Supply chains make it into the headlines when there are consumer shortages – when the shelves are bare in the supermarkets. When supply chains are functioning well the mainstream media ignore them. When things go wrong the media point to high consumer demand overstretching supply chains. Alternatively experts blame shortages in materials for driving up prices. This post will take a deeper dive into ideas relating to supply chains and how they relate to supply chain finance.
What is a Supply Chain?
A supply chain is a group of companies involved in the process of accessing raw materials and turning them into products that are sold to the end consumer. It involves complex logistics. The more complicated the final consumer product, generally speaking, the more stages there are in the supply chain. For example, sourcing all the raw materials and components to make a laptop computer would involve a more complex supply chain then it would for making pencils.
In supply chain theory companies are classified in tiers. First tier suppliers are at the end of the chain. They supply the finished product to a retailer or wholesaler. Second tier suppliers provide parts, components, materials etc. to first tier suppliers. Third tier suppliers sell materials to second tier suppliers and so on.
Another key distinction that is made in supply chain theory is the difference between production and distribution stages. In the production stage components and semi-finished parts are made in factories. These parts are then put together in an assembly plant. This is particularly true of car manufacture. All the parts are made elsewhere and collected at assembly plants to be finally made into cars. The other part of the supply chain is the distribution stage. This part involves logistical companies that take the finished products to distribution centres throughout a country. These distribution centres are responsible for delivering the finished products to the end consumer.
Not a Chain but a Network
Academics and business analysts alike have made the observation that the linear ‘chain’ model for describing this process is inaccurate. The process of sourcing raw materials and components and making finished consumer products involves a network of companies. You will commonly find tier 3 and 4 suppliers selling to a variety of other companies in a network. The network narrows as a product reaches completion and then expands again in the distribution phase. The following diagram from Wikipedia captures a possible ‘supply network’ for making laptops.
Different Types of Supply Networks
Economists have identified two types of supply networks: loosely coupled and tightly coupled. Loosely coupled refers to a collection of businesses that don’t have strong relationships with each other. Each seeks profits by participating in the production process. The advantage of loosely coupled businesses in a supply network is that there is greater flexibility. There aren’t any commitments between businesses so production can easily be altered to suit market conditions. Poor performers are also easily replaced.
In tightly coupled supply networks all the players know each other and work closely together in production. The strength of this arrangement is that the network can be better managed to reduce the build up of inventory and the opposite – namely, a stockout where there are shortages of the finished product. In terms of supply chain finance tightly coupled businesses have stronger relationships and are less likely to delay or default on payments to each other.
Early and Later Stages
Another key distinction when looking at supply chains is between early and later stages in the production. The early stage consists of raw material processing and manufacturing. The break-even costs at this stage are calculated by determining production costs relative to market price. The later stage is the wholesale and retail businesses. The break-even point is determined by comparing transaction costs relative to market price.
All stages in the supply chain also incur financial costs. These are the costs for borrowing money to keep suitable levels of working capital until payments for services and goods are forthcoming. These are often factoring costs or asset-based lending costs.
Supply Chain Management
In the early 1980s the term ‘supply chain management’ entered business parlance. This term refers to all companies in any given supply chain exchanging information in order to maximise the overall efficiency of the supply chain. Companies share information about production capabilities, distribution capacity and market demand so that decisions are made in the interest of the entire supply chain rather than for certain localised areas of the chain. It is common for companies at the end of supply chains to offer web-based platforms to facilitate supply chain finance.
Companies within a supply chain are no longer in competition with each other in this set up. The competition shifts to supply chains vying with other supply chains for contracts and market share.
One of the goals of supply chain management is to fulfil customer demands through efficient use of resources that include distribution, inventory and labour. By doing so, supply is more accurately matched with demand to reduce inventory. Excess inventory incurs warehousing costs.
Supply chain management also seeks to remove bottlenecks in production, find cheaper materials or materials that can be sourced locally, co-ordinate just-in-time deliveries and implement other logistical optimization strategies.
The Advent of Computer Management
The 1990s saw the dawn of the computing age, with it eventually came cloud-based supply chain management systems that track all the aspects of a supply chain, share the information in real time and facilitate the optimization of the entire supply chain process. The blockchain revolution of 2008 further improved these systems by introducing the possibility of using a decentralised ledger that can record all the stages of the supply chain. The digging out of raw materials to the packaging of the finished product to the delivery to a shop can all be monitored. The ledger can be easily accessed. It is updated in real time and cannot be tampered with. See our article about VeChain for an example of how blockchain technology can improve supply chain management efficacy.
