Tempering the Supply Chain With Dynamic Discounting
In a long-term slack economy, finding new business efficiencies is difficult. Strategies for tightening up the supply chain can go a long way. "Dynamic discounting is really a win-win," said Ariba's Drew Hofler. "There is value to both sides [of purchasing relationships], and it's not just one imposing their will on the other in order to make their company better at the expense of the other."
Recent trends are driving savvy companies to improve how they manage their supplier and buying processes using dynamic discounting.
Discount management and dynamic discounting can dramatically improve how enterprises procure by better managing the buying process, improving cash management, and gaining an analytic edge on constantly improving processes through cloud-enabled automation.
To learn more about how buyers and sellers can benefit from such improved business processes around cash management in the procurement phase we interviewed Drew Hofler, senior manager, working capital solution at Ariba. The discussion is moderated by Dana Gardner, principal analyst at Interarbor Solutions.
Listen to the podcast (33:33 minutes).
Here are some excerpts:
Dana Gardner: In a long-term slack economy, finding new business efficiencies is not really an option.
Drew Hofler: We've seen a lot of growth in this area, particularly over the last three or four years with another wave of economic bad news coming up now. In 2008, when the credit crisis first hit and supply chains became dramatically impacted, you had a lot of suppliers who found their access to credit severely curtailed. You had a lot of buyers who were using the opportunity to enhance their cash flow and their cash position by extending terms with suppliers.
So you had kind of a perfect storm of buying organizations pushing out payment terms and supplying organizations not able to fund those longer terms via traditional credit means, because those were being pulled away. So that created a real cash flow crisis within supply chains. ...
If you look at that in conjunction with suppliers still having their access to credit curtailed, it's not as bad as it was at the height of 2008, but it still is far from where it was pre-2008 in terms of their access to credit.
You have this situation where there is significant liquidity risk in the supply chain due to suppliers who are not in as good a cash position -- smaller and medium sized suppliers typically -- facing a downturn in orders, facing a downturn in the economy, and not having necessarily the cash buffer or access to credit to weather that.
On the other hand, you have buyers who have massive amounts of cash that are sitting in banks, where they are earning next to nothing. In fact, two days after the S&P downgrade, Ben Bernanke and the Fed stated that they'll probably keep rates down at around zero for the next two years, until mid-2013. ...
People are looking for everything to make their companies leaner and better and capture all the value that they possibly can.
Dynamic discounting is really a win-win. There is value to both sides [of purchasing relationships], and it's not just one imposing their will on the other in order to make their company better at the expense of the other. There are significant and tangible benefits to both sides when they do this.
I think that's why we've seen so many companies pick this up. We've had growth rates of 60 percent or so in our buyer customer base. Our customers, shortly after going live, have been seeing growth rates in their opportunity and discount capture with their suppliers of 60-80 percent month over month. Obviously that will stabilize at some point, but I think what that says is that huge growth curve, particularly in the first year or so of doing it, speaks to the fact that there is this latent opportunity out there.
We have customers and some of them will average around 24 percent annualized return on their cash. Others will average less. It depends on how they want to approach their supply base. Many buyers will take the opportunity, when there's an opportunity to earn very significant returns on their cash of 36 percent or more from a certain part of their supply base. Typically, the longer tail, the smaller suppliers, will take advantage of that.
But others, especially more recently, are realizing that they can take a nuanced approach to this and look at their entire supply chain and approach each segment differently.
So if you are a long tail of suppliers that otherwise would take P-Card or do things like that, you can get a large amount of return on your cash. But on the other end of your supply chain, your goal as a buying organization with more strategic suppliers is not so much to wring all the value in terms of return on cash that you can out of them, but to make sure that they are there for you when you need them, to reduce the liquidity risk.
So a lot of buyers are taking the cash that they have, using this product, and offering the opportunity to their more strategic suppliers to gain access to the cash piles that the buying organization has, but at rates that are much lower, that are closer to what they might be able to get out in the marketplace from a bank.
Those are more around 6 percent, 4 percent annualized, but still much better than the buying organization gets on their cash sitting in a money market account earning less than a quarter of a percent, or close to zero right now. But they do it in such a way that does not add a burden to their supplier.
I'm seeing buying organizations take a blended, more nuanced approach to using this. The great thing about the tools online is that they have full flexibility to do that, to group their suppliers how they wish, to offer different rates to different suppliers, to control the amount of cash that they make available, and they are really starting to take advantage of that.
When you talk about dynamic discounting, what we like to say is that it enables collaborative cash flow, and that collaboration is really what the cloud, social networking, business social networking, is really all about. It's about communicating, communicating need and collaborating over solutions.
