Combining Logistics with Financing for Enhanced Profitability

Authored by: Richard Palmieri;

Credit Suisse First Boston The traditional view of supply chain management is that real savings come from the substitution of information for inventory and the integrated management of both the physical product and information flows. However, the financial flow, perhaps even more than the physical and information flows, holds substantial promise for cost reduction. The hidden truth is that the costs to finance products moving through the supply chain, over 4% of GDP in 1998, approach the costs associated with transportation and distribution. The financial opportunity for the owners of supply chain information to share in the revenue streams associated with the financing of that product often far exceeds the cost reduction opportunities in transportation and distribution operations. INTRODUCTION
The goal of successful supply chain management is to minimize mass and time. To do this effectively, one must be able to measure the costs associated with not only the physical movement of the product and the associated information requirements, but also the costs associated with the inventory: financing, taking credit risks upon sale, supporting trade credit and the like. Because few companies have a clear idea of this "total" cost, they tend to target the more tangible elements of logistics costs, such as transportation and warehousing. As with every service, however, there is a point at which costs can no longer be reduced without affecting service quality. Many feel that if the transportation industry isn't there now, it's close. Meanwhile, while many conclude that the reduction in inventory carrying costs over the last several years from about 5.4% of GDP in 1990 to just over 4% last year is due to great strides in reducing inventory levels, the facts show that a marked reduction in interest rates over the same time frame has driven the majority of the benefit. In short, cost reducers, or logistics companies seeking new sources of revenue, need a new, more tangible target. When one considers the total dollar value of goods shipped through third party providers, the value created by reducing the financing cost by even a few basis points is far greater than any cost savings possible from traditional transportation and warehousing targets.

Current Situation
Three phenomena, none of which are likely to go away anytime soon, are driving this cost reduction opportunity. The first two, the failure of supply chain information owners to share and coordinate shipment status and product availability data with financiers, drives financing costs artificially higher; the third, the relentless pressure on suppliers in virtually every industry to accept longer and longer trade terms to enhance their customers' return on invested capital (ROIC) and return on assets (ROA) comes from Wall Street pressure: when managing ROA, if you can't up the "R," cut the "A". In short, own the inventory for the shortest time possible.

Lack of Information Sharing

Could owners of supply chain information, if that information were shared, influence the costs to finance inventory? Consider the components of an interest rate; In addition to the cost to fund, embedded in any financier's rate is the risk premium associated with credit and the costs to service, e.g. the costs to audit and inspect inventory. In effect, financiers seek out the same information that logistics providers require to provide service to their customers, and/or that customers gather directly, as financiers rely on asset tracking as a means to verify collateral levels and location to establish borrowing bases from which they extend credit. This alone provides a revenue opportunity in that real-time information on inventory levels and status has value to financiers because certainty

of asset location and control of physical movement and possession results in a reduction in risk that can be reflected in the cost of credit. Put another way, the risk premium and servicing cost components of the interest rate are artificially high because financiers gather supply chain information independently and far less accurately than logistics providers, increasing risk and cost, resulting in an artificially higher rate. In short, reliable supply chain information is credit-enhancing. Owners of this information have a great asset, but they fail to maximize its value.

Poor Coordination
At the same time, each supply chain participant typically arranges financing separately. Suppliers establish lines of credit with financial service providers to acquire equipment to produce their products, to provide financing to build inventory and to support the extension of trade credit. Manufacturers, distributors and value added re-sellers follow the same practice (see Figure1). In so doing, each participant typically utilizes different financial service providers, each with its own terms and conditions, pricing hurdles, risk parameters, credit capacity and industry/product knowledge. Objective coordination with information exchange and physical movement through the supply chain to support the financing of inventory as it passes from one participant to the next is rare. As a result, process duplication occurs between suppliers utilizing a variety of different finance and logistics providers. In short, supply chain partners rarely talk about financing as part of Figure 1. Current State their vendor negotiations, and as a result all pay more.

Elongated payment terms

Countless suppliers are in effect financing their customers, as "net 30" becomes net 60 or worse. Most supplier discounts e.g. 2% 10 days/net 30 are either not taken or abused. Again, the Fortune 1000's relentless focus on ROA is the culprit; in effect, suppliers who do not want to lose an important account pay the price. As a result, a gross inefficiency exists in most supply chains as higher cost of capital suppliers finance lower cost of capital manufacturers, assemblers, retailers or distributors. Almost regardless of industry computer PCs, automotive and retail to name a few the little guys are financing the big guys, creating a significant revenue opportunity for supply chain information owners to share their data on product movement and, working in conjunction with financiers, to manipulate the resulting arbitrage opportunity while earning a slice of the financing revenue in return.

CREDIT SUISSE FIRST BOSTON'S SOLUTION Partnerships

Progress to date in achieving the supply chain goals of suppliers, manufacturers and retailers has focused on forming closer relationships or "partnerships" with one another. In theory, by working more closely together, all parties should achieve their ultimate goal of exceeding customer expectations at a lower cost with more seamless delivery. The overuse of the term "partnerships" and mixed results to date notwithstanding, we believe that to achieve real value, these partnerships must not be confined to traditional supply chain participants, but extend to financial service providers. To realize value, we utilize the following well-structured approach one that demonstrates the fundamental improvement opportunities and is articulated to the CEO, CFO and senior logistics management.

