Expert Perspectives: Bringing Together Finance and Operations to Solve Supply Chain Challenges in 2022
Over the last two years, the pandemic exposed vulnerabilities in supply chains that had delivered on customer expectations consistently and with historically low costs. Disruptions ranging from natural disasters to canal blockages compounded the challenges of rolling shutdowns. And these events may be increasingly the norm.
Participants throughout the supply chain have been adopting more sophisticated financing techniques to manage complexity, mitigate risk, and access working capital more efficiently.
In light of these factors, it is more crucial than ever for finance and operations functions to align on objectives to balance supply chain resiliency, cost, customer service expectations, and other factors such as sustainability.
Understanding the Role of Finance in Supply Chains
One could argue that supply chains today actually comprise two separate but interrelated systems. It is useful to distinguish between the Physical Supply Chain (PSC) and the Financial Supply Chain (FSC).
The PSC comprises “organizations, people, activities, information, and resources involved in moving a product or service from seller to buyer, either domestically or across borders.” The FSC is “the chain of financial processes, events, and activities that provide financial support to PSC participants,” and includes activities within a firm and with third-party intermediaries that facilitate transactions between buyers and suppliers.
There is no one-size-fits-all solution to supply chain finance. In fact, the Global Supply Chain Finance Forum (GSCFF) identifies 11 classes of supply chain finance (SCF) tools falling into three major categories: receivables purchase, advanced payables, and loans. Firms can leverage these tools to tailor solutions unique to the characteristics and requirements of their supply chains.
One trap that has plagued supply chains of late has been the increased focus on lean concepts, such as cost minimization and inventory reduction that free up working capital but to the detriment of resiliency. During a period of calm and stability, this is fine. However, the impacts can be myriad when disruptions come, including an inability to meet customer demand or a sharp increase in input costs. In turn, buyers may attempt to extend supplier payment terms, which may strain upstream suppliers and lead to their failure.
A more holistic approach to financial and physical supply chain objectives is needed to mitigate risks in meeting customer demand in the short term and avoid supplier risks that can lead to more intermediate and long-term supply chain problems.
In general, SCF tools can lower financing costs at the transaction level and reduce risk throughout the supply chain. Coordination between finance and operations functions can streamline, standardize, and automate transactions.
SCF tools can also help suppliers reduce uncertainty around payment times and future cash flows, which can bolster their health and financial fitness. Over time, these implementations can help improve overall creditworthiness and lower the overall credit costs for suppliers. Under optimal SCF conditions, both the buyer and supplier benefit from a more efficient turnover of working capital.
Perspectives on Supply Chain Finance
1. The buyer perspective: Harmonizing supplier terms across geos and tiers to more efficiently use working capital.
In one instance, a large global industrials firm, a client of RRDS Chicago, had an objective to achieve about $2Bn in supply chain efficiency over three years. The client had already identified the role that finance could play in helping them reach their goal. One initial target was to develop a policy to standardize payment terms across suppliers.
In coordination with the leaders in the firm’s finance and supply chain verticals, RRDS Chicago stratified vendors by category of part or material and the regions from and to which they supplied. The mapping to standard terms enabled our team to use analytics to identify where there were significant deviations automatically. This automated approach helped to highlight areas of accountability across the supply chain team and simplified payment execution. Additionally, it helped facilitate contract negotiation between the client and their thousands of global suppliers to realize better and more consistent terms.
2. The supplier perspective: How bad terms can threaten the health of a supply chain.
For a buyer, extending payment terms can provide short-term relief when faced with a cash crunch, but it can put extreme financial pressure on suppliers, particularly smaller ones. We have seen this play out in many industries during the pandemic where payment terms were extended or invoices paid late regularly. Another form this kind of terms shifting can take is when buyers adopt widely differing terms across geographies, industries, or tiers.
The risk to suppliers has become a focal concern and an example from the UK illustrates where one firm has committed to paying suppliers early and called on their competitors to do the same. Squeezing small suppliers to the point that they go out of business can have significant long-term consequences, not just for one buyer but across an industry.
Third-party intermediaries can lessen the impact on suppliers through SCF tools that enable a buyer to continue to extend payment terms and simultaneously allow suppliers to receive prompt payment.
How to Align the Incentives of the Finance and Supply Chain Teams
For an organization looking to ensure that its physical supply chain (PSC) and financial supply chain (FSC) are working together efficiently, we recommend the following seven points of action:
- Ensure there is a clear overarching corporate strategy towards which both finance and supply chain teams are working. The agreed-upon strategy must prioritize all the market requirements and factors on which participants compete, e.g. features, price, delivery, financing cost, and more.
- Proactively identify the areas where the physical supply chain positively or adversely impacts corporate strategy and how finance can increase competitive advantage or mitigate risks.
- Identify supply chain metrics that align to financial performance and are well-placed in the context of overall corporate strategy.
- Consider your performance along both physical and financial supply chains relative to competitors. Remember that supply chain optimization is a balancing act. It is impossible to be the “best” in every way. Pinpoint your point of differentiation versus competitors and then maximize it.
- Analyze your supply chain for areas of financial inefficiency with a long-term goal to streamline. It could take the form of consolidation, relocation, reducing exposure to risky suppliers, and more.
- Craft performance evaluations and bonuses to consider holistic factors. For example, look to incorporate financial metrics for supply chain managers and supplier health metrics for senior finance staff.
- Stress-test both the PSC and FSC using sensitivity analysis to understand the overall financial impact of disruptions. Bring the finance and operations teams together to prioritize trade-offs between cost, resiliency, redundancy, and more.
Align Operations and Finance on Supply Chain Objectives
Some organizations shy away from taking on the challenge of analyzing and understanding the interactions between their physical and financial supply chains. It can be costly and time-consuming to undertake comprehensive studies that ferret out sustainable cost savings and risk mitigation.
Increasing the types of SCF tools and the universe of intermediaries required to enact them can add a layer of intricacy that buyers and suppliers might be hesitant to embrace. Additionally, as regulatory and reporting requirements around SCF grow and evolve, this can add additional cost and complexity to organizations that may be ill-equipped to handle them. For firms that choose to move some portion of their supply chain towards more local/regional suppliers (in response to black swan events like a global pandemic), it may lessen the appeal of more sophisticated supply chain finance techniques.
And for suppliers, in particular, there may be concerns that adopting SCF tools will allow large buyers to abuse their market power. There have been cases where buyers offer either/or propositions that can harm suppliers. For example, either extending terms to 180+ days or offering a shorter term with a substantial discount on prior prices.
Regardless, for most buyers and suppliers, the benefits of SCF tend to outweigh these pitfalls. Tighter coupling of PSC and FSC encourages collaboration between parties, which may help to maximize profit through the overall supply chain. Because SCF negotiations tend to be more complex between buyers and key suppliers, it also helps to make the relationship less transactional.
For companies that take the time to analyze and understand the interactions between their physical and financial supply chains, the benefits can be substantial and long-ranging.
Meet the Authors
Kara has over a decade of experience as a specialist in finance, analytics, and operational and digital transformation. She is Principal at RRDS Chicago — a Data Science and Quantitative Research Company. Kara earned her undergraduate degree from Harvard and her MBA from The Wharton School of Business at the University of Pennsylvania.
Ben is an Assistant Professor at Clemson University’s Wilbur O. and Ann Powers College of Business. He is also Chief Data Scientist at RRDS Chicago — a Data Science and Quantitative Research Company. His specialties include Operations Management, Optimization, Data Science, Computer Programming, Financial Modeling, Risk Analysis, and Applied Statistics.