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In this guest post, Procurement Leaders invites GEP's Santosh Nair to discuss supplier innovation and look at the approaches businesses have taken to connecting procurement, finance and suppliers for purposes of creating value.
In a previous blog post, we reviewed approaches to empower and incentivize suppliers to foster innovative value creation. There are many initiatives to unlock value through innovative approaches such as new product development, process reengineering, joint investments, product standardization, etc. What's been particularly interesting in recent times is the rise of much higher engagement from the finance function to support and drive such innovation.
One such programme is supply chain financing (through reverse factoring) that puts finance in the center of procurement innovation and drives working capital improvement among other benefits. Most traditional efforts to free up cash flow are focused on inventory management or squeezing suppliers for better payment terms. This approach soon displays diminishing returns while introducing risk into the supply chain and souring supplier relationships.
An alternate mechanism called "factoring" has been used in a few areas wherein the supplier sells its accounts receivable to a lender at a discount. This provides immediate cash to suppliers but the process is cumbersome and largely inefficient, and ignores the buyer community. I've been involved in several projects implementing a more innovative solution of "reverse factoring" requiring buyer collaboration, particularly finance and treasury. In this case, buyers utilize their higher credit rating to get cheaper finance for suppliers and benefit from the intermediary funding source. In practice, the buyer selects a third party funding source / bank.
Suppliers send invoices to the buyer for approval through the bank system. Once approved by the buyers, the supplier can work with the bank to either get paid early (with finance charge discounts) or wait longer. The finance charges are mainly driven by the buyer's credit relationship with the bank. The bank will pay the suppliers accordingly and will then collect invoice payments from the buyer, usually later than the original invoice date. The systems can be set up to allow multiple funding sources, dynamic negotiations with each supplier, customized real-time financing options, etc. I've received extremely positive feedback from all concerned stakeholders in this arrangement due to the following reasons:
While there are significant benefits to this approach, successful implementation requires upfront investment of time and expertise. High levels of collaboration are needed between finance, treasury, legal and procurement. The right funding partner and technology platform has to be selected, with capabilities aligned with the client requirements. The right selection framework must also be used to identify suppliers for program enrolment. Appropriate communication mechanisms and on-boarding processes follow before the system begins to function seamlessly and generates tremendous value for all stakeholders involved.
Santosh Nair is Sr. Director with GEP Worldwide and a management consulting professional with over 12 years of experience in leading strategic & operational consulting engagements for Fortune 200 clients.