Achieving Total Economic Benefits From Supply Chain Efficiency Vision Becomes Reality
Parallel Supply Chains: Physical and Financial
Two supply chains exist in virtually all forms of commerce, the physical supply chain and the financial supply chain. The management of the physical supply chain has evolved from physical logistics management to more sophisticated transaction management and now to planning and collaboration between trading partners. Most companies have spent the last few years focused on improving physical supply chain efficiency. Some of the benefits include shorter time to market, reduced production costs, reduced inventory costs, and better collaboration between trading parties.
Similarly, the financial supply chain has also been improved over the last few years. Companies have streamlined their financial information flow by implementing ERP applications targeted specific functions of the financial supply chain, such as the accounts receivable (AR), accounts payable (AP), and general ledger (GL). The financial supply chain is much broader as it incorporates not only the flow of financial information, but also financial products, such as credit assessment, risk management, financing, payments, and servicing (Figure 1). Financial products and information are used throughout the physical transaction process. New financial products, such as online trade financing and letters of credit, have emerged to help speed up and reduce the cost of facilitating international trade. Greater visibility of receivables, working capital needs, and the overall financial position of an organization exist today due to financial supply chain efficiency efforts.
Multiple Supply Chain Inefficiencies Revealed
Although great advances have been made in the physical and financial supply chains individually, there has been very little focus on improving the integration between the two. The result is an opportunity to further improve overall supply chain efficiency. For example, procurement supplier hubs automate the procurement process but still require buyers to go offline to make the payment. This increases the time to complete the order, transaction costs, and reconciliation issues. Following the decision to buy an item, a customer might still need to call her banker to finance a purchase, elongating the purchase execution cycle, the inventory hold time, and delaying the receipt of payment for the supplier. Product managers who do not consider the payment history of their customers may price products at a level where the margin is insufficient to recover the long payment cycle and many hours of AR staff follow-up with customers who have poor payment histories. In essence, selling the product below the total product cost.
These examples of real life issues occur at the interface between the physical and financial supply chains. Issues such as these have typically been handled in cumbersome and manual ways or have fallen through the cracks because they do not fit squarely in one supply chain and are thus not owned by any single department. These examples of uncoordinated physical and financial supply chain activities are a financial detriment to an organization and also impede having a mutually beneficial and financially solid relationship with trading partners.
Some examples of the financial effects of this dropped intersection point between the two supply chains are as follows:
- Eighty-six percent of all electronic B2B transactions are paid by check and reconciled with paper invoices and purchase orders (POs) resulting in high processing costs.1
- Twenty percent of orders contain discrepancies that result in inflated days sales outstanding (DSO) averaging 57 days; these discrepancies require manual processing and reduce working capital while being resolved through reconciliation and dispute resolution processes.2
- More than $20 billion of working capital is unavailable to Fortune 500 companies due to the lack of clarity on their receivables.3
Other metrics impacted include inventory turns, safety stock availability, manual processing costs, dropped transactions due to inefficiencies, etc. While the full extent of these issues cannot be solely attributed to the lack of collaboration between the physical and financial supply chains, integration of the supply chains at key points can greatly impact these issues.
Show Me the Money
Gaining visibility to the transactional flow among buyers, suppliers, logistics providers, intermediaries, and financial services providers can eliminate many of these costly inefficiencies. Furthermore, the visibility and analytics of information at various stages of the transactional flow opens the door to revenue generation opportunities. The key to both cost reduction and revenue enhancement is to enable collaboration between the physical and financial supply chains. This creates three types of collaboration opportunities between the physical and financial supply chain.
First, we'll consider the collaboration of physical supply chain systems to ERP systems (e.g., the procurement system to the payment system). This allows information to flow from one system to another, in an electronic "handshake," so that trading partners do not have to reenter information or step out of the interaction to complete the next step. Collaboration between systems reduces the time to complete a transaction, reduces errors in rekeying information and reconciliation cost on the back end, it also increases the likelihood that trading parties complete transactions, and provides a more efficient interaction between trading partners.
Second, consider the collaboration between customer behavior and financial products and services in the physical and financial supply chain. This is the ability to understand the trading partners, their financial needs and preferences based on the interaction point, and to provide the appropriate financial products at the right time to streamline the supply chain. Take, for example, a foreign buyer purchasing a large piece of equipment. At the point of transaction, you may be able to offer the buyer a letter of credit option, a financing option, shipment tracking through customs via an integrated shipping function that allows for immediate payment on customs inspection of the goods. This not only reduces time to getting the inventory out and accepted at the destination, and increases the satisfaction on the buyer side because of the "no-hassle" transaction process, it also provides a new stream of revenue for the supplier by offering access to financial providers.
The key to both cost reduction and revenue enhancement is to enable collaboration between the physical and financial supply chains. |
The third type of collaboration is based on business intelligence. This is where the right financial or physical information informs the right person at the right stage to be able to make a better decision than before. Today, trade terms are often set a standard way, such as 2 in 10/net 30, and typically do not discriminate based on past performance. Take our same example of the international buyer. He typically pays 90 days out, which means the company is basically funding the buyer 60 days of capital. Assuming a cost of capital at 10 percent, that is 1.67 percent of lost capital for the 60 days of outstanding receivable. On a $100,000 invoice, that would amount to $1,667 for 60 days. With this information, we can intelligently price the product and the relationship.
The fundamental challenge is to automate business processes and integrate financial processes and information throughout. Few of these processes are integrated today. Once integrated, trading partners will have access to the right products and services when they need them on a transaction basis, irrespective of which electronic channel they use. Further, the buyer, supplier, and all intermediaries will have a single, consistent, and complete view of the transaction. The buying process will be less prone to error, and management will have a holistic and accurate base of enterprise information.
