supplier risk management as well. Often, a barrier exists between the finance, procurement and supply chain departments. Different goals and different perspectives often come into conflict with each other. It must be recognized that if the treasury seeks to extend terms to improve its cash position, there’s a dollar amount tacked onto the cost of goods. A programmatic approach that sees the value in removing dollars from the supply chain is in everyone’s best interest. It’s one value chain and everyone needs to act in the best interests of the chain, instead of seeing it as a series of separate parties.
Supplier Risk Management as a Differentiator
When an OEM buys supplies from a tier-one provider, it needs to know if the provider has a dependable risk management plan in place to protect its own suppliers. Supplier risk is becoming a differentiator in the market. Why would General Motors take a chance on a company with significant supply risk, for example? Some would argue that keeping supply viable is more important than parts prices. But there has to be assurance for the supply chain to work. In fact, one major auto company practically shut down part of its operations in 2011 because it couldn’t produce 45,000 cars when it didn’t have access to a small fastener. The company actually had to reissue earnings and the stock price dropped 40 percent. When sourcing anything, companies can’t always assure supply. Companies that think they’re not exposed to single-source risk need to take a closer look.
Squeezing suppliers can be counterproductive to manufacturers, but a fast-moving evolution is occurring in the way suppliers are managed. As a result, an internal shift is happening that is breaking down barriers between the treasury, procurement and supply chain departments. A collaborative approach to internal and external communication can drastically remove risk, costs and inefficiency from the manufacturing business.