Solution Model
CSFB's solution model is the creation of a structure whereby logistics providers jointly market their core products in conjunction with financial services designed to support customer solutions, or Figure 2. CSFB Model customers using third parties direct their provider(s) to offer these more comprehensive services to their vendor base. As a result, logistics vendors include financial and insurance services in conjunction with their core offering (see Figure 2). The objective is to establish service groups composed of finance and insurance companies that work in unison with supply chain participants to facilitate the movement of products while altering the current method of logistics and financing interaction to lower costs. As part of this equation, the use of asset securitization is key to further reduce the financing costs of product distribution. Note that this "single source solution model" is not the creation of a new product, but rather a re-alignment of existing processes to realize yet-untapped cost reduction opportunities.

Mechanics
In its most basic format, the logistics service provider and/or customer leverages its information capabilities and physical movement controls in a cooperative venture with the appropriate financial providers to capture excess charges between trading partners for financing and insurance. In most in-bound cases, this takes the form of accelerated payments for goods in-transit and the introduction of a Product Transit (insurance) Policy to cover insurable risk. In those situations where the supplier has a higher cost of capital than does the customer and the customer's actual payment practice has created extended payment situations (45 + days), the economics of accelerating payment can be substantial. Since the payments are made by a party unrelated to the customer, there is no increase in the customer's liabilities, while transaction costs are covered by the discount captured by accelerated payment of the suppliers' invoice. That is, we use the prompt payment discount often 2% or more to fund the program. To enhance the potential margin, the funding source needs to be more highly rated than is the customer and have the ability to tap the securitization markets. Revenue flows to the participants in the form of fees for sharing product status information and asset management services, including continued responsibility for accounts payable management. Note that this continued responsibility for accounts payable management allows the customer to maintain vendor contact while benefiting from the arbitrage opportunity with its suppliers. Meanwhile, the use of the Product Transit Policy consolidates the placement of insurance coverage, replacing the current process of independent and uncoordinated coverage placement. The net result is a lowering of costs to insure for all parties involved in the product's movement. Clearly, participant selection is key to program performance, as each customer's trading situation is unique and each financing/logistics solution is tailored to the specific requirements of the customer's trading practices.

Value Creation
When a supplier ships products to a customer utilizing a logistics provider offering this single source solution, the supplier is able to receive an immediate payment for the sale, subject to the terms and conditions under which it has sold its products, instead of having to book a receivable and fund it on the company's own balance sheet. Note that if the supplier wants to transfer ownership of the receivable or title to the goods, it will be able to do so. As a result, the supplier has a new source of financing geared to the credit quality of the customers it sells to rather than to its own balance sheet. As a result, larger credit exposures can be taken with customers than would otherwise be possible,

while financing costs generally fall because the interest rate is associated with the customer's credit rating, not the supplier's. At the same time, both the customer and the logistics provider share in a potentially significant revenue stream (or viewed another way, lower costs), while the logistics provider has a new, differentiated service vis-a-vis the competition with no balance sheet encumbrance. More generally, value creation arises from the coordinated utilization of existing processes inherent in logistics services and financing. The difference between what is charged currently under a poorly coordinated set of services versus the savings that can be generated by delivering these services in a revised format results in reduced costs. In addition to the cost savings, there is the opportunity for reduced recourse and off-balance sheet treatment that may accrue to the suppliers and manufacturers serviced under these programs.

EXAMPLES Computer PCs

Figure 3 depicts an inbound logistics program for a major computer assembler. The logistics provider, in this Figure 3. Example: Computers case, a major assetbased provider with the exclusive contract to support the assembler's plant, picks up from key vendors, delivering to the assembly center on a just-in-time basis. At any given time, $250 million in inventory value is outstanding, that is, delivered but not yet paid for (in financiers' terms, this $250 million represents the "average net investment"). The vendors, smaller than the computer assembler and less creditworthy, offer on average a 2.5% prompt payment incentive to the assembler, i.e. a "trade discount", but the assembler chooses to ignore it. This solution is fairly straightforward. The logistics competitor continues to control inbound product movement and provides product status information to the special purpose company (SPC) set up to make and receive payments. The invoice servicer supporting the SPC provides electronic payment to each supplier at point of control by the logistics competitor, less the 2.5% trade discount. The servicer also provides cash management and risk underwriting. Note that the SPC now "owns" the inventory, not the logistics provider. Meanwhile, the computer assembler pays the full value of each invoice to the SPC under its normal payment practice. This program generates $3.3 million in free cash flow per year. What is the key to success here? We use the trade discount and a bona fide receivable from an investment grade credit (the computer assembler) to cover the costs to fund, service, risk underwrite and insure. The free cash flow is split among CSFB, the logistics provider and the computer assembler.

Generalizations

Figure 4. Prioritizing Opportunities We are often asked to generalize the set of circumstances that make for the best opportunities. While such generalizations are difficult because

each customer situation/solution is customized, we can make a few summary statements (see Figure 4). First and most simply, higher value products offer larger cost improvement opportunities because there is more to finance for any given volume of product and level of inventory turns. Likewise, faster turn products generally mean more potential for cost improvement for any given product value and trade terms. Next, trade terms that are offered but not taken e.g. "2% 10 days/net 30" accompanied by an elongated or abused payment cycle make for extremely low hanging fruit. These opportunities are especially lucrative when the supplier has a higher cost of capital than the customer to whom it ships. Sound familiar?

