Many of your company's suppliers might be facing difficult cash situations because it has become very hard for them to obtain credit from financial institutions. Still, you need most of these suppliers to continue in business.
To make things worse, many companies are delaying payments to suppliers and, therefore, dramatically exacerbating their working capital problem.
An ironic example is the case of General Motors. Earlier this year, GM notified its suppliers that payment terms would be extended from 30 to 60 days.
Then, a few weeks ago, GM was in the news because, just after coming out of bankruptcy, it began lending money to a supplier, Visteon, to avoid the supplier stopping operations.
To make this irony even more absurd, companies that have cash do not know what to do with it. Banks are too risky (much more than many suppliers who need the money) and the demand for government bonds is so high that their yields are close to zero.
How has this illogical situation become so commonplace? While executives manage and optimize the flow of goods and information between a company and its customers and suppliers, the flow of cash between companies has been mostly handed over to financial institutions.
This was based on the assumption that the financial system would be much more efficient than companies.
This assumption is well accepted in academia, and research has been done to understand why some companies still prefer to use trade credit from suppliers rather than using the perfectly efficient financial system.
However, we argue that it is time to ask the reverse question: Why use financial institutions to manage the flow of money between companies?
They are high risk, have shown major mistakes in evaluating risk, are charging very high rates to borrowers and give very low remuneration to recover profits from their mistakes (one executive even argued that this is a way to pay themselves big bonuses again).
What value do financial institutions bring to the table? Are they the problem rather than the solution?
Today, many companies might be much better off putting cash back into their value chains. Rather than collecting money as early as possible from customers and paying suppliers as late as possible in order to maximize cash and invest it in extremely low yield government bonds, why not look at your customers and suppliers as an opportunity to create value with cash?
Companies need most of their suppliers to continue operations. They also know a lot about them and their future.
In fact, many companies have a substantial information advantage over any financial institution when it comes to evaluating the risk of a supplier.
If your company is a major customer of a strategic supplier, your sourcing executives likely have a very deep knowledge about the supplier's finances, operations and strategy.
Not only that, your company executives might also know how much of your business will go to the supplier in the future.
In fact, it might be that the future of the supplier is partially in your company's hands.
Therefore, your company has a very strong influence on the supplier's risk.
This advantage is so strong that many big corporations have supply chain finance initiatives by which they provide support to their suppliers to help them to obtain financing from banks.
In other words, the customer companies are telling bankers: "This supplier has a good future because we are going to continue buying from them, so you must change your risk evaluation of the supplier and lend them money."
With this information advantage, would companies be better off lending money to their suppliers rather than trying to look for alternatives within the financial system?
I can already hear a passionate: "NO, the financial system is much more efficient at pricing the risk, and if companies have excess cash, they should return it to their shareholders." That was the ideology of the past.
Unfortunately, the financial system does not know how to price risk. In general, it has used the past as a proxy for the future.
Today's future, however, is very different from the past, and investors might prefer that companies don't return the money since they do not know where to invest it.
In fact, the substantial increase that we are now seeing in the debt market is equivalent to investors saying: "I prefer to deposit my money in an industrial company rather than in a financial institution."
Apple, another example of a company that is lending money to a supplier, announced a few months ago that it was pre-paying US$500 million to Toshiba for flash memory chips.
As the future unfolds, we might see more companies choosing to manage their cash in the value chain, with the financial system playing a much more minor role in the ecosystem of industrial companies.
In the meantime, executives must dramatically change the way cash is managed in companies.
Carlos Cordon is Professor of Process Management at IMD (www.imd.ch). He is the Co-Director of the Program for Executive Development and he also teaches on the Orchestrating Winning Performance, Managing the Global Supply Chain and Partnership Programs.
