Last week we discussed the relationship between the Time Value of Money (TVM) and capturing supplier discounts. This week we continue our conversation on discounts by taking a look at Dynamic Discounting and Supply Chain Finance (SCF). These two concepts are used interchangeably by some, and are no doubt closely related, but each has its’ own distinct characteristics and uses. Let’s start by taking a deeper dive into Dynamic Discounting and then we will explore Supply Chain Finance.
Dynamic Discounting
Dynamic Discounting is the name for both the process and the technology platforms that enable buyers and suppliers to alter standard terms of payment. The basic component of Dynamic Discounting is for the buying organization to offer early payment for a stated discount to a supplier (or group of suppliers) based upon certain buyer-specified criteria. Buyers, and their Accounts Payable (“AP”) departments, typically manage their discount offers according to their cash/treasury needs and strategies, allowing them to use their payables to generate higher yields on their available cash. Buyers also choose the APR (Annual Percentage Rate) to be used in calculating the early payment discount. This allows them to offer the same rate for all suppliers, or segment suppliers into different groups. The suppliers then see a dynamically calculated discount rate based on the number of days early that the payment is accelerated. It is important to note that Dynamic Discounting platforms are almost always buyer funded.
Dynamic Discounting solutions from technology companies such as Tradeshift, Basware, Esker, Corcentric, SAP Ariba, Palette and Medius, allow AP departments to set rules to make discount offers based on certain requirements, or allow suppliers to offer a dynamic discount based upon payment timing. Most Dynamic Discounting solutions allow AP/Finance teams to change their offers in real-time, allowing them to incorporate their often fast-changing cash positions and needs into their analysis and offers.
Buying organizations also benefit from the ability to create customized discounting programs for various supplier groups throughout the supply chain because they can offer discounts, at rates, that make most economical sense for each supplier segment. This flexibility yields a higher return than a single enterprise-wide discount program (or offer) given the variations that exist in supplier size, strategic importance, access to credit, industry, etc. This is important because many suppliers, and in some cases, large supplier segments, lack access to flexible financing options where traditional SCF programs are only available to a buyer’s largest suppliers. This frequently leaves the “long tail” of suppliers (those who often need financing most) without early payment options. Dynamic Discounting programs can be applied to a buyer’s entire spend and entire supplier base, providing more early payment opportunities and greater flexibility in setting sliding-scale discounts driven by buyer-specified APRs.
While Dynamic Discounting solutions are typically sold to buying organizations, the return on investment in these solutions is directly linked to the level of internal usage and supplier participation. To create an incentive for suppliers to link to a Dynamic Discounting platform, the solutions should reflect supplier requirements and create value for participating suppliers. Comprehensive self-service supplier portals that provide invoice and payment capability along with historical visibility, are the de facto standard for solutions in this space.
Supply Chain Finance
Supply Chain Finance is very similar to Dynamic Discounting, except it uses third-party capital as opposed to internal buyer funds to make the early payment. One common form of SCF allows a supplier to sell its receivables to a bank (or other financial institutions and third-party funders) at a discount as soon as the buyer approves the payment. The third-party will buy the receivable from the supplier at a discount and receives the full payment from the buyer at the original maturity date. One limitation to this type of SCF is that it generally makes financial sense to the banks (and some third-party funders) to initiate financing relationships with large suppliers only.
This is where solution providers such as C2FO, PrimeRevenue, and Taulia have developed SCF platforms that better address a buying organizations’ long tail of suppliers. These solution providers offer Dynamic Discounting platforms that can, or always do, include third-party funding options from banks, financial and/or other funders. Since the credit risk in the transaction for the third-party financier is typically tied to the buyer’s finances, SCF can be an innovative way for large companies to help their suppliers’ access credit and improve cash-flow at a below-market cost, with benefits accruing to both the buyer and supplier.
Conclusion
Not that long ago, SCF was the exclusive realm of large banks and other global financial institutions. Today, however, most ePayables solution providers offer buyer-funded Dynamic Discounting functionality within their offerings and this, combined with the stand-alone SCF platforms that commonly include third-party funding, provides buying organizations with an excellent opportunity to broaden the financing strategies it can offer its’ entire supply base. As AP departments look to transform from a tactical function to a strategic, value-adding operation, Dynamic Discounting and SCF are both great strategies to leverage that can help