CONCLUSION
We believe that the proper definition of logistics embraces three flows: physical movement, information and financial; any solution that addresses only information and physical movement is not a complete solution, only a transitional one. The service providers that can articulate this new definition to customer decision makers and deliver a single source solution or customers progressive enough to direct their logistics providers to offer an integrated service will add significant economic value to their customers' businesses and enhanced revenue to their own bottom line. As we look out over the business landscape, we see major outsourcing projects under consideration in industries where global growth requires new supply chain solutions, all of them requiring financing.

About The Authors

Jon M. Africk Managing Director, Co-Head of the Global Transportation and Logistics Group. Jon Africk is a Managing Director in the Investment Banking Division of Credit Suisse First Boston, responsible for co-leading its investment banking activities in the Transportation and Logistics sectors. Prior to joining CSFB, Mr. Africk co-founded the logistics investment banking practice at Deutsche Morgan Grenfell, and spent seven years with A.T. Kearney, where he was a partner in the Transportation Practice. Leading the firm's work with global logistics companies, Jon Africk was A.T. Kearney's link between its carrier strategy practice and supply chain integration team. He has more than ten years experience in the industry. Jon Africk received his MBA from Northwestern University's Kellogg Graduate School of Management where he is now a guest lecturer and member of the Transportation Center's Business Advisory Committee. Jon Africk earned his bachelor's degree in economics, magna cum laude, from UCLA. Richard P. Palmieri Managing Director, Co-Head of the Global Transportation and Logistics Group. Rich Palmieri is a Managing Director in Credit Suisse First Boston's Investment Banking practice, and responsible for co-leading the Transportation and Logistics Group. Prior to joining CSFB, Mr. Palmieri was Managing Director of Logistics and Supply Chain Financing for Deutsche Morgan Grenfell where he co-founded the logistics investment banking practice. Mr. Palmieri was Executive Vice President of Marketing and Corporate Development for Deutsche Financial Services, the Asset Based Financing subsidiary of Deutsche Bank and President of Deutsche Credit Helicopter Finance. Before joining Deutsche Bank, Mr. Palmieri was President of Whirlpool Financial Corporation, Chairman of Whirlpool Financial Aerospace, Ltd. and Chairman of Whirlpool Finance Spain. Mr. Palmieri is an Officer of the Commercial Finance Association and a member of the Expert Advisory Panel to the United Nations Commission on International Trade Law. Mr. Palmieri has over 25 years experience in the Distribution Finance Industry.

About the Author Title: Managing Director Credit Suisse First Boston Managing Director, Co-Head of the Global Transportation and Logistics Group.

Rich Palmieri is a Managing Director in Credit Suisse First Boston''s Investment Banking practice, and responsible for co-leading the Transportation and Logistics Group. Prior to joining CSFB, Mr. Palmieri was Managing Director of Logistics and Supply Chain Financing for Deutsche Morgan Grenfell where he co-founded the logistics investment banking practice. Mr. Palmieri was Executive Vice President of Marketing and Corporate Development for Deutsche Financial Services, the Asset Based Financing subsidiary of Deutsche Bank and President of Deutsche Credit Helicopter Finance. Before joining Deutsche Bank, Mr. Palmieri was President of Whirlpool Financial Corporation, Chairman of Whirlpool Financial Aerospace, Ltd. and Chairman of Whirlpool Finance Spain. Mr. Palmieri is an Officer of the Commercial Finance Association and a member of the Expert Advisory Panel to the United Nations Commission on International Trade Law. Mr. Palmieri has over 25 years experience in the Distribution Finance Industry.

Economic Issues related to Logistics

Economic utility the value or usefulness of a product in fulfilling customer needs or wants. There are four general types of economic utility; however, logistics contributes to the place and time utility: o o o o Possession utility the value or usefulness that comes from a customer being able to take possession of a product. Form utility products being in a form that (1) can be used by the customer and (2) is of value to the customer. Place utility having products available where they are needed by the customers; products are moved from points of lesser value to points of greater value. Time utility having products available when they are needed by customers.

*Note: It is important to know that even if all these utilities are satisfied, the customer satisfaction is
not guaranteed (Valentines Day Example) pg.5.

Logistics Definition
The latest definition for logistics by CSCMP: Logistics is that part of SCM that plans, implements, and controls the efficient, effective, forward and reverse flow and storage of goods, services, and related information between the point of origin and point of consumption in order to meet customers requirements. Various terms have been used to describe logistics such as: Business logistics Distribution Industrial distribution Logistics Logistics management Materials management Physical distribution Supply chain management

These terms are similar to what logistics is but they are not the same. For more info read end of pg.5. So what does the definition mean?

1. The definition says that it is part of the supply chain management- this means that supply chain involves a bigger process which engages different organizations; however, logistics determines how well or how poor an individual firm can achieve their goals. 2. It is part of SCM that plans, implements, and controls this means that logistics must cover all these areas not just one or two. 3. It also mentions the efficient, effective, forward and reverse flow and storage this means How well does the company do what they ay they are going to do? 4. goods, services, and related information between the point of origin and point of consumption this means that information about what you are delivering is as important as the delivery itself. 5. to meet customers requirements means logistics strategies should be focused on customers needs and wants . Reverse Logistics (opposite to Forward Logistics) is "the process of planning, implementing, and controlling the efficient, cost effective flow of raw materials, in-process inventory, finished goods and related information from the point of consumption to the point of origin for the purpose of recapturing value or proper disposal. Mass Logistics is when companies use one logistics approach to target ALL their customers. Tailored Logistics is when companies use various logistics approach to target various groups of their customers.

