In Part 1 of this post, we provided the first component of our analysis of the days sales outstanding (DSO) calculation and benefit to Ariba suppliers via the Ariba network (to learn more about the impact of Ariba's network fee increases in September, you can read a recent article and analysis on the subject or download our full free report as well). In today's installment, we'll look more specifically at the cost of capital calculation as a component of the claimed supplier benefit Ariba makes. In writing this component of the paper, we consulted with a colleague who has served as acting CFO and controller for half a dozen SMB companies and business units of Global 2000 organizations to get his take on whether Ariba's claimed 12% cost of capital basis is the right number to plug into an equation.
Based on the percentage that Ariba throws out (12%), it's our view that it appears they are using internal hurdle rates or weighted average cost of capital (WACC) when calculating the DSO reduction benefits. But in reality, WACC is an internal measure of approving capital projects that produce a certain level of return for their efforts. We believe that Ariba should consider also using an actual bank borrowing rate / base -- e.g., 5%+ for middle market lines of credit (LOCs), potentially less for larger organization revolving lines -- as a basis for comparison.
If Ariba wants to use WACC, it would exceed 12% in many cases -- so the number they provide is not necessarily realistic in this case either. More important, our research suggests that Ariba should present more realistic costs of borrowing for companies today in a revolving credit situation. Currently, our experience with credit worthy middle market companies suggests that banks are lending on a LIBOR plus 4% basis with a typical floor of 5% -- for Fortune 500 A-rated suppliers, it might be possible to shave off another 50, 100 or more basis points on a lending rate. Ariba's numbers may, however, be realistic for companies without prime borrowing credentials.
The net impact of the change of the DSO reduction benefit calculation is very significant if we move away from WACC to a revolving credit -- or other debt -- facility percentage rate. Companies evaluating Ariba's network price changes, especially for their larger transacting suppliers, should create their own benefit calculation to understand the actual value equation both pragmatically and as their suppliers look at it.