In this post-covid era, enabling access to necessary liquidity is a need of the hour

The COVID19 pandemic created a seismic shift in the Indian economy, shutting down businesses for months and dramatically affecting the financial health of a swathe of India’s businesses.

Riddled with supply and demand side uncertainty, every business went into cash conservation mode during the lockdown, but as companies restart their operations, designing an optimal working capital management strategy has become paramount for all. Suspending or delaying vendor payments is not a long-term viable solution, and collecting from customers is harder than ever before.

In such times, while healthier corporates have raised fresh capital and opened new credit lines to prepare for the worst, new credit for relatively weaker and often smaller businesses has been hard to come by, as they struggle to meet their existing loan obligations, pushing many companies into a fight for survival.

Amidst all of this, dynamic vendor financing has emerged as an increasingly potent avenue to unlock working capital, going beyond the traditional models of bank led supply chain financing.

Supply chains are very much a key strategic asset for many organizations, built over years. A recent report from EY indicates excess of Rs. 4 lakh crore of working capital trapped in India’s supply chains. This number has likely gone up further in the last 6 months. In the wake of the disruption from the pandemic, many companies have looked at creating win-win arrangements from their supply chain, attempting to simultaneously solve a 2-part challenge:

• How can the financial health of the supplier base be strengthened, reducing risk of disruption, without affecting existing contracts or expending thousands of man-hours in negotiations and supplier management?
• How can the entire supply chain be leveraged to improve credit terms and internal working capital levels, without also harming the financial position of suppliers?

Cash-rich companies are looking at their supply chains as an investment vehicle to achieve superior risk-free returns to the sub 6% ROIs currently achieved by most corporate treasuries.

However, leveraging existing supply chains is easier said than done. Vendor finance programs have existed in the west and in India for many years. A PWC Report in fact expects Asia to be the fastest growing region for Supply Chain finance in the near future.

An SCF program done right can ensure a financially healthy supply chain and lead to 300 bps increase in EBITDA or improve overall organization’s cash conversion cycle by up to 45 days at no cost. Yet, the promise remains largely unfulfilled till date. Programs in India have faced numerous challenges, and our qualitative research has surfaced four key impediments to successful implementation:

• Programs tend to be one-size-fits-all – Essentially manually deployed supply chain finance programs, bank-led or treasury-led, have a standard single discount rate for all vendors – while each vendor’s cost of capital is different. Manually deciding personalized discounting terms with each vendor is neither advisable nor practical, as it can lead to potential vendor backlash, limiting program scale to typical a fraction of the vendor base.
• Lack of flexibility for vendors and buyers – This creates a lose-lose situation. Vendors may need cash not at the time of order delivery, but say, 25 days later. They may need more cash 2 months before “season” to ramp up production. The buyer corporate too needs flexibility – in the mix of funding sources, eligible vendor segments and other structural aspects of the program. The inherent rigidity in manual programs limits the off-take to a fraction of total potential.
• Adverse outcomes: Supply chain financing has traditionally gone hand in hand with 1-1 negotiations with vendors. This leads to two negative perceptions – “arm-twisting” by the buyer, and potential price increase from the vendor in the future. But how does one bring fairness and objectivity in the dealing between the buyer and supplier so that transactional friction is eliminated?
• Execution at scale – Supply chain finance creates material impact for the buyer if and only if, executed at scale across the entire supply chain and creates participation across a bulk of the purchasing spends, which requires dealing with multiple financiers, extensive vendor education and onboarding efforts, cross-functional collaboration, accuracy in accounting entries and payments across thousands of invoices, all of which are hard to achieve manually and non-core to buyer corporate’s organisation.

Over the last 3 years, working with leading corporates on implementing dynamic vendor finance, we’ve identified 6 key imperatives to deliver value:

• Optimizing interest pricing across not just financiers but also vendors
• Ensure Flexibility for Corporate treasuries to decide funding mix between own balance sheet capital and external financiers
• Setup effective Chinese walls between to bring neutrality and objectivity in balancing needs of corporates and their vendors
• Find the right balance between corporate and vendor objectives to drive throughput
• Run an extensive Vendor education and onboarding program
• Recognize the need for robust program management, hand-holding and support on an ongoing basis, beyond just the technology enablement

The first four imperatives above are structural – and require, in essence, a working capital exchange. An exchange allows transactional separation – a buyer can deploy working capital (supply) independently of supplier access of working capital (demand). This allows both parties to optimize their half of the equation – supply and demand, and let the exchange bring the two pieces together seamlessly, without manual negotiations.

The next two imperatives are operational – without catering to them, even the most perfectly designed program would not succeed. In fact, a recent McKinsey study ranks “Ease of onboarding suppliers” and “support and education for procurement teams and suppliers” as the two most cited success factors for a supply chain finance program. These two imperatives are also why global platforms may not necessarily be the most optimal choice for Indian supply chains. In fact, no two supply chains are the same and a bespoke solution is required for truly implementing a successful supply chain financing program. Everything from vendor onboarding to regulatory compliance to structural flexibility (such as managing late payments or disputes, recourse structure) need to be built in at platform level for a uniquely Indian context.

In this post-covid era, enabling access to necessary liquidity is a need of the hour and responsible corporates are increasingly setting up programs to support their supply chain, which is the only viable way for SMEs to access affordable working capital in these times of adversity.