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Is ‘supply chain finance’ a fancy way of saying ‘financialization’?

What is financialization?

“Financialization is profit margin growth without labor productivity growth. Financialization is squeezing more earnings from a dollar of sales without squeezing at all, but through tax arbitrage or balance sheet arbitrage.” — Ben Hunt, Epsilon Theory

Is payable finance (aka reverse factoring or its generic form, supply chain finance) as practiced by large corporates, really just balance sheet manipulation? 

Large Companies Lack Cash to Fund Their Supply Chains

procurement

David Gustin is the chief strategy officer for The Interface Financial Group responsible for digital supply chain finance and is a contributing author to Trade Financing Matters.

The popular opinion has been that many large American companies are flush with cash. In fact, surveys from some reputable institutions support this view. The AFP’s corporate cash survey found during the second quarter of 2019, U.S. businesses continued to build their cash and short-term investment holdings. This is intuitively supported by events like the corporate tax cut last year.

But this narrative is highly misleading.

Goldilocks, Capital Structure and Supply Chain Finance

David Gustin is the chief strategy officer for The Interface Financial Group responsible for digital supply chain finance and is a contributing author to Trade Financing Matters.

Ahhh. This porridge is just right.”

— from “Goldilocks and the Three Bears”

The Goldilocks principle is named by analogy to the children's story “The Three Bears,” in which finding the right temperature for porridge took some sampling.

So how do you make sure the porridge is just right if you are today’s middle market treasurer and need to balance liquidity, access to capital (and if rated, a quality rating), and ensuring the right amount of cash?

Most middle market companies are not flush with cash. In fact, when thinking of capital structure, there are many things that keep the CFO/treasurer up at night.

What’s the Big Deal Behind Vodafone’s Supply Chain Finance Program?

David Gustin is the chief strategy officer for The Interface Financial Group responsible for digital supply chain finance and is a contributing author to Trade Financing Matters.

In a recent TXF article on Vodafone's supply chain finance program and its early pay program, Oliver Gordon, features editor, said: “Vodafone has been using complex financial engineering devised by GAM and Greensill to enable it to profit from and invest in its own SCF offerings and bolster its DPO (days payable outstanding).”

Personally, I have no problem with a company wanting to use its cash to self-fund an early payment program for their suppliers in exchange for discounts. Many large corporates implement some form of dynamic discounting that enables their long tail suppliers, and specific segments — diversity suppliers, choice suppliers, small businesses — access to early payment once an invoice has been approved. In fact, this practice has been going on for decades and now technology allows companies to systematize it and offer it to select suppliers, different supplier segments or all suppliers.

I also have no problem if a company wants to use this construct to invest in their own payables or some other company’s payables. But this does bring up three important questions.

Addressing S2P Platform Misconceptions Around Early Pay Programs

David Gustin is the chief strategy officer for The Interface Financial Group responsible for digital supply chain finance and is a contributing author to Trade Financing Matters.

Few source-to-pay platforms, payment processors or other networks have been able to develop early pay dynamic discounting management (DDM) or supply chain finance solutions that have added significant revenue to their enterprises. (See Why Platforms Need to Monetize Their Supplier Ecosystem.)

This comes at a time when these platforms are building new capabilities to boost revenues, including providing supplier invoice aggregation services; adding payment functionality; and helping clients migrate to cloud solutions.

From my conversations with many S2P platform vendors and payment processors, I hear three buckets of objections:

Many Fintechs Still Rely on Bring-Your-Own-Bank Strategy for Supply Chain Finance

Today, banks are by far the dominant player in providing supply chain finance, and do so in four ways. And many Fintechs that offer source-to-pay (S2P) and other supply chain collaboration solutions still have a strategy of using their clients’ house banks for supply chain finance. While it makes things easy if the customer can bring their own bank, it does not come without risk.

How the Contagion Effect Could Blow Up Network Finance

In the real world, you plan for an event and it works out for a while. Then things fall apart. So you react and plan more — hoping to stop the problem from creating a contagion effect.

And here you are, thinking that you built this nice network finance model to finance your suppliers not just on approved invoices, but invoices that have been issued, or even more upstream, purchase orders that have been issued. And things have been working smoothly for a couple of quarters, or maybe for even a year or two.

But then it happens. More things fall apart.

The Blurring of Supply Chain Finance Definitions

I often get this question about how factoring and supply chain finance differ from traditional invoice finance. And the real answer is its very murky. There is certainly a blurring between invoice finance, invoice discounting, factoring, supply chain finance and asset-based lending.

By whatever name you want to call it, what really matters is what usury laws are governed by the lending technique and how bankruptcy court will interpret the structure (loan, asset purchase) and what the state or legal jurisdiction laws are in relation to the technique. Definitions are fine to help educate and illustrate, but they are meaningless when it comes to judges and investors.

Supply Chain Finance: Gray Area Abounds on Early Pay Programs, Accounting

Whichever way you look at it and define it, supply chain finance has grown into a big number. And if you define it as using the balance sheet of a large company to offer early payment to some or all of its suppliers, it is has gained in popularity. Plus, it’s not only offered by large banks who can both originate and distribute large-scale programs for the likes of Unilever or Procter & Gamble, but also non-bank asset arrangers like Greensill, Seaport and others working together with source-to-pay platforms or directly with buyers to develop programs. And always in the background we have heard this whispering of accounting treatment. And by now, most people who have dabbled in this space know the issue: Is it trade payable or is it debt? Fewer understand the implications.