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Chain reactions
From bottlenecks to the bullwhip effect, manufacturers around the world are struggling with supply chain challenges while ensuring that their practices are as sustainable as possible. Here, we examine the role banks can play in smoothing the process.
What do cream cheese, carbon dioxide, Christmas trees, Champagne, computer chips and chlorine have in common? All of them remain scarce owing to COVID-related supply issues. The ongoing war in Ukraine has since intensified the highly publicised shortages that the world is currently experiencing, with the recent Nova Kakhovka dam disaster impacting production even further.
In December last year, six in 10 businesses were facing supply chain difficulties. Goods worth a total value of £23.6bn were awaiting completion in UK manufacturers’ warehouses as key parts, ingredients and materials were delayed due to supply chain issues. Almost £10bn worth of steel and metals products, £3bn of food and drink, £2.6bn of plastic goods and £2bn of electronics were unfinished because of supply logjams.
Dr Florian Lücker, Senior Lecturer in Supply Chain Management, Bayes Business School, says: “Supply chains have been disrupted across different industries, across different markets and across different products, and the reasons behind these disruptions are quite diverse. We had lockdown, which resulted in an oversupply of goods. We also had the bullwhip effect, which is when small variations on the customer side cause significant variations closer to the factories. For example, if there’s a small decline in demand, the factories might assume that there is less need to produce these goods. But then they might exacerbate this by producing significantly less. Then demand goes up, so they think there is significantly more demand than there is, and they will produce more. And so it continues.
“This phenomenon has been studied in economic literature. It is a confirmed practice and we know it happened during the pandemic,” Lücker continues. “The problem is that many of these supply chains are designed to operate very cost efficiently. Take for example Just in Time. This is a management philosophy that refers to the production of goods to precisely meet customer demand in terms of time, quality and quantity. But if there are variations, this can jeopardise these supply chains. And we have seen this happen globally.”
Persistent bottlenecks
Mike Conroy, Director, Commercial Finance Team, UK Finance, explains the impact that supply chain issues have had on the economy. “The reopening of the economy after the pandemic gave a boost to demand at a time when supply chain issues were still needing to be resolved, and that of course resulted in a number of persistent bottlenecks. This led to firms reacting by building up inventories, which has contributed quite considerably to the inflation we’ve experienced during the past three years.
“And while I’m hearing of some signs of improvement, we’re still seeing issues. If we look at industries such as vehicle manufacturing, we still see some quite long lead times when it comes to supply of new cars, and this has driven up the price of used vehicles. And even broadly, businesses and supply chains are still having to navigate a number of challenges presented by a range of factors, which is leading to further disruption.”
“We still see real challenges where businesses end up with some very lengthy payment periods – certainly more than 60 days. And this places a lot of pressure on small firms.” Mike Conroy, Director, Commercial Finance Team, UK Finance
Conroy breaks these factors down. “Obviously, there is the war in Ukraine. Then we have economic fluctuations, which can be really challenging for businesses operating in the supply chain. There are also, of course, issues surrounding climate change. This is causing more frequent severe weather events – and that results in disruption to supply chains due to damaged infrastructure, transportation issues and resource scarcity. So, if we have failure of certain crops, for example, that plays into the scarcity of resource and makes it difficult for, say, supermarkets to supply the right sort of goods. And, of course, finally we have evolving regulations, which are, increasingly, impacting supply chains. As I said, there are signs of improvement, but there are also still a number of issues that are continuing to present challenges today.”
Driving trade relations
Conroy turns his attention to the role that banks can play in smoothing out the supply chain process and driving trade relations. “Trade and business finance has been around now for well over a century. Its purpose is to help businesses mitigate the risks and smooth out the cash flow in their trading environment.”
There are, he explains, a number of solutions to help reduce those risks. “We’ve got invoice financing or invoice factoring. That’s been around since the mid-19th century, but has seen significant growth over the last decade or so. It’s used in situations where someone’s made a sale but they’re selling on perhaps 30-, 60- or 90-day terms. It enables the invoice to be effectively discounted, meaning the financier will provide less than face value for the invoice. It’s a helpful product for those that sell business to business.
“Another product, which has been around for about 25 years, is supply chain finance [SCF]. This is sometimes known as reverse factoring and it’s a solution that is designed to benefit both suppliers and buyers – with suppliers getting paid early and buyers extending payment terms.
“Buyers of goods can make this product available to their suppliers, and again it’s a financing arrangement that can help smooth out some of these cash flow difficulties. But it also helps businesses tackle some of the more strategic challenges within their supply chains, such as streamlining processes or investing in systems.
It’s fair to say that some of the systems that are managing supply chains today are quite old and haven’t really been a focus of investment for many years. But there are opportunities through the banking sector to help people upscale and invest in systems and processes.”
Curing the late payment headache
A long-established difficulty within the SME end of the supply chain market is late payment. In fact, in 2022, more than half of small businesses encountered this problem. Conroy says: “Although governments and other bodies have made considerable efforts to tackle this issue, we still see real challenges where businesses end up with some very lengthy payment periods – certainly more than 60 days. And this places a lot of pressure on small firms.
