Back in the 1990s much of my supply chain management research was in the area of purchasing and I discovered that many people had very little understanding regarding payment terms. It was surprising that cash discounts could be so huge – 2% for paying on day 10 rather than day 30, for example – and yet I had to point out to corporates that these were such good deals they had to take advantage of them straight away. Eventually, more powerful buyers picked up on this and started asking for these kind of terms to be written into contracts rather than suppliers offering them (and often finding that buyers weren’t interested).

Moving ahead to the global financial crisis and the great recession and the picture changed – but not for the better. Suddenly, corporates scrapped the idea of wanting early payment discounts and instead simply lengthened their payment terms to their suppliers. I admit I was pretty shocked when that started happening.

Professor Lisa Ellram

It’s reassuring, therefore, to see how the supply chain finance landscape is unfolding today. While banks have been dealing with the big companies to help provide their suppliers various options for the timing of payments, we now also have fintechs bringing many creative offerings, helped by their greater agility and lighter-weight regulatory environment. Companies themselves are stepping into the game, too. Rather than turning to financing companies, the current model has some companies financing their own supply chains. That has to be a good thing.

From my standpoint as a supply chain specialist, however, I find it extraordinary that people within finance functions still believe that it is a good idea to shift the burden of financing the corporate onto the supply chain without putting any financial support mechanism in place for suppliers. Their failure to take a holistic look at their supply chains is akin to sitting in a decrepit lifeboat, happily bleating that the leak isn’t at your end of the boat.

“We have a long memory,” said suppliers

Companies have become so much more dependent on their suppliers: they outsource so much more, they depend on suppliers for carrying inventory for them and they turn to their suppliers for new ideas. So how can they think it’s a good idea to forcibly push the burden of financing their company onto a supplier? You aren’t taking a holistic view if your focus is purely on your own cash flow.

Even from that narrow cash flow perspective, if you’re not treating your suppliers well then it’s going to affect your ability to get product from the supplier and it’s going to affect that supplier’s willingness to work with you and invest with you. In a competitive environment it can make a big difference.

Here’s an example. During the great recession I worked on a research project that dealt with buyer-supplier relationships in the automotive industry. There were companies like Honda that were really monitoring their suppliers’ liquidity and paying their suppliers more quickly. Then Ford started paying their suppliers every 10 days or so, because they wanted to make sure their suppliers stayed in business. Then GM had to get the US government to bail them out – and they extended their payment terms, paying their suppliers in 60 days.

I talked with businesses that supplied all of the big car manufacturers – and they had very different ideas about how those customers were going to be treated as they came out of recession. “We have a long memory,” the suppliers told me. “We’re going to remember the companies that tried to help us. We’re going to remember who didn’t help us. When we have choices about capacity and about attention, it’s going to show.”

So I don’t understand it: do people in finance truly think that they are so powerful that companies are going to clamour to do business with them regardless of how they treat them? Maybe in some cases that’s true. But there can’t be many companies in that kind of position.

I interviewed a plastics company some time ago. They made precision parts for the automotive industry and for medical industries. Over time they got out of automotive – except for one customer – because the industry was extending payment terms and playing a lot of games with them. So it is actually possible to become so unattractive as a customer that your suppliers will walk away from you.

A sugar rush to the balance sheet

The catalyst for change is the opportunity that is afforded to the new service providers and finance providers. They are coming in with strategies and tools that will mean corporates’ suppliers can get paid. They are generally in a position to take on a little more risk than a bank. And so they can help sharply reduce the financing costs in the supply chain.

When companies extend payment terms while also requiring suppliers to do things like carry all the inventory, the suppliers have got to be able to pass those costs along. Companies are fooling themselves if they think this is a good deal for themselves. If the supplier’s cost of capital is 15% and your cost of capital is 4%, you’ve just increased the part of your supply chain’s cost of finance that you put on your supplier by 11%. Where is that going to show up? It’s going to get passed along back to you as higher prices or reduced service, making your whole supply chain less competitive.

Wall Street might get really excited because you’ve now got so much cash, of course. But if because of the way you’ve treated your suppliers your sales are dropping or your margins are getting squeezed or your product quality suffers, that’s not going to be good. It’s like getting a sugar rush because the balance sheet looks great – but the downer comes in the P&L before very long.

If your supplier is a trucking firm, for example, once they’ve bought their trucks their cost base is pure variable cost: it’s all fuel and payroll. They can’t wait 90 days to pay for those things. Their financing cost comes creeping back to the buyer sooner or later. I think people in purchasing understand that. I’m not sure that people in finance do.
If you’re going to push your financing costs to somebody else in the supply chain, the only person you should push it onto is somebody who has lower financing costs than you – unless, for some reason, you think the supply chain doesn’t matter and you’re impervious to everything that goes on in it.

As I said at the beginning, years ago I had to teach corporates about the benefits of paying early. Now I find I’m having to tell them about the competitive disadvantages of paying as late as possible. Supply chain finance tools provide an alternative. It gives purchasing people something to fall back on so they don’t have to feel like they are just taking complete advantage of their suppliers. But purchasing needs to step up and tell their finance colleagues that these types of solutions should be offered whenever payment terms are extended.