Will the transparency of payment practices lead to a change in corporate behaviour?

Would the behaviours of big business change if they were forced to report on how they paid their suppliers? Well we don’t have very long to find out as in 2016 new regulation comes into force which will require all quoted companies and LLP’s to do exactly that.

Over the last year there have been a number of high profile cases where big business has been accused of taking up the role of classroom bully. Mondelez has been taken to task, as well as Mars, Kellogg, Heinz, InBev and Tesco amongst others and their favourite practices does seem to be the extending of payment terms. Pre-crash 2008 there doesn’t seem to have been too much reporting on the subject and it would appear that while pushing out terms was initially used to ensure continued existence during that rocky period it has since turned into a valuable cash cow at a time of limited growth and diminishing profits. There is also a push to follow the pack, driven by the demands of shareholders and analysts. These businesses are vastly competitive and cannot afford to allow rivals to steal a march; especially one as tangible as this when pushing out terms can offer potentially tens or hundreds of millions of pounds to an organisations cash flow.

I am pretty sure that part of the reason organisations are able to do this is that they are mainly geared up adapt and react to the demands of their consumer. As it stands there is little information that is presented to the consumer that allows them to make an informed choice about whether they buy based on a firm’s payment processes, and as such not much that stops them in following this route.

I can however see this becoming more and more of a customer issue. We have already seen over the last year in the UK that Starbucks has been forced to change tact on corporation tax, based largely on the backlash from consumers. No one would have wanted press like that.

Customers put a large amount of faith in the organisations they choose to buy from and expect a degree of business integrity, ethical and social standards that they may not have considered 10 or 15 years ago. When a company is not deemed to have hit these standards in the eyes of the customer they don’t react well (recent examples such as “horse gate” spring to mind) and given the rise of social media and the transparency of information what may have been one person’s gripe in years gone by may now be a topic of interest to the masses.

This legislation change may well push the payment processes of organisations into the sphere of interest of the consumer. New information will be readily available to an attentive press corps to whom it should be no trouble to report on industry comparisons and the best / worst practices of big business. It is easy to see how one well-placed article might spark curiosity in the subject.

So will behaviours change? Well I have discussed before how focus on such a singular element of the working capital equation as payment terms is probably not effective in the short or long term and hopefully businesses start to agree. I would like to think that this legislation will act as an impetus to change as firms begin to see the negative PR risk from simply extending terms.

Procurement can take a lead in this area, helping to improve overall working capital through a collaborative supplier management approach. Business relationships need not be so one sided and the negative risks associated with them being so will come back to bite in this new world of transparency.

A holistic approach to working capital - Why increased payment terms don't always result in a benefit

We have seen many articles and news stories over the past few months regarding the ethical positions of organisations and their procurement teams. I would like to specifically focus on what I have seen happen in the past when firms decide to focus heavily on implementing quick win payment term extensions which, of the 3 elements of working capital (payables, receivables and stock management) the easiest element to focus.

Payment terms negotiated and agreed as part of any supplier contract have a direct impact on the organization’s cost of working capital, the lifeblood of any business.

For Procurement however payment terms can be a double edged sword. Extended payment terms may help lower the cost of working capital but they don’t always support healthy supplier relationships or indeed their finances. Further this easy approach doesn’t make sense as, looking at this holistically, it costs a fortune, especially in our post 2008 world.

With interest rates so low even exceptionally cash rich organisations achieve little more than 1% on their cash holding and extending payment terms for a further 30 days will see them gain minimally (less than 0.01%). The supplier on the other hand may have to pay a 3%+ factoring cost to cover that extra period with additional costs for early payment. Although firms implementing these changes may not see it as such the reality is that these additional costs will not only be passed downstream but back upstream as well.

In many instances procurement departments don’t even consider working capital, and there are benefits to be had from tying the two areas together. Extending payment terms isn’t necessarily the right answer though.

Procurement should look more generally at their supply chain to understand the potential benefits of supply chain finance. By understanding the working capital requirements of suppliers, significant sourcing cost can be generated by imaginative use of discounts in return for early payment. Supply chain techniques like dynamic discounting should be developed and managed by Procurement who should take the lead in identifying and prioritizing suppliers.

It may also be true that a slightly more managed approach, such as supplier discounting, provides an important fail safe mechanism for a supplier during turbulent times and for the buyer, it helps to mitigate the risk of the supplier failing.

So in a nutshell, firms should take a broader view of procurement costs and consider the wider implications of payment term changes in the supply chain. There may be further hidden opportunity costs of not using supply chain finance that simply focusing on extending payment terms can blind you to.

All of this does involve a pretty joined up approach between Procurement, Finance and the Treasury team. Clearly there is a downside to “days payable outstanding” (DPO) for early payment and in a siloed world that’s all that Finance may focus on.

Of course all I have really done here is focus on one element of working capital, namely the payment process, but there may be wider benefit in procurement considering their impact on working capital more generally as well (stock management etc.). For example a buyer, incentivised solely on achieving a favourable unit price, may negotiate a rate at 50% below the market price but if the company ends up with 10 years stock the deal may not necessarily be of overall value to the business.

Working capital provides the financial foundation to any commercial business and has traditionally been seen as being within the realm of a firm’s finance function. A joined up approach with Procurement however may help organisations to develop a more rounded view on the subject. Such an approach may help firms uncover further benefits and, again linking to the recent headlines, avoid such ethical quandaries.