How Well is a Supply Chain Performing?
There is no one simple way to assess the efficiency and cost-effectiveness of a supply chain. 150 key metrics have been proposed by the Supply-Chain Operations Reference (SCOR), which is compiled by industry experts and the non-profit Supply Chain Council, to analyse the performance of a particular supply chain.
However, two points stand out. Firstly, cost benchmarking across a range of performance factors is clearly the best place to begin. The other point is made by Debra Hofman who identifies three crucial areas to focus on. They are accuracy of demand forecasting, quality of order fulfilment, and supply chain cost. In other words, the most efficient supply chains are very good at predicting demand, delivering correct and undamaged items on time, and getting value for money for sourcing, producing and distributing materials and goods.
Ethical Considerations
Ever since journalists and activists started uncovering unsavoury details about particular companies using child labour, forcing factory workers to work 12-hour days for a pittance, and farmers damaging eco-systems there has been a recognition by corporations and large businesses that supply chains need to be better audited. One front page scandal can damage a global brand. Consumers don’t want the guilt of their purchases having human and environmental costs. In light of this, the big companies financing supply chains are careful to employ experts to monitor ESG factors and to source suppliers that don’t exploit people and destroy environmental capital.
Agribusiness is particularly relevant to this topic. They have made huge strides in this direction. The trend is to directly source food products from smallholding farmers and trusted aggregators. This way they can pay farmers more for their products as several layers of middle-men are removed. They can also offer resources to make farming more sustainable and environmentally friendly.
Supply and Demand
Supply and demand are the twin gods of supply chains. If you can’t get the materials the supply network is disrupted. This could be because of a shortage of natural resources or components (see recently natural gas from Russia and microprocessors from Taiwan, 2022) or it could be disruption to transport routes (see the super tanker blocking the Suez Canal). Much of the 2023 global economic slowdown has been attributed to supply side shortages.
The other side of the coin is demand. Consumers are fickle. Regulations change. In 2001 Tony Blair’s government introduced tax breaks for diesel vehicles. This drove up demand for diesel engine cars in the UK.
However in 2015 government regulators did a U-turn. Scientists discovered that diesel vehicles were actually more polluting than petrol vehicles. This discovery resulted in higher taxes for diesel vehicles to nudge consumers away from purchasing diesel vehicles.
Another aspect of demand is product design. As globalisation starts to saturate world markets consumer demand has become key. And fundamental to consumer demand is product design. Making a product the most attractive in its sector pays dividends. Ask Apple. Once the product design has been finalised then the supply network can be put together with the needs of the product in mind.
Implications for Supply Chain Finance
The first thing to note is that if a supply chain is more aptly described as a supply network then this more sophisticated model needs to be understood by invoice financiers offering reverse factoring services. If the laptop company is offering reverse factoring to all its suppliers than there could arise the issue of contra trading. This is when companies buy and sell from each other. Often invoices are not fully paid, but rather the difference is paid between what the two companies owe each other. These types of invoices are normally subject to retentions – meaning namely that they don’t qualify for early payment by the factoring company.
If a supply network covers several countries and geographic areas, offering reverse factoring will involve bringing in local invoice financiers to facilitate payments. Finding trusted international partners to finance large and international supply chains becomes crucial.
There is also the issue of funders. Factoring companies rely on funders to provide the cash for their business. Funders will not authorise prepayments for reverse factoring if the risk of a payment default is high. In the case of the war in Ukraine (2022 – ) when insurance companies refused to insure super tankers carrying Russian oil for export the supply chain ground to a near halt (except for oil being piped to India and China). Funding factoring for very large invoices would be extremely risky without the correct credit insurance.
Finally, there are ESG factors. Just as major corporations don’t want to be exposed as damaging people and the planet so factoring companies are becoming increasingly keen to eschew dealing with such ethically unsavoury suppliers.
In Summary
Supply chains are a significant part of what people think of as globalisation. Supermarket shoppers can buy agribusiness products and manufactured products from all over the world. In 2020 supply chain management was worth $15.85 billion.
It is thus no surprise that business analysts and academics have focused on supply chains in order to improve them; to make them more resilient, more cost effective, more transparent, and more ethically responsible.
One of the key challenges for supply chain finance is ensuring prompt and regular payments for goods and services. Suppliers need working capital to maximise output. Logistical companies have large overheads. It is the job of factoring companies to provide prepayments on invoices to keep supply chains optimised. Typically, reverse factoring is preferred since the company at the end of the supply chain will be able to secure better terms. In the case of tightly coupled supply chains the end company will often operate a digital platform for its suppliers to access early payments.