Something in It for Everyone
The benefits of physical and financial supply chain collaboration are compelling for all parties involved in a transaction.
Suppliers
End-to-end financial integration facilitates demand forecasting, improves the ability to manage credit risk, enhances the focus on dispute resolution, and reduces the need for internal financing of AR. When POs, shipping documents, and invoices are error-free, buyers accept them faster, decreasing a supplier's DSO. Working capital is reduced in two ways: fewer exceptions in order processing smooths order flows, trimming inventory levels; and faster and more predictable cash flows create earnings stability, lowering company-specific risk and thus the cost of capital. Processing costs decrease by reducing the need for manual processing equipment, labor, and paper-based forms. This can translate to a 3 to 5 percent reduction in a supplier's total purchase costs.
Physical and financial supply chain collaboration also paves the way for new revenue creation. Suppliers can offer buyers a broad selection of financial services, such as risk mitigation and spot financing, on an individual transaction basis. In turn, access to information opens up other possibilities in the areas of planning and analysis and customer service. Detailed account histories help build a better base for forecasting and identifying servicing and sales opportunities. Analysis of accurate invoice and payment information enables negotiation of trade terms.
Buyers
Buyers can increase their ability to forecast and synchronize purchase arrivals, thus reducing demands on working capital. By eliminating manual processes and reducing reconciliation costs, buyers can reduce purchase costs by 2 to 4 percent. Buyers can also increase transaction efficiency by being able to step through a transaction in one sitting without having to go outside of the transaction for activities like financing.
Solution Providers
The greatest opportunity lies in creating new revenue streams. Solution providers can accrue reseller and "click-charges" from corporate clients for initial solutions such as invoice presentment and payment, perhaps jointly marketed with physical fulfillment and logistics software providers. Additional possibilities involve gathering and using more comprehensive data about transactions and their participants. This information enhances supply chain processes. The buyer-supplier negotiation process can be improved by creating actionable information about the total cost of responding to a request-for-quotation; that is, one that includes quantification of risk and cost implications of using certain financial products like insurance and trade financing. Negotiations can also be complemented by tracking the cost (working capital, float, etc.) of a supplier's prior deviation from service levels in areas such as invoice accuracy. Third-party solution providers are well placed to offer such value-added information.
Market Is Moving Forward – Where Are You?
In the last two years, more than 150 companies have moved into the area of providing e-enabled financial products that enhance the efficiency of the supply chain. ERP and e-procurement vendors such as Oracle, i2, CommerceOne and Ariba are actively trying to integrate physical and financial workflows between buyers and suppliers. These companies have identified this as the next area of supply chain improvement and as a way to upgrade their revenue streams. Players, such as Visa and BCE Emergis, are entering the physical and financial supply chain collaboration space through targeted solutions, such as integrated order to pay, payment linked to logistics, line item data capture, and e-invoicing and reconciliation capabilities. Logistics companies like UPS are offering financial capabilities, such as payment and risk management linked to their logistics capability.
Even as early entrants take these initial steps, the challenge of achieving full financial integration is becoming increasingly complex. As B2B commerce takes hold, the required financial capabilities will become increasingly varied, going well beyond the payment process. Emerging real-time collaboration capabilities will enable increased efficiencies and transaction cost reduction.
At the same time, the physical supply chain itself is becoming more sophisticated, incorporating an increasing numbers of parties, more complex terms-of-trade, and different geographies that do not fit conveniently into existing logistics and risk management operations. The growth of cross-border trade adds additional complexities such as multiple currencies, multiple languages, and tax requirements.
As B2B commerce takes hold, the required financial capabilities will become increasingly varied, going well beyond the payment process. |
Vision Becomes Reality – Are You Ready?
The collaboration between physical and financial supply chain is becoming a reality. Benefits are evident as it evolves into the next level of overall supply chain efficiency. For this vision to be realized, several challenges need to be overcome.
Organization maturity and sophistication – Physical and financial supply chain collaboration is best undertaken by companies who are already on the path of supply chain transformation.To be successful, efficiencies need to be achieved in the supply chain separately before linking them together.
Organizational barriers removed to allow for supply chain transformation – Departments within organizations generally operate independently, in a silo. Breaking down the walls will enable ownership of cross-functional issues. There are many touch points between the physical and financial supply chain that will need to be examined and redefined.
Network of solution providers – There is no magic bullet or single solution provider. The solution will need to be pieced together from various providers. This requires willingness and an ability to knit together providers who can help bring together the collaboration of the two supply chains. Physical and financial supply chain collaboration efforts may seem overwhelming, but so are the benefits. Organizations can take steps today to get on the road of unlocking the full economic and collaboration value from the physical and financial supply chain collaboration. First, break up the problem into bite-sized chunks – identify two or three key pain points (e.g., reconciliation costs, DSO, know your customer). Organizations should not try to take on the entire supply chain all at once.
Second, once the critical areas of pain are identified, work backward to define the interaction points, information needs, and products/services needs. Third, create a cross-functional task force. Identify a team made up of people from finance, logistics and procurement, and task out the entire flow of the target process and solving the problem. And last, act quickly. The financial supply chain can enable physical supply chain efficiency and effectiveness. No matter what area of the supply chain a company is focused on, there is probably an opportunity to collaborate with the financial supply chain.
Endnotes
1"B2B Electronic Invoicing and Payments," Gartner Group, December 2000.
2 "Optimizing the Financial Supply Chain," Killen & Associates, October 2000.
3 eCFO, December 2000.