What I see coming down the line is that, as more and more network or cloud effect takes place, where suppliers who are on the Ariba Network, for example, have multiple buyers participating in this and so they are doing this across different buyers, it becomes more of a norm.
It becomes something that is a normal part of business. I think we're starting to see that normalized, because dynamic discounting is a very fairly young industry still in terms of overall business practices and processes. But we're starting to see it become more of a norm.
When you have that happening over the cloud, when you have that kind of collaboration of information going back and forth, you have more suppliers becoming normal, we'll see buyers learning and having access to aggregated data, trends, and behaviors that show them how to approach this, because they can see how it has worked across industries in the past, and then supplying organizations finding it much more normal.
I see it tying into the communication methods that are becoming so prevalent in social media and in the cloud, just basically to give suppliers access to the opportunity and open up the opportunity. We've seen such growth when buyers become active and make this available to suppliers, simply because it's tapping into the late need that suppliers didn't know they had a fix for, that they had a solution for, in terms of accessing this cash.
As that becomes more available and more known through the cloud, through the collaboration, the suppliers hear about it more, they realize they have the access. Just that ability for it to go viral is what's really going to happen more and more, as we go into the future and it kind of snowballs.
In the meantime, you have this big dichotomy, where you have buyers who have lots of cash earning basically nothing on it in the short-term, and their suppliers who don't have the access to that cash and have longer terms extended to them. When they do get credit, there are some pretty restrictive covenants with their banks and they're paying a little bit higher rate than they would otherwise. You have this significant liquidity risk.
All of that is to say that what we're seeing is that buying organizations are starting to realize that they can take advantage of the fact that they have all this cash and suppliers who have this need to essentially become the bank and put that cash to work.
They earn a greater return by paying suppliers early in exchange for a discount -- so they're earning a better return on their cash than it would have sitting in the bank -- but they also remove some risk from their supply chain by injecting liquidity into their supply chain, giving suppliers access to liquidity that they might not have otherwise in a way that, one, is not debt to their supplier, and two, improves their working capital position by lowering their days sales outstanding (DSO), when they get paid early on that receivable.
We are seeing all these things line up to create a perfect opportunity for both buyers and suppliers to collaborate over these cash flow needs that are being created by the economy right now.
Gardner: I suppose the solution then at the high level is fairly clear, but how to implement that becomes the issue. So many organizations have disparate ways of managing these issues, managing their procurement and supply chain, often manual processes still at work.
How do you allow for the suppliers to create an incentive for this improved discounting and improved cash flow for them, and how do they then manage and instantiate this and make it repeatable?
Hofler: It's a great point, because a lot of organizations in this realm of payment terms, agreements with suppliers, paying suppliers, approving invoices, and all of this type of thing, is still a very manual process in so many organizations.
I have looked at buying organization and analyzed their vendor files and at times found literally hundreds of different payment terms to their suppliers, where a best practice would be to have maybe five to 10 that are pretty standardized, unless there happens to be some great exception. People are just making terms with the folks that they know, buyers knowing the salesperson on the supplier side, and agreeing to specific terms that may have nothing to do with the corporate objectives or strategy.
In order to reap this opportunity and understand what's happening a company needs to get visibility into what's actually happening. That's where Ariba's cloud technology allows companies to pull this through the Ariba Network and gain visibility into what's going on and automate the process greatly.
Once they have that visibility, on the one hand, they realize they can get their terms and their payment under control. A lot of times, a company will have what's supposed to be a standard term, let's say 45 days, 60 days payment, but a supplier is being paid immediately. Somebody called in to the company and the supplier said, "I can't wait this long for my cash. Can you pay me early?" And the person on other end of the phone changed the payment to "immediate" in the ERP for the buyer.
That's a cash flow waste right there. You're paying immediately when a buying organization could be holding up their money for 45-60 days, or exchanging that immediate pay for some value in the form of a discount.
We're seeing that companies are getting control of that process through automating it, through sending POs through the Ariba Network to their suppliers, where it's centralized and visible to corporate as a whole, bringing invoices back in to accelerate the approval process, and also bringing it under some control and visibility as well.
That opens up the opportunity that we're talking about in terms of collaborating over cash flow, because what you have are these invoices coming in and being approved in a rapid manner, because they're coming in clean. The Ariba Network assures that invoices come in clean and they're being approved quickly. Now you have invoices that are approved say on the fifth day after receipt, but not due until day 60 after the invoice date. That time gap is where the collaboration can come in.