Supply chain finance not only helps retailers improve terms for their suppliers, but bolsters the working relationship too. Liz Morrell reports on the benefits for both parties

In today’s retail age, the supply chain is a prime focus for cutting costs. Retailers have become aware of the efficiencies to be gained by improving their supply chain processes on the physical side – and are realising there are also savings to be made on the financial side. The benefits can be substantial, not only allowing improved margins, but also helping to reduce working capital and improve relations with suppliers.

Retailers increasingly want extended credit terms, but this rarely suits the supplier. Supply chain finance offers a halfway house with which both retailer and supplier can be happy, since the retailer gets the credit terms it is after and the supplier gets paid on time. “It’s a way of improving payment terms without having the adverse PR that normally comes with it,” says Ernst & Young head of retail Gavin George.

Working in partnership with a bank that specialises in supply chain finance, the supplier will sell its receivables – that is, invoices – to the bank at a rate discounted against the credit rating of the retailer, whereby the supplier is effectively borrowing off the retailer’s covenant. The bank pays the supplier when the supplier wants payment and the retailer pays the bank in line with its normal or revised payment terms.

The advantage for suppliers – above receiving earlier payment and therefore achieving improved cash flow – is that such borrowing generally works out substantially cheaper than having to borrow in their own market, particularly for suppliers in emerging markets, such as India.

“If you are a supplier with strong creditworthiness that doesn’t require the working capital, then you won’t use it. But it really comes into play when you have a supplier that needs to borrow in its own country,” says Andrew Betts, global head of supply chain business and transaction banking at ABN AMRO.

Supply chain financing not only enhances relationships with suppliers and allows the retailer to negotiate improved terms of supply, such as extended credit terms or discounted rates, but it can also ensure important but perhaps more vulnerable suppliers remain viable by improving their financial stability. “Retailers typically want the ability to rely on their top tier of suppliers and build sustainability of supply into their stores,” says Betts.

Although supply chain finance is a relatively new concept, some believe it is one that retailers should increasingly be using. “The early adopters are those with slick supply chain management. If you are an investment-grade corporate and are sourcing internationally, you will be looking at the cost of working capital within the supply chain,” says Betts.

Sainsbury’s is one of a few UK retailers, along with B&Q, that are leading the way in deploying supply chain finance. The supermarket announced the creation of its supply chain finance scheme at a supplier conference in November last year and began trials in April. “Suppliers will be able to view their trading account with Sainsbury’s – including invoices, debit notes, remittance advices and payment dates – online, giving them much better visibility of their expected cash flow,” the retailer said at the time. In addition, it highlighted the extra financial benefit to suppliers. “Qualifying suppliers will have the option to be paid early once their invoices are approved for payment. Early cash settlements will be made by those opting to sell their invoices to Morgan Stanley, via the new system, at a financing rate linked to Sainsbury’s credit ratings,” it said. Suppliers are understood to have reacted positively to the new system so far.

But it won’t work with all suppliers, warns Betts. “It’s a way of looking at the top tier of suppliers and the cost of the supply chain for all parties. It’s not a programme that is run with a one-off supplier. Spend per key supplier would typically be about£20 million – these are not small-scale programmes,” he says.

Joe Juliano, chief executive of US-based PrimeRevenue, which is providing the IT platform for Sainsbury’s trial, admits that suppliers can initially be reticent about supply chain finance. “When a retailer announces another supplier programme, the supplier initially isn’t open to it and there is some scepticism. But once they get trained on it and see the benefits, they get very excited,” he says.

However, Professor Martin Christopher of the Centre for Logistics and Supply Chain Management at Cranfield University, says it does require retailers to change the way they work with suppliers. “It depends on a high level of collaborative working – it’s a new way of thinking,” he says.

Betts warns that supply-chain finance needs to be more than just a short-term fad. “Retailers need to ensure the bank that provides the finance has a long-term strategy – if finance is later withdrawn, your whole supply chain will be in jeopardy,” he says.

Christopher believes retailers should be looking seriously at supply-chain finance. “In a low-margin business such as retail, if you can squeeze one extra penny out of your supply chain that will be magnified,” he says. In future, he believes most retailers will use the concept with at least some of their supply base. “It will become the way to do business,” he says. Juliano agrees: “There is an enormous amount of money tied up in the supply chain – and there are huge inefficiencies. Use technology to eliminate those inefficiencies and there will be benefits to all.”