“For every action, there is an equal and opposite reaction.” As it turns out, Newton’s law applies not only to the world of physics but also to today’s global supply chains. For instance, a manufacturing company begins sourcing goods from an overseas supplier at lower costs. But, that same company’s distribution arm now needs to figure out an efficient way to move the finished goods from the overseas factories to the markets where they’ll be sold—an equal and opposite reaction that can cut into the very savings generated by the move to an offshore supplier.

For the most part, the manufacturing and distribution teams have been able to solve this conundrum in today’s global economy through innovations in the physical supply chain—the movement of goods—which remains the focus of much attention.

Finance, on the other hand, is still in the process of making substantial adjustments to these new global processes.

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.

But there just might be a solution.

The supply chain marriage

It’s time to marry the physical supply chain with the financial one. At the heart of this marriage is a better, more efficient business model. After all, a $1 billion company can save from $10 million to $40 million in cash by improving basic trade processes, according to the Aberdeen Group’s “The CFO Agenda for Global Trade Benchmark Report.”

But just like any marriage, this one won’t be easy. It will require communication, creativity, and a willingness to change. It will require banks and non-banks to partner, logistics providers to launch banks, and maybe even banks to launch logistics arms.

The linchpin of the success of both the physical and financial supply chains is information—data that provides “visibility” into the disposition of goods, or the ability to “see” where goods are at any point in the supply chain. Fifty-seven percent of CFOs surveyed by the Aberdeen Group in September 2005 cited “improved visibility to order activity, inventory, and commitments” as a desired response to financial challenges in global trade. Moreover, the Aberdeen Group found that 90 percent of companies report that their global supply chain technology is inadequate to provide the corporate finance organization with the timely information it requires for budget and cash flow planning and management.

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.

Creativity

Okay, so let’s assume that we have the visibility problem fixed. Let’s assume that trading partners have access to precise data—via technology—that shows exactly where individual items are in real time—in what warehouse or on what boat, plane, train, or truck. With this data in hand, a bank would be able to extend credit to the owner of the goods, using the inventory as collateral, right?

Wrong. What if the goods are still in a foreign country? And, what if the owner of the goods is forced to liquidate? Will the U.S. bank be able to take ownership of the collateral? It varies greatly depending on local laws.

So, even with precise visibility, we still have a legal problem here because the laws of certain countries are not defined enough yet to clearly delineate the lien law hierarchy on the goods pledged as collateral. This lack of a uniform security interest code internationally makes it difficult for the banks to perfect a valid security interest against the goods, creating a credit manager’s nightmare.

There are two ways to mitigate this risk. The first would be to work diligently with the governments of every single country that has undefined lien laws and try to change those laws. Quite a daunting task, and we likely will be writing about the “lunar supply chain” before we change all of these laws. This one’s a non-starter.

The other mitigant involves creativity and the formulation of new and unique lending options.

For instance, what if banks and logistics companies were to 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.

Banks and logistics companies need to join together to develop these types of new offerings that mutually benefit buyers and suppliers. The whole purpose of these new offerings would be to make it easier for buyers and sellers to trade.

Imagine if a buyer could provide faster payments to a seller and, in return, negotiate a lower price for the goods. That would give the buyer a competitive advantage, and it would enable the seller to lower the burden of inventory carrying costs.

Logistics companies and financial institutions must combine services and operate cooperatively—not competitively—to achieve optimal global supply chain finance efficiency. The buyer gets its goods on time…the seller receives its payment on time…companies on opposite ends of the supply chain build stronger credit…and consumers everywhere receive products at cheaper costs and faster speeds.

Truly a win-win situation, from shore to shore.

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