Reasons for the increased importance of Logistics

1. A reduction in economic regulation US was posing less regulation on logistics activities and this made it possible for logistics managers engage in tailored logistics and also reduce their transportation costs by leveraging amounts of freight with a limited number of carriers. 2. Changes in consumer Behavior - Market Demassification this means that people more and more have customized wants and needs so mass logistics cannot be used - Changing family roles from the 60s more women have entered the workforce and they have pushed to have a convenience shopping experience. This includes home deliveries, more extended store hours etc. - Rising customer expectations People constantly want more, and this means that satisfactory level of performance must be kept up to date with the customer expectations. 3. Technological Advancements Development of various technological tools to handle information have been created so that it is getting easier to control and disperse information. Here the Internet has increased the importance of logistics because it has enabled people to communicate all over the world and this has increased the effectiveness and efficiency of logistics. 4. The growing power of retailers Powerful retailers such as Wal-mart, Home Depot, Best Buy have large market share and low costs and they have superior logistics. For this reason they are considered as trend-setters of logistics.

5. Globalization of Trade it is important to know here that international logistics costs more time and money than domestic logistic. Globalization of Trade is made possible because of the globalization of logistic services.

The Systems and Total Cost Approaches to Logistics

Systems approach indicates that companys objectives can be realized by recognizing the mutual interdependence of the major functional areas of the firm, such as marketing,production, finance, and logistics. Implications of the systems approach: One logistics system does not fit all companies Stock-keeping units (SKUs) or line items of inventory (stocks of goods that are maintained for a variety of purposes) o From logistics perspective the proliferation of SKUs means more items to identify, store, and track.

Intrafunctional logistics coordinating inbound logistics, materials management, and physical distribution in a cost-efficient manner that supports an organizations customer service objectives. Inbound Logistics: Movement and storage of materials into the firm.

Materials Management: Movement and storage of materials and components within a firm. Physical Distribution: Storage of finished product and movement to the customer.

Logistics Managers use the total cost approach to coordinate inbound logistics, materials management, and physical distribution in a cost-efficient manner. This means that all relevant activities should be considered as a whole, not individually. Use of this approach requires understanding of cost trade-offs, in other words, changes to one logistics activity can cause some costs to increase and other to decrease. This is also referred to as a total logistics concept.

Logistics Relationships within the Firm

Logistics vs. Finance There are a lot of issues where the logistics department must interface with the finance department mainly because logistical decisions are only as good as the quality of cost data which they are working. Example: The logistics department needs forklifts and other materials to do day to day activities, so they must report to the finance department when they make the capital investments budget. Logistics vs. Marketing Marketing places n emphasis on consumer satisfaction, and logistics strategies can facilitate customer satisfaction through reducing the cost of products, which can translate into lower process as well bringing a broader variety of choices closer to where the customer wishes to buy or use the product. Logistics can be used to differentiate the company from other companies. Marketing Mix (4 Ps): Place: It is very important that products are on the right place. This is important for both departments the marketing people and the logistics people. If a manufacturer is not able to provide a certain product at the right time, in the right quantities and in an undamaged condition, the channel members may end their relationship with the supplier. Price: a firm cannot be profitable if it does not take into account its logistics costs. The price of a product must cober production, marketing, distribution, and general admin costs. Some companies decide to raise the cost of the products in order to include their higher logistics costs, but this is not very attractive. Another option to this is to decrease the quality of the product but keep price the same. Or the company can absorb these costs itself. There are other costs associated here, like inventory costs, transportation costs etc. If you want to read more go to pg. 15. Product: Here one should know that there are a lot of interfaces between the marketing and logistics ppl in terms of how many units of products they want to have in stock, how many in the inventory, etc. Promotion: many promotional decisions require close coordination between marketing and logistics. One important situation is the availability of highly advertised products when the company has pricing campaign that lower the price of certain products. It can be very bad for a company to have a stock-out when these powerful ads are displayed everywhere about certain products. Logistics vs. Production The most common interface between production and logistic involve the length of production lines. Do you want long production runs or shorter ones? This means, do you want to have more inventory and more products in stock, or do you want to risk and produce less in the short run?

Marketing Channels
Marketing channels are sets of interdependent organizations involved in the process of making a product or service available for use or consumption. The main actors in the marketing channel: manufacturers, wholesalers, and retailers. Each of them assumes an ownership of the inventory of goods: o o o o o Ownership channel (movement of the title to the good) Negotiation channel (buy and sell agreements are reached) Financing channel (handles payments for goods) Promotions channel (promoting a new or existing product) Logistics channel (handles the physical flow of product)

The Logistics Channel: Sorting function rearranging the assortment of products as they flow through the channels toward the customer. It has four steps which take place between the manufacturer and the customer (performed by wholesaler, retailer, or specialist intermediaries): - Sorting out sorting a heterogeneous supply of products into stocks that are homogeneous - Accumulating bringing together similar stocks from different sources - Allocation breaking a homogeneous supply into smaller lots - Assorting building up assortments of goods for resale, usually to retail customers Facilitators or channel intermediaries are people who take part in the communication process between wholesalers and other actors. One example might be translators.

