The Financial Supply Chain

September 7, 2006 by SwizStick  
Filed under 3PL, Education, Supply Chain Management

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My entire career, so far, has been working in logistics services that involve the physical supply chain. My experience with the financial side of things has been limited only to managerial finance involved with the running of the company I happened to be working for, so I must admit I had never given thought to the concept of the “Financial Supply Chain” until I read this article from World Trade Magazine:

In the past, the manufacturing and, subsequently, the warehousing of goods usually took place in a company’s home “country” say, the United States. With the goods made and warehoused locally, an asset-based borrower could borrow money from U.S. banks, using the inventory as collateral (advantageous from a cash flow perspective).

But now, in a global economy, with goods made and warehoused all over the world, the elongated supply chain makes it more difficult to fund working capital. For starters, U.S. banks are cautious about lending against foreign-domiciled inventory because visibility into the “ownership” and disposition of the goods becomes blurry, as many countries don’t yet have fully defined loan security laws along these lines.

Also, trading partners have historically relied on document-intensive letters of credit to facilitate global trade transactions. At the start of a relationship, letters of credit are great because they minimize risk for all but LCs are also, time- and labor-intensive and tie up critical working capital by reducing availability under borrowing base formulas.

Unfortunately, in this situation, the trading partners continue to navigate two separate and distinct supply chains: the physical supply chain, which handles all of the logistical duties, and the financial supply chain, which handles the transaction of money for the goods. As a result overall costs are greater in both segments.

The author makes the argument that “marrying” the physical supply chain with the financial supply chain will save money and increase efficiency. He suggests that financial services firms first need supply chain visibility:

Unfortunately, supply chain visibility in today’s world is confined primarily to shipment tracking”knowing where large orders of goods are while in transit. But, this is not the same type of visibility that financial institutions require when extending a line of credit against inventory or deciding when to make payments to sellers on behalf of buyers. In order to mitigate risk, the bank needs to know the whereabouts and integrity of individual units rather than simply where large shipments are in transport.

As a result, there is a need for logistics providers and financial services firms to join together to develop precise visibility tools that provide CFOs and global supply chain managers with the shipment data they need and banks with the collateral security information they require. Then, once a robust information-based system is established, trading partners, logistics companies, and banks need to be able to access the information quickly and efficiently.

He then continues that banks and logistics companies should partner with each other:

In such a partnership, the logistics company would provide the bank with two key elements: the warehousing and transportation of the goods and the visibility into the movement of those goods. This increased visibility into the physical supply chain would allow banks to extend credit to the trading partners, often eliminating the need for letters of credit. The creation of such alternative supply chain financing instruments through the marriage of the physical and financial supply chain processes would inject additional and more cost-effective liquidity into the system, increasing the buyer’s access to working capital and reducing the supplier’s reliance on letters of credit as a local financing tool.

I am no international finance expert and strongly encourage those with strong finance backgrounds and expertise to comment on this article, but I would agree with the author’s premise that logistics companies and banks should cooperate closely with each other as company’s supply chains grow increasingly global and complex.

However, while I am in full agreement of cooperation, I am not sure yet about the prospect of physically partnering logistics companies and banks together. The author is also clear that he believes a true marriage of the financial supply chain to the physical one would involve logistics companies launching banks or banks launching logistics companies. While I must admit skepticism on my part, that’s not to say it will never happen or never work. Automobile manufacturers have set up their own financial services companies to handle loans and leases. Wal-Mart wants to start its own bank to process debit and credit card transactions. It should also be noted that the author of this article is the President of UPS Capital, a financial services division of UPS that offers customers – guess what? – very similar services to those of a commercial bank: small business loans, commercial finance, credit card services, and merchant services together with traditional international trade financial services.

This brings up an interesting question: in an effort to provide an ever widening range of services to their customers, is it possible for logistics companies to go too far, i.e. try to do too much? By appealing to as wide a customer base as possible, is it possible that logistics companies risk a “watering down” of their overall service? Or opening up their company to possible financial risk by investing in untested or unknown waters? I am just throwing these questions out there for general thought and discussion. I don’t have the answers to these questions nor is it my intention to insinuate a particular position. I just think these are valid questions to be asking as logistics companies continue to diversify the kinds of services they offer.

One thing I am certain of is that smaller logistics firms need not worry if their services portfolio is not as expansive as larger competitors. There is plenty of room for the large global 3PL who can offer a wide range of services to Fortune-500 type clients and plenty of room for the smaller provider who offers a level of specialized service that the larger players can not match. And before any size firm gets an itch to get into the financial services side of business, they should take a very close look at their core competencies and decide if such a move will fit. As always, a realistic analysis should be conducted to weigh the risks vs rewards and resources needed before endeavoring on any new venture or service.

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