In this guest post, Procurement Leaders invites Accounts Payable News editor Ellen Leith to share her views on the recent scrutiny of payment terms and to look at what kind of options are available to procurement teams.
As Diageo becomes the latest corporate giant to hit the spotlight for all the wrong reasons, one of the fundamental business tensions between buyers and suppliers has once again come to the fore – when can payment for goods received reasonably be expected? A buyer buys from a supplier, supplier gets paid; it’s the foundation of any business. But what happens when the balance of power sits so definitively with the buyer? In an ethical operation, that balance shouldn’t matter – the transaction should fulfil the obligations outlined in the (no doubt much negotiated) contract.
And yet, in the case of Tesco, Premier Foods and AB InBev, the demands of the buyer have pushed some of their smaller suppliers to the brink – with some saying that they can no longer afford to do business with them. Of course any transaction is essentially a form of compromise, but for any relationship to work, it has to at least seem fair. So when Diageo sent a letter to suppliers saying that as from 1st February all new contracts will have 90 days terms attached to them, unsurprisingly some suppliers branded that decidedly "unfair".
Of course, one of the reasons the corporates are able to extend their payment terms so much, is that they’re fully aware of the importance of their contract to the lifeblood of their suppliers. A decent contract with a company like Tesco’s can generate growth and provide a cash injection into the business.
But when payment terms are extended to 60, 90 or 120 days, big business is effectively being bank rolled on the back of their smaller suppliers. And while this may make the larger corporates appear more financially stable – the practice actually introduces risk and poisoned supplier relationships into the business. Not only that, it’s not a huge leap to consider that a squeezed supplier may be pushed to cut quality corners – with, if discovered, serious damage implications to brand (and ultimately to the company’s bottom line).
Much has been made of the supply chain finance offers on the table from the corporates – but again this can only work if it offers enough benefit for both parties. If the bank charges are punitive, or if the supplier is not able to access the bank finance available, the fact that it is offered by the company is not much help. Neither should the introduction of a supply chain finance scheme be offered as a sweetner for drastically increased payment terms.
So what’s the answer? Of course, the reasonable response would be to simply pay all suppliers within acceptable terms, and in fact the UK’s Federation of Small Businesses has called for the UK government’s Prompt Payment Code to be given "more teeth" to make 60 days max the standard.
However, there will always be situations when payment terms do need negotiating. And if they do, organisations could do worse than consider solutions such as dynamic discounting which provide one that’s fair to both parties. It’s a solution which offers suppliers the opportunity to get paid early, in return for offering buyers a discount on a sliding scale depending on when that payment is wanted.
Alternatively there are solutions which offer suppliers the chance to get paid on time, while also having the opportunity to extend the buying organisation’s payment terms. Ultimately, the key message corporates should be sending out to their suppliers should be that they have choice, enabling them to regain suppliers’ trust while generating better visibility and control of working capital at the same time.
Ellen Leith is editor, Accounts Payable News.
This blog post has been reproduced from the Account Payable News website, with permission of the editor.