Activities in the Logistics Channel

Activities that are considered to be logistics related include, but are not limited to: Customer service Demand forecasting Facility location decision Industrial packaging Inventory management (cost of carrying/holding, cost of ordering, and cost of being out of stock) Materials handling Order management Parts and service support Production scheduling Procurement Returned products Salvage and scrap disposal Transportation management Warehousing management

Managing Global Trade Finance

Supply chain managers need to learn more about whats involved in financing international goods movement and the new methods and technologies available to help them.

May 21, 2010 - SCMR Editorial In the past decade, thousands of companies worldwide have embraced strategic sourcing and international distribution. About 90 percent of all companies in North America now import and/or export goods and products. Effective management (and financing) of global supply chains is increasingly important to the economic health of companies across all industry sectors. Yet many supply chain managers do not fully understand the economics of these global movements or the best practices to manage them effectively. The guidelines that Tompkins Associates developed for the Institute of Management Accountants, Managing the Total Costs of Global Supply Chains, emphasize the need to identify all costs of sourcing and distribution, and make intelligent use of innovative financing methods. Although an in-depth knowledge of global trade financing is not always necessary, supply chain managers at least need a working knowledge and awareness of the key related issues and solutions. This column provides an overview of three basic categories of global trade finance awareness for supply chain managers: (1) the terminology of global trade finance; (2) the key business processes involved; and (3) the methods and technologies available to help manage the financing. Global Trade Finance Terminology

The most understandable of the supply chain cash flowsthe speed at which cash flows through supply chainsis a key performance indicator (KPI) that supply chain managers need to tightly grasp. The main indicator, known as the Cortera Supply Chain Index (SCI) (http://www.cortera.com), tracks the length of payment periods among suppliers, transporters, and customers. The Cortera SCI currently reports at nine days beyond the average payment terms that are specified by accounts receivable. Because of low cash flow and increased debt caused by the recession, the SCI is almost 20 percent less healthy now than in January 2009. Most supply chain managers have become familiar with terms such as costs of goods sold (COGS), total landed/delivered costs, and working capitalall of which are impacted directly by lengthy supply chains. Few, however, are able to explain the terms that represent the financial supply chain; that is, the supply chain flow of funds associated with the movement and storage of goods throughout the chain. The flow of funds may be enabled by letters of credit (LCs) or by open accounts. The costs of customs, taxes, and security compliance are part of the trade finance equation. The Incoterms (International Chamber of Commerce Shipments and Delivery Terms) that surround these financing requirements have somewhat rigid definitions. Supply chain managers do not have to become experts in these terms or regulations. Yet they need to know where to go with questions or for clarification. Key resources include their freight forwarders, logistics services providers, customs advisory firms, their bankers advisory services, or globally experienced consultants. Key Business Processes of GTM Global Trade Management is (GTM) is the umbrella term that describes the processes required to support cross-border transactions. Its the holistic framework against which companies view their global supply chainsfrom end-to-end, involving the multiple partners that comprise the chain. Global trade finance is one component of GTM; thus, there are several processes that address the financial flows. One very useful resource is the Stanford University 2009 research report titled How Enterprises and Trading Partners Gain from Global Trade Management: A New Process Model (http://www.gsb.stanford.edu/scforum). Sponsored by Trade Beam, this work identifies 106 process steps in the importer/exporter trade flows. Supply chain managers involved in these processes are typically aware of the steps associated with efficiencies in global trade. Yet the intricacies of global trade finance are such that gaps frequently exist in their knowledge and ability to fully understand and to gain the benefits of tightly managing financial flows.

The Stanford report cites numerous categories of financial flows that all supply chain managers should be familiar with. They need a basic understanding of these costswhich cover procurement, inventory, financing, logistics insurance, and moreand their underlying processes. Once supply chain managers achieve that level of understanding, they can decide on the best approaches to identify, plan, manage, and control the costs. Methods for Managing Costs Over the past decade, several methods and technologies have been developed to respond to the rapid growth of global trade flows. These can be viewed with two broad categories: services and technologies. Services. Global trade groups at leading banks specializing in global finance assistance provide trade services such as LCs, collections, bankers acceptances, and risk mitigation tools. They also provide support services for growing open account trade business. In addition, they look for ways to optimize tied up working capital. Recently, due to the economic impacts of global trade, the burden of financing has fallen on suppliers and has pushed banks to focus on vendors. Larger buyers have the leverage to push payment terms to the cost of suppliers DSO. Thus, the leading banks have designed services to create more balanced risks for the buyer, seller, and the bank. Technologies. The leading GTM applications support many of the 106 processes identified by the Stanford report. (See accompanying exhibit.) Through trade portals, trading partners can interact with either LCs or open accounts. The systems generate export/import documentation, provide tax and duty rates, and enable trade finance objectives such as reducing transactions fees while supporting compliance controls and providing visibility. GTM systems also help supply chain managers determine total landed/delivered costs. The ability to calculate these for various scenarios or orders to delivery is critical to effective supply chain costing and product pricing. In summary, companies stand to benefit significantly by improving their global trade processes, information, and knowledge. To assure that finance is considered comprehensively in global supply chain plans, supply chain managers should develop a working awareness of trade finance and the key methods and technologies of supply chain finance.

