Are You Financing Your Competition?

You can have anything you want

But you better not take it from me

– Guns N' Roses, “Welcome to the Jungle” (1987)

If you have some knowledge of Game Theory, you probably heard about The Prisoner’s Dilemma Paradox. In the classic dilemma, two suspected criminals are given options to cooperate and there is a 2 x 2 matrix of outcomes across the "cooperate" or "not cooperate" axis. It explains why two apparently "rational" individuals might not cooperate, even if it appears that it is in their best interests to do so.

Now I am not saying paying suppliers is classic cooperative behaviour, but there are elements of game theory. Company A and company B both buy from many of the same factories and suppliers to those factories. Think of garment companies like Nike, Under Armour, Reebok and others making shirts.

Obviously each of these factories knows the terms with their end buyers, and has negotiated terms as part of an open book cost model. Working capital is the lifeblood of many factories which must absorb direct costs, labor, etc. weeks or months before getting paid.

Ken Ho, cofounder of FlowLabs, described an interesting game theory scenario:

"If two firms pay their suppliers quickly, they receive the same adequate compensation. However, if Firm A decides to delay payment in order to invest the savings or finance short-term projects, it can benefit from higher compensation. Firm B is put at a competitive disadvantage and might even have to absorb the costs of Firm A’s delay. Firm B now wants the same benefits as Firm A, so it decides to delay payment as well. Now the supplier is being squeezed by both firms, resulting in shoddy goods, unstable output, and/or higher prices. In effect, everybody loses."

For many Procurement managers, their job is to drive cost out of supply chain so they can help drive growth. Driving $50M in expense reduction is worth $200M in sales for a company with an operating margin (before overheads) of 25%.

Do companies that have a culture of paying fast risk helping their competitors? You could make two arguments, first that fast pay companies will get the best service, support, and bargaining power, all things the same.  Or you could say that factories who are negotiating with buyers that have brand, leverage, and volumes will look to find other buyers that can help them bear the brunt of the larger buyers.

What I am hearing is the fast pay guys are putting pressure to extend terms, seeing the working capital gains outweighing any supplier relationships.

What do others think who have experienced this?

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