Cutting Out the Middleman: A Lesson in Unit Cost Reduction Vs. Working Capital Requirements

Last week, Lisa Reisman and I lectured at a joint ISM/APICS dinner in Chicago. The combined procurement and supply chain audience could not have been more appropriate to discuss the following topic that Procurement Leaders highlights in a recent story: examining how the move to direct sourcing (i.e., cutting out the middleman) can impact working capital even in cases where such a move can reduce unit costs and provide greater overall supply chain control and risk reduction. According to the example emphasized by Procurement Leaders, "A concerted effort by British retailer Sainsbury's to increase the volume of direct global sourcing has contributed to a £104m increase in working capital during the first half of 2011...The retailer, which has increased direct sourcing from its three sourcing offices in Hong Kong, Dhaka and Shanghai by 23% during the period, has also doubled the volume of direct general merchandise sourcing following the opening of the Dhaka office."

In many cases, working capital takes a hit when companies cut out the middleman -- as organizations must hold more inventory and/or commit to different payment terms with manufacturers when a distribution or trading company is not sitting in the middle of the trading partner relationship. The same situation often holds true when companies move to a global export sourcing model when they're buying from suppliers halfway around the globe and more inventory must be warehoused or on the water to make up for the extended supply chain. Regardless, it's important to note that moving to a direct model does not necessarily have to increase working capital requirements. Organizations have a number of potential options at their disposal to counter the working capital hit from direct relationships with suppliers.

These include offering early payment discount programs, financed based on their own credit rating to allow suppliers to receive payment in 5-10 days (or FOB) based on a low APR (e.g., 3% or less). In addition, organizations working directly with suppliers in a model that replaces previous intermediaries may offer to consolidate spend with fewer suppliers in exchange for vendor investment in warehousing facilities or virtual facilities (e.g., having suppliers pay the cost of working with 3PLs that can provide a program that looks just like a supplier-run JIT or VMI program). Regardless, organizations going the direct sourcing route should actively focus on a range of electronic invoicing/low APR discounting models, trade finance and 3PL options to reduce the impact of increased working capital requirements that can come from cutting out the middleman.

Jason Busch

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