Unconventional Wisdom: On-time delivery and cost versus cash — a two-sided quandary

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During a recent discussion with Norbert Dean, the CPO of world-class cruise line operator, Carnival Cruise Lines, we found that in some industries and for certain supplies on-time delivery is absolutely non-negotiable. When a ship leaves port, it leaves. There’s no contingency for lateness. (Read Norbert’s interesting account of how being at the head of procurement and supply in this industry throws up some unique and complex challenges.)

As we know, there are always two sides to the supply/demand equation. The buyer at a supplying firm might well encounter delays in parts acquisition, might think enough time has been built into the order process, or might have a CFO ordering them to keep cash in the business until absolutely necessary and to buy just in time. The customer, on the other hand, just wants their goods on time.

It throws up all sorts of questions for the supplier:

Are CFO/CPO mutual expectations understood? Does the customer have a reasonable understanding of what’s involved in the supply chain process (in this case ports, access, documents)? If the supplier is late, whose balance sheet does the transportation cost sit on? Are customer-facing service levels and associated contract clauses and penalties passed on to the supplier’s supplier?

The supplying firm wants to please its customer, its CFO (e.g., working capital performance) and its bottom line — the customer just wants the goods as agreed. It’s a common conundrum. We asked our chief analyst Pierre Mitchell and this was his counsel (edited):

What's a supplier to do?

"From a supply chain risk, resiliency and customer service standpoint, this type of mission-critical supplier compliance issue must be considered carefully and cross-functionally so that there’s a common perspective taken out to your commercial partners. In situations where the supplier misses on-time delivery, for whatever reason (market disruption, parts shortages, etc.) the product would likely have to be dispatched via a different method to get to the customer, in this case flown to the ship’s docking destination (unless the ship has a helipad). The downside is that clearly this carries a large cost and environmental impact. But it happens a lot, especially these days with all the logistics constraints out there.

"One big question is: who holds the inventory? You’ll need to be in agreement initially that the inventory does need to be carried by someone — that’s the first step. There needs to be some buffer in the contract to allow customer service levels to be supported, and in this case the SLAs need to be extremely high because there is zero tolerance for lateness. This applies especially to mission-critical goods (which on a cruise might be parts for the ship or comms equipment for example); for general supplies (like food stuffs and linens for example) recovery is less difficult since you can accommodate a replacement. However, both scenarios should be in the contract.

"Basically (unless there’s a force majeure) when you are contracted for the supplies, then you are on the hook for them, and there’s going to be some type of penalty, possibly even contract termination, if you don’t deliver. Clearly, for the supply of mission-critical MRO items, contract terms will be more stringent, since business continuity is put in jeopardy. The long and the short is that this is all good contract management practice: it should all be spelled out in the contracts and the playbooks, so that suppliers know how to respond to each situation. This is the crux of supply chain risk management; making sure you AND your supplier have business continuity plans in place (e.g., alternative means to get the goods to the helipad while out at sea or to the nearest port)."

OK, but who holds the cash for contingency?

"That’s indeed the next question: who’s going to hold the inventory (which is basically unconverted cash), whose balance sheet does late shipment sit on? You generally want the firm with the lowest cost of capital to hold it, but as we know, that doesn’t always happen with large powerful buyers whose CFOs don’t want the working capital on their books even if they end up paying for it in the form of higher prices. If it’s not one or the other in the party, there are third-party options to consider. Off-balance-sheet arrangements can be made (in essence a supply chain intermediary who would hold the inventory and get it off the seller’s books) but that does introduce some complexity (as we saw with the Greensill debacle). The whole notion of supply chain finance is about bringing the lowest cost of capital as possible AND getting the working capital off of both balance sheets.

"Another way of looking at it is the cash-versus-cost dilemma. It depends what the motivator is. The CFO may be driven by the total working capital number (DSO+DIO-DPO) with DPO and DIO (for raw materials) being important on the procurement side and DSO and finished goods DIO on the seller side. If you care a little less about margin, then you can trade some of that by using the third-party arrangement that I mentioned before, but that intermediary has to be paid and wants to make a bit of a margin too. If the CFO is driven by the working capital side, then either they have to be able to give up a little margin. So you have to make mutual decisions about these trade-offs between cost and cash internally and then between the trading parties. This is why offering supply chain finance as a service that’s baked into the P2P process is a great way for buyers to offer that third-party financing option for suppliers who value cash over margin just as much as the buyers do.

"In short, going back to the original scenario, everyone must be on the same page about the necessity of getting the customer the critical supplies. And that involves trade-offs of where to position inventory whether it’s in a JIT warehouse near a manufacturing site or a cruise ship alike! And that inventory again is unconverted cash, so this is why you have the cash-versus-cost discussion, agree on whose books the working capital sits, and if there’s no agreement, then try to reduce the trade-off via a third-party financing option. There are other considerations here too such as service level trade-offs, contract enforcement, and insurance policies, but those are topics for another day."

Basically, when in doubt, it’s worth remembering that supply markets will almost always be able to offer a solution.

 

If you’re looking for procurement technology to help with supply chain risk , try out Spend Matters TechMatchSM,  a new RFI tool that enables you to generate and benchmark a vendor shortlist.

 

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