Supply Chain Finance is coming! Supply Chain Finance is coming! Supply Chain Finance is coming! Many observers, including me, have been saying this for 7 years, so it is hard not to feel like Chicken Little. But I think SCF may finally be happening–at some point soon. (Note: I’m still hedging.)
Why has it taken so long for SCF to catch on?
- SCF is easier (and safer) to do when the entire P2P process is electronic. Unfortunately, we all know how long that has taken to start to be true– more than a decade. We could ask the same question about B2B electronic payments. Why have they taken so long to catch on in the US? Why has E-invoicing taken so long? The list of B2B processes that have been slow to catch on is substantial. In the spirit of the Passover holiday, why should SCF be any different from all other B2B processes? (Apologies to the gentile readers.)
- The opportunities for SCF to be a win-win for all parties are greatest when the cost of capital differential between buyers and their suppliers are greatest. However, for most of the past 7 years, one of two odd conditions have persisted: either there was a historically low differential between buyer and supplier credit ratings (e.g., AAA-rated buyers and BBB-rated suppliers) as was the case before the 2008 meltdown, or credit was completely unavailable to low-rated suppliers, as was the case after the meltdown. It would be an understatement to say the last 7 years have been abnormal in the financial sector, credit markets, and in the evaluation of risk.
- For SCF to really take hold, the market for receivables/payables needs to be standardized, securitized, rated, etc.–just like the mortgage market has been along with other debt obligations. Imagine how eager the financial markets were in 2009 and 2010 to hear that we had come up with another financial market we could make like the mortgage market! No one wanted to hear about slicing and dicing securities, rating them, putting them into tranches and creating another market that could create another disaster for investors.
- Banks have not been aggressive with their lending to small businesses since 2008 and they will never be good at the technology and supplier enablement part of the SCF process. Likewise, especially in the economic environment of 2008-2010, no one trusted the small start-ups that were trying to apply the technology and supplier enablement required for the SCF market to develop. So neither end of the competitive spectrum in the market held an especially strong hand.
- Finally, one could argue that SCF has been making inroads through the likes of many small start-ups (e.g., Prime Revenue, Orbian, Demica, Taulia, Pollenware, etc.) who may not have exactly thrived, but did survive during all of this turmoil. In addition, growing SCF practices at Citi, Deutsche Bank, JPMC, Standard Charter, and several other banks would suggest that SCF has been “taking off”. SCF in the logistics space through PowerTrack and CASS has been expanding nicely as well. (In fact, one could argue that p-cards are the original form of supply chain finance and they have grown to cover $200 billion in spend since their advent in the 90s!). Maybe we just do not know how to define success?
In any case, the time for SCF may be now, or in the near future, as many of the above conditions are abating:
- Some day interest rates and costs of capital will normalize, won’t they? 😉
- E-invoicing really has taken off and the P2P processes really are being automated, so the underlying docs are finally being made electronic.
- The small SCF suppliers have survived and seem to be gaining momentum. They are also gaining credibility (e.g., the NYSE and The Receivables Exchange).
- As mentioned above, several banks have stayed in the space and had some success.
- Big and machine readable data is enabling the ability to make granular, real-time lending decisions economically, even automatically.
- The consumer and small business space for alternative payment methods and credit sources is starting to grow and pave the way. (Ever heard of Capital Access Network, Kabbage and OnDeck Capital?) These companies may influence the B2B space from the small business space up.
It’s hard to know when SCF will really take hold, but SCF’s day is coming–it seems inevitable. I worked in finance for only a very short period of time (though a summer in investment banking is the hourly equivalent of a year in most jobs), but I learned that the capital markets are highly innovative and that capital is like water: it will flow directly to a space that has gaps created by inefficiencies, risk-averaging, or bundling of dissimilar assets, etc. Right now, traditional factoring, letters of credit, and conventional working capital loans involve too many of these compromises. These risks can be better segmented, better evaluated, and better priced, so eventually they will be. This happened in credit cards, mortgages, and many other securities–it will happen in the receivables/payables market as well. Having an electronic history of the P2P transactions between two parties, will allow better risk evaluation, better pricing, less fraud, and better granularity. Mix in financial ingenuity, when everyone is not freaked out any more, and the capital will flow.
Supply Chain Finance is coming.