Global Trade Finance in Todays Economy

Current State of Global Trade Finance

The year 2011 opened with positive growth prospects for global exports and imports, with both were projected to recover their pre-crisis volume level. However the year 2011 saw a series of global shocks such as the earthquake in Japan, Arab Spring disruptions and the debt crises in the eurozone and the US. These global shocks dampened the global trade performance in 2011 with annual trade volume growth closed at 6.6 percent. According to the recently published ICC Global Survey on Trade Finance for 2012, the outlook for annual trade volume for 2012 is expected to have a negative carry-over, with annual growth forecast at 5.2 percent for 2012 and 7.2 percent in 2013. Some of the key findings of the ICC Global Survey are: Letter of Credit remained the predominant settlement product. LC is seen today as the classic form international export payment, especially in trade between distant partners 51 percent of respondents reported an increase in export LC volume and 56 percent an increase in import LC volume However, historically open account trade has represented around 80 to 85 percent of world trade, although it is widely expected that this figure fell between 2007 and 2011 as exporters sought a more secure method of settlement. Further the recent Financial Supply Chain Survey 2011 conducted by gtnews, an Association for Financial Professional Company and the leading bank SEB revealed that supply chain finance techniques are becoming prevalent among survey respondents with over 43 percent of buyers and 34 percent of sellers using this method to manage open account risks. Alluding to the above trend, major global banks have been taking steps to improve their capabilities in trade finance products and for open-account based trade such as supplier finance. This article highlights how supply chain finance fits with more conventional trade finance and shows how these two disciplines complement and interlink each other.

Advantage of Trade Finance

Trade finance can be defined as the provision of bank credit facilities and services to meet a corporates needs in relation to their export and import activities. Transactional control is one of the principal advantages of trade finance instruments. For instance, by requiring a full set of bills of lading in a letter of credit, the importer will not be able to take possession of goods until he accepts or pays a bill of exchange, thereby giving the exporter a high level of confidence that his trade debt will be settled. Transactional control also helps an importer to delay paying until he knows he has received the goods he has ordered say under import LC. One of the sharp trade trends identified in recent years is that there is a movement towards open account and away from usage of LC and documentary collections. Unlike trade finance, which generally relates to cross-border commerce, supply chain finance has an extremely important domestic dimension. For instance the buyer-backed reverse factoring can benefit both domestic and international supply chains.

Before we take a deep dive into various aspects of supply chain finance, let us now briefly look at two popular financing solutions viz.: factoring and purchase order financing. These solutions have been metamorphosed to meet the changing supply chain finance world as well.

Factoring solution
Factoring is a structured working capital finance solution that includes finance against suppliers domestic or export receivables, collection of receivables on due date. Thus factoring or accounts receivables financing helps suppliers to convert their invoices or account receivables into cash thereby releasing the cash generation potential of their business.

Purchase Order financing solution

Purchase order financing provides companies with a short-term solution for funding inventory required to complete sales transactions. This form of finance is provided to meet sudden and large sales opportunity. The finance can be availed to fund the cost of manufacturing inventory and the related logistics costs.

Supply Chain Finances fit with Trade Finance

Over the past few years, there has been increased focus to develop an open account financing techniques to make supply chain more competitive. Importers seek a move towards open account to cut costs, reduce the need for bank credit lines and improve efficiency. On the other hand, open account terms of trade can be bad news for suppliers. They take on increasing risk and lose access to local finance backed by LCs, resulting in a reduction in valuable funding. Often a suppliers size and geographical location, such as emerging market, mean that local financing is very expensive in terms of underlying interest rates, margins and fees. Hence capital constrained small and medium enterprises find themselves obliged to raise finance through traditional accounts receivable factoring. With globalization of trade, a growing percentage of receivables are now based on exports to remote markets. These invoices carry longer payment terms than domestic receivables. Buyers wish to extend payment terms for as long as possible in order to improve their Days Payable Outstanding (DPO). These factors can have a negative impact on an exporters Days Sales Outstanding (DSO) and working capital.

Innovative Financing Solutions

The above open account business has, thus, driven demand for new financing solutions, both at preshipment and post-shipment stages. This has led to the emergence of web-based solutions that create a win-win for the buyer and supplier.

Buyer-backed reverse factoring

The first solution conceived is buyer-backed reverse factoring. This would involve a strong buyer and many smaller suppliers in need of a financing platform that would match the liquidity gap. The traditional

factoring uses an invoice as the underlying asset for financing, while the reverse factoring brings the qualified invoices, which are approved by buyers, into play. Thus traditional factoring deals with the suppliers receivables from many unknown buyers, whereas reverse factoring deals with the payables of one well-known buyer. To cite an example, a large Multinational Corporation buyer procuring goods from several smaller suppliers can have buyer-backed reverse factoring arrangement with his banker. This arrangement would help financing bank to provide finance to the smaller buyers based on invoices approved by the buyer. Ideally this arrangement would involve smaller buyers riding on the balance sheet strength of the large buyer. In this scenario, the smaller buyers would upload the invoices in the web-based application which would then be approved by the buyer. Armed with buyers approval, bank would have more confidence to provide finance to the smaller suppliers. The smaller suppliers due to their small size may not be able to secure credit facility on their own. Hence the buyer-backed reverse factoring would facilitate the buyer to lend his strong credit rating that would benefit smaller buyers. Since this arrangement would involve relying on the strength of the large buyer, banks would provide more favourable credit terms to buyer.Thus this supply chain optimization technique provides the buyer with longer payment terms or lower cost of goods, whereas the supplier gets lower cost and reliable finance. Spanish banks have pioneered this reverse factoring technique, initially in their domestic Iberian markets and later in Latin America. This reverse factoring structure strengthens buyers core supplier relationship. Currently the market focus is around post-shipment finance, when goods have been shipped and invoices have been presented and approved by the buyer using the web-based solution. This payer centric reverse factoring solutions rely heavily on the large buyer using his strong credit rating to support his supply chain.

