Looking at SCF as a supply chain risk mitigation tool

The benefits of supply chain finance as a portfolio of tools to reduce cost and optimise working capital are, of course, very well known to us all. And SCF is also widely acknowledged as a means of reducing the risk of supplier failure by enabling suppliers to get early access to liquidity.

But SCF is actually an even more powerful toolkit than that. There are many different kinds of risk across the entirety of the supply base – and SCF is able to have at least some mitigating effect on almost all of them, as my research colleague Olaf Weeda and I recently concluded. This is not yet in the mindset of supply chain managers – and it should be.

One of the leading papers on supply chain risk in general was written in 2004 by Chopra and Sodhi in the MIT Sloan Management Review. In it, the authors identified a number of different types of risk, making the straightforward argument that “By understanding the variety and interconnectedness of supply chain risks, managers can tailor balanced, effective risk-reduction strategies for their companies.”

For example, under the heading of ‘Disruptions’ such as might be caused by a fire destroying a key plant, effective mitigation strategies could include having additional inventory in store as a buffer or by sourcing from multiple suppliers rather than single-sourcing.

‘Procurement risk’ was the heading given to unanticipated increases in acquisition costs caused by supplier price hikes or foreign exchange volatility. The authors suggested long-term contracts and FX hedges could be useful ways to mitigate such risks.

But for all the range of supply chain risks that Chopra and Sodhi considered, the one mitigation strategy that they never discussed was the use of supply chain finance. Admittedly, SCF was still a relative toddler when they wrote their paper more than a dozen years ago. But Olaf and I have taken a fresh look at their work and found that SCF is a mitigation tool that can helpfully handle almost all the physical supply chain risks the authors identified:

Disruptions: Supply risks can be caused by incidents such as natural disaster or fire or supplier insolvency. SCF can help in mitigating supplier bankruptcy, of course, but it can also help get suppliers back on their feet more quickly by making capital more readily available. So SCF is potentially a very strong tool to mitigate disruption risk.

Delays: Sometimes delays are caused by the deliberate decision by a supplier to favour one customer over another. The lesson, then, is to be an easy customer to do business with. Giving suppliers access to an SCF programme could well mean that the buying organisation gets preferential treatment and so experiences fewer delays from the supplier. More sophisticated supply chain finance tools can also help suppliers invest in more equipment and tools, which allows them to increase their responsiveness and reduce supply delays.

Forecast risk: From the supplier perspective, forecast risk is obviously reduced by supply chain finance as it removes the credit risk and payment uncertainty surrounding receivables. However, there is a less obvious but no less important forecast risk mitigation aspect from the buyer’s perspective, too. Because SCF takes financial risk out of the supply chain and can provide the capital and liquidity needed to support suppliers in their time of need, it reduces the chances of having to switch suppliers at short notice – a move that almost always results in higher-than-budgeted costs. In this way, SCF can reduce forecasting risk for the buyer by reducing unanticipated cost volatility.

Procurement risk: Deployed properly, supply chain finance tools such as reverse factoring can be an excellent way of fostering loyalty among the supply base, which goes some way to mitigating against supplier price hikes.

Receivables risk: This is obviously on the side of the supplier where SCF helps reduce the risk of non-payment – which could have a knock-on effect onto disruption risk should a supplier fail. But SCF also creates a discipline on the part of the buying organisation: by resetting the balance of power such that the buyer now needs to pay a bank rather than suppliers, the debtor and creditor are on a more equal footing which enhances the sustainability of the supply chain.

Capacity risk: This is discussed by Chopra and Sodhi (2004) in the context of the risk faced by suppliers who may suddenly find they have excess capacity in the face of a sudden market weakness. But it cuts both ways: production capacity can’t be expanded overnight in the face of a demand surge by a buyer – which would be damaging to the buying organisation by thwarting its greater ambitions. We saw an example some years ago when, in the run-up to a major football tournament, there was a spike in demand for televisions. Set manufacturers were fighting for production capacity but Philips, through its SCF programme, managed to claim a larger chunk, allowing them to make and sell more TVs.

Inventory risk: Back when the financial crisis was in full swing and businesses had destocked as much as they could, we saw Caterpillar step in to provide financial support to its suppliers to ensure they had the resources needed to ramp up production again so that distributors could be restocked and the company positioned for growth. We are also seeing SCF solutions coming in such as consignment stock – inventories owned by one party in the supply chain but held by another – to transfer ownership to the party that is best placed to bear the financing cost. Hard tolling and contract farming arrangements, such as those used by Heineken and referred to in this column a couple of months ago, are supply chain finance tools that specifically address concerns about security of supply rather than cost-reduction.

Clearly many of these risks are related – delay, capacity, inventory and procurement risks, for example, are heavily intertwined. But supply chain finance is a common tool to addressing a wide range of these supply chain risks. It ticks all the boxes by providing financial support, building supplier loyalty, reducing physical supply chain risk and the cost volatility that goes with it. It’s so much more than just a working capital tool.