“There was some recent Federation of Small Businesses research that indicated that nearly 20% of their members are paid more than 60 days after providing an invoice. And you can envisage the challenges that this presents for small businesses when they’re trying to look at cash flow forecast.
“For SMEs, cash is king and they offer 30-day terms and are anticipating getting the money in on time. But if somebody takes twice as long to pay them, that gives them problems with paying their own suppliers and managing an overdraft that they might have.
“It’s a real headache and it’s something that governments have sought to tackle. They’ve introduced interest that becomes payable if invoices are paid late. But what you find in practice is that most, if not all, small businesses never claim it because first, they have to be able to calculate it, then they have to submit yet another invoice to a major supplier – but they are fearful of damaging that relationship.”
This is why, according to the Chartered Institute of Procurement & Supply (CIPS), the number of suppliers taking monthly early payments using SCF services has doubled since 2018. CIPS’ report, which surveyed almost 80,000 companies, found that such technologies have meant “suppliers are becoming more empowered when it comes to early payments”.
Lücker continues to explain the extent to which SCF can support smaller businesses. “It’s a tool that is especially helpful in the scenario where there is a large buyer that has an SME as a supplier. Typically, SMEs struggle to find money. The buyer might be a AAA-rated company like Jaguar Land Rover [JLR], and they pay their suppliers after, say, 30 or 60 days. The supplier needs to find this money in order to provide to JLR, which won’t be easy for them. This results in a mismatch for smaller SMEs, meaning that they benefit from solutions such as reverse factoring.
“That’s where it has the biggest impact. If, on the other hand, the scenario involves two large companies, then reverse factoring doesn’t really add value because both companies can raise money on a capital market.
“Say we have Marks and Spencer as a retailer and Nestlé as a supplier – both of them have easy access to capital, so reverse factoring doesn’t work. But it does work if Marks and Spencer has a small cheese manufacturer as a customer, or maybe even a supplier from a country where they have less access to banking solutions.”
Helping SMEs to navigate ESG
Another difficulty that SMEs are encountering within their supply chains is ensuring that they are as ESG-friendly as possible. Conroy says: “It’s a real challenge – particularly for very small and micro businesses. A number of them are going to be unfamiliar with this whole agenda, as well as unfamiliar with the requirements of their larger suppliers and lenders. It’s not that they aren’t wishing to engage, but that they need help navigating the landscape.”
He uses electric vehicles as an example. “At the moment, they’re obviously a lot more expensive than those operating on petrol or diesel. So, if a small business invests in that technology, it does great things for their carbon footprint, but it might make their expenses and costs considerably higher than those of their competitors. And this means they have to charge more for their goods and services.
“They may find that the requirements and measurements of one particular supplier are different to many others – especially because we currently have different forms of measurement and different carbon calculators. It will be very challenging for some SMEs to think about managing this right across the board. And it’s a challenging investment decision to make because they could invest in today’s green technology but find it’s obsolete in two or three years’ time. So, do they go with battery-operated vehicles today or do they read the headlines and think, actually, the future might be in hydrogen?”
He explains that relatively few very small businesses have heard of or would be able to access products such as green or sustainable bonds. “There are a growing number of financial products that look to provide some reward for businesses that are consciously looking to reduce their carbon footprint. But in terms of the journey to net zero, it’s quite difficult for many small businesses that are not living and breathing this all the time to really understand what their options are and how they should go about planning for change.
“It’s hard to keep abreast of the situation, but I think that’s why the industry is trying to, as best it can, hold the hands of those customers that are impacted and help them navigate the landscape.”
NATURE-BASED FINANCE AND ESG CONSIDERATIONS
Bearing in mind ESG considerations and the fact that initiatives can seem inaccessible to smaller firms, what are governments doing to make supply chains greener? Nature-based solutions refer to actions and policies that use natures resources to protect and restore ecosystems while helping resolve societys challenges. It’s an approach to agriculture, forestry and land management that treats nature as a planetary life-support system, preserving woodlands, peat and grasslands, aquatic systems and working lands used to grow crops or rear livestock.
Nature-based solutions aim to reduce greenhouse gas emissions, promote healthy ecosystems and reduce the likelihood of flooding, soil erosion, drought and other extremes of the climate crisis. Plans to accelerate investment in nature were set out by the UK government in March this year as part of its drive to net zero by 2050.
The Green Finance Strategy sets out how the government will encourage green finance for nature-based solutions such as tree planting and peatland restoration and support farmers to access new private sector revenue streams while protecting the natural environment.
The government has set a target to raise at least £500m in private finance to support natures recovery every year by 2027 in England, rising to more than £1bn per year by 2030. This will support greater biodiversity and contribute to achieving the Strategys Environment Targets. Undoubtedly, FIs will have a role to play in providing green finance solutions to businesses, and ultimately, keep supply chains moving.
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