Invoice discounting services

The above buyer-backed reverse factoring solution helps buyers to extend DPO and retain cash flow as long as possible. On the contrary, large exporters want to accelerate the conversion of international receivables into cash and hence improving their own DSO. To address these requirements, banks are providing a growing range of web-based invoice discounting services or export factoring, with or without recourse to the supplier. One major difference between supplier-backed receivables financing (invoice discounting services) and buyer-backed reverse factoring is that while the latter benefits from buyer data (viz.: knowledge that invoices to be financed have been approved), factors and invoice discounters are generally reliant on information solely from the supplier at the point when funds are advanced.

Other innovations in the industry

eInvoicing A number of innovative banks are beginning to partner with e-invoicing solution providers (or launch their own proprietary solutions) in order to streamline electronic purchase order (PO) distribution,

invoice receipt and matching of these documents for buyers and suppliers. This matching is sometimes achieved through a device known as PO flip, whereby the original PO is used as the basis to create a new invoice. The more sophisticated solutions produce and exchange invoices that are fully compliant with VAT requirements in wide range of countries such as UK, Europe Event triggered finance With improved visibility in the supply chain, banks are exploring using key milestones in the trade cycle as triggers for the release of finance. For instance, credit can be made available at a decreasing cost of finance as successive transport data is provided showing that the goods are progressing satisfactorily towards their destination and that the contract is more likely to be fulfilled. From a bankers perspective, this information demonstrates that the risk of default on the transaction is steadily reducing. One classic case of event driven finance is in-transit finance. A logistics company has control over goods and can track where the goods are located, for instance in a distribution center or in transit using the logistics companys transportation capabilities. In these circumstances, a financing partner can mitigate risk in making available finance for these goods. This transactional control can be used to provide competitive financing. SWIFTs new initiatives SWIFT has taken new initiatives to supplement industrys effort towards open account transactions. For instance, its Trade Services Utility (TSU) and Bank Payment Obligation (BPO) facilitate banks and financing agencies to exchange and process trade data quickly. Conclusion Supply chain finance cant take over from trade finance, but actually complements traditional trade finance instruments that will continue to have an important role for years to come. The trade finance instruments meet the needs of specific markets and specific phases in a business relationship. At the same time, considering vast potential in the supply chain finance, the trade banks and financing agencies can ride this opportunity wave by offering a full range of pre-shipment, in-transit and postshipment finance solutions.

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Transport and Logistics Industry

Major Industry Trends
Slump in Global Trade Devastates Industry
The fortunes of the transport and logistics industry are closely connected to the economic cycle. When economic activity is buoyant, demand for transport and logistics services is equally strong. Consumer and business demand for goods and services inevitably translates into higher demand for transport and logistics services. Thus, the slump in global economic growth that occurred in the second half of 2008 and during the course of 2009 caused global trade volumes to plummet, and had a severe impact on the transport and logistics industry. Around the world, ports and airports reported sharp falls in traffic. The International Air Transport Association (IATA) reported that cargo volumes fell by 4% in 2008 and the closing stages of the year and the opening months of 2009 saw further, unprecedented declines in cargo volumes. By December 2008 they had fallen by 22.6% and by 23.2% year-on-year by January 2009. Reacting to the January 2009 figures, Giovanni Bisignani, IATAs

