The global crisis in Covid-19 could fuel the acceleration of purchasing order financing, as companies urgently need money to bring their supply chains back to life.
As some lockdown measures across Europe are cautiously eased, many businesses will be eager to restart their broken supply chains and revive their broken supply chains.
But to almost restart – which is the case for those who suddenly had to close factories, warehouses and brick-and-mortar stores in March – will collect a huge amount of liquidity or cash.
Many companies, particularly smaller companies, have been pushed to the limit, causing job losses, sitting on expensive but potentially unsaleable out-of-season inventory, and relying on government support to maintain the workforce. With a prolonged recession looming, manufacturers will wonder how they will meet their immediate working capital needs to cover overheads and pay for commodities before they start paying for their goods and services to receive from their major customers – which could still be months away.
Fintech product opportunities
However, in this time of crisis, I see an opportunity – an opportunity to develop not only our industry, but also a possible way to relieve the pressure on small businesses.
It is an opportunity for us as an industry to further implement ‘upstream’ supply chain finance products. We’ve been talking about it for a while at numerous conferences and roundtables, and yet the concept of “purchase order financing” – providing liquidity at the point of approved order rather than in the approved invoice phase – has not yet gained significant traction.
Today I see the conversation around purchase order financing product starting to heat up particularly among fintechs and other industry experts.
There’s also an opportunity for big buyers to improve the way they look for their supplier network, especially those that give them a long history. ‘Sustainability’ in supply chains has become a buzzword in our world lately, but now buyers can start investing in it and providing liquidity when needed.
Just as the global financial crisis of 2008 was a catalyst for the wider introduction of reverse factoring solutions due to a sudden urgent need for new sources of liquidity, this could be the possibility of increasing funding of purchase orders.
“I see similarities today to the financial crisis more than a decade ago, when banks collapsed and the cost of financing – especially for smaller companies – rose exorbitantly. Just as there is now, suppliers urgently need money and large companies want to minimize disruption of supply chains.”
Back in 2008-09, U.S. supermarket chain Walmart stepped in to support their suppliers with the use of reverse factoring solutions, after a large bank that provided factoring facilities to its smaller suppliers collapsed. This is just one example of how the 2008 crisis encouraged large buyers to think about how to ensure the security of their supply chain in times of crisis.
Today, similar scenarios could arise. Consider, for example, the textile industry where large retailers no longer placed orders earlier this year and factories had to close. To get this industry going again, those smaller suppliers need immediate cash injections so they can purchase the necessary materials and pay their employees to fulfill new orders.
Companies like Zara or H&M and other major retailers can use forms of purchase order financing products to restart their supply chains and keep their suppliers in business.
There are already signs of an increase in demand for typical reverse factoring around the world, with reports from more vendors looking to participate in SCF programs.
Coupled with advances in technology, the Covid-19 pandemic could also be the catalyst that will take supply chain financing techniques to the next level.
Challenges to fintech product adoption
Of course, there are numerous hurdles that can delay the absorption of the purchase order financing.
Purchase order financing entails many performance risks – the ability of the producer to meet the requirements of the order. Banks are notoriously reluctant to take on this risk, as it lies with the often poorly rated smaller supplier.
Banks tend to prefer credit risk, and in the case of the more commonly used reverse factoring solutions, that risk usually lies with the larger highly rated buyer.
To ensure banks are comfortable with the risks of purchase order financing, the buyer may need to agree to an irrevocable commitment to pay the supplier. Still, the buyer may be reluctant to do so, as this may need to be recorded as debt on their balance sheet, depending on the way the transactions are structured.
While banks seem to be in more of a “wait and see” mode when it comes to developing purchase order products, it’s the fintechs that I see pushing forward.
Tech companies will play a crucial role in encouraging banks and other funding parties to have a greater degree of comfort in taking the risk of perioperative financing. Their ability to analyze large amounts of data on supplier performance will be essential to calculate how likely it is that a supplier will execute an order.
The better the quality data and analytics are, the easier it will be to assess performance risks and whether it is worth funding.
Developments in artificial technology can help with this, as fintechs need to process large datasets collected from different trigger points in a supply chain, including the historical performance of suppliers, the quality of the products produced and the time it takes to deliver. In other supply chains, AI may not be necessary if the right quality controls are completed at the right time.
If the data is reliable enough, you can also see insurance companies intervene to cover the performance risk aspect of the transaction so that the finance parties can focus on credit risks. You could segment risks and offload the risk to the party that is comfortable with taking it.
The other challenge will be to make purchase order financing a scalable product. It is currently difficult to convert a purchase order into pure ‘IOU’, as is the case with invoice financing or reverse factoring. A purchase order is not a financial instrument unlike a confirmed invoice.
This means that you may need a different legal structure for each purchase order financing arrangement with a customer, preventing the product from becoming a more “commoditised” solution that fits into each supply chain.
Will it end up being a “mini” structured finance project with each transaction? It will take some time to figure out a more scalable structure.
Despite the challenges ahead, I see the momentum picking up, and as in 2008, it may again be adverse economic conditions that are fueling the necessary growth and innovation within the financial sector of the supply chain.