director general and CEO, said: The industry is in crisis and nobody knows that better than our cargo colleagues. Cargo demand has fallen off a cliff. He had earlier described the December 2008 figures as unprecedented and shocking, adding that there is no clearer description of the slowdown in world trade. Even in September 2001, when much of the global fleet was grounded, the decline was only 13.9%. The low point for air freight was reached in March 2009, after which the fall in demand began to stabilize. The fall in air cargo through 2009 was steep at 10.5%, surpassing the 3.5% decline recorded among passengers, but not quite the disaster that had been indicated by the figures for the start of the year. IATAs Bisignani called 2009 the worst year in aviation history in terms of demand, predicting that airlines would lose US$5.6 billion on a net basis in 2010 after losing US$11 billion in 2009. However, freight demand began to pick up sharply towards the end of 2009, signaling a wider revival in the global economy. Thus, air freight demand rose by 24.4% in December 2009, compared with the figure a year earlier. But this year-on-year strength was exaggerated by an unusually weak December 2008, the low point in the cycle. According to IATA, air cargo represents about 10% of the airline industrys revenues. As 35% of the value of goods traded internationally are transported by air, air cargo is a barometer of global economic health. The shipping industry has also been badly affected by the slump in global economic growth and trade. The Baltic Dry Index provides the daily average cost to ship bulk dry commodities (such as grain products or coal) around the world. It is highly sensitive to global economic activity, as the freight costs it measures move in response to demand for shipping services. The greater the demand for raw materials around the globe, the higher the index moves. It normally takes around six to nine months for raw materials to be delivered to customers and made into finished products. Thus the index is also a highly accurate leading indicator of global economic activityin other words, movements in the Baltic Dry Index provide a very good guide to the future direction of the global economy. On May 20, 2008, the index reached its record high level since its introduction in 1985, reaching 11,793 points. But by December 2008, the index had dropped by 94%, to 663 points, the lowest since 1986, presaging the global recession. Overall, the Baltic Dry Index fell by 92% in 2008. In August 2009, it reached a low of 2,772, but it then rallied sharply to a 2009 high of 4,381 points in November. By April 2010, the Baltic Dry Index had risen by 58.5% over the previous 12 months. However, in April 2010, it was also showing weakness, despite the fact that global industrial production was rebounding at the strongest rate since 2000. Average global container freight rates saw a major rally in late 2009, according to Drewrys Container Freight Rate Insight report. After collapsing in the first half of 2009, the Drewry Global Freight Rate Index increased by 18% between July and September, and rose by another 6% between September and November. According to Drewry, the global all-in container freight rate index rose from US$2,040 per 40-foot container to US$2,160 from September to November. The upturn continued through 2010 and into 2011. Danish logistics operator DSV, for example, reported in April 2010 that it saw maritime container volumes surge 19% in the first quarter of 2010 and added that deep-sea freight rates have reached a peak on the Far East to Europe trades, which accounts for half of its ocean business.

Recession Affects Logistics Industry

The global recession has also taken a toll on logistics firms. In March 2009, DHL reported that business had declined in the fourth quarter of 2008, with volumes dropping by as much as 30%, depending on the region. In March 2010, DHL reported that it had successfully managed the repercussions of the economic crisis and exceeded its targets for 2009. It also forecast a moderate recovery in global transport volumes. By July 2011

DHL was able to report that consolidated EBIT (earnings before interest and taxation) would be close to 2.4 billion. The company continued to see encouraging growth in its European domestic parcels business and in Asia, with profits and margins rising significantly.

Environmental Laws Could Hit Transport Firms

Air freight companies may be affected by stricter environmental regulations over the next few years, according to Cargonews Asia. The website said that the likely advent of more stringent global environmental regulations would impact not only the economics of using air transport, but would also possibly result in punitive sanctions against goods produced with environmentally questionable practices. It added that the latter element would significantly erode the comparative advantage enjoyed by manufacturers in Asia, which have fueled the growth in demand for air cargo in recent years. These concerns appear to be shared by IATA. Cargonews Asia quoted the organizations chief economist Brian Pearce as saying that the cost of protectionism and deglobalization, higher taxes, and climate-change policies will all have an impact on the industry.

Market Analysis

Aviation Industry Cuts Jobs and Capacity, While Mergers Increase

The slump in global trade hit the airlines and shipping companies hard. Airlines cut capacity, routes, and jobs in 2008 and 2009. The downturn has also hurried the consolidation of the industry. In November 2009, British Airways and Spanish airline Iberia said that they had reached a preliminary agreement for a merger, which completed in late 2010. In May 2010, Continental Airlines and UAL Corporations United Airlines merged to create the worlds largest airline. The new airline is a US$3 billion company capable of carrying 144 million passengers per year. Sector analysts generally approve of mergers since they allow carriers to pool costs and to raise fares on routes where they used to compete. However, this latter reason is also why regulators scrutinize potential merger deals very closely before giving their approval.

Overcapacity Plagues Shipping Industry

The shipping sector is suffering from a combination of plummeting demand and an oversupply of ships as vessels ordered during the growth years are delivered. The shipping industry enjoyed five boom years until 2007, but the global recession has sapped demand for the transportation of Asian-made goods. In 2010, many shipping companies reported that, although demand picked up, overcapacity affected both rates and their profits. In April 2009, for example, China Cosco Holdings Co., the worlds largest operator of dry-bulk ships, announced an annual loss after rates for hauling commodities, while container prices tumbled on overcapacity.

Global Economic Slump Hits Logistics Specialists

Many of the major logistics firms were affected by the global economic slump, but have made a reasonable recovery through to the first half of 2011. In its 2009 annual results, the CEO of the logistics giant TNT said that while 2008 was a year of two halves, with the second half clearly marked by the impact of the global economic crisis, 2009 has seen the impact of the economic crisis for its full duration. The company said that its express business, with its cyclical nature, was most severely affected. Many customers in Europe have chosen slower and cheaper forms of transport, leading to a move away from air towards road express. The result was an unprecedented drop in volumes of air express of 25% in the beginning of the year, with road volume declines also building up during the year to double digit levels. Looking forward, TNT said that the fourth quarter of 2009 showed the return of positive growth in express volumes, compared to the dramatic lows in the final quarter of 2008. TNT CEO Peter Bakker said in the Groups 2010 Annual Report (for the year ending December 31, 2010) that 2010 had been a year of large operating challenges for logistics companies, complicated by both the volcanic ash cloud which grounded large numbers of European flights, and by the extreme winter conditions experienced in 2010. However, the year also saw growth returning to both advanced markets and, more robustly, to emerging markets. The companys express delivery volumes rose to pre-economic crisis levels and the volume growth in the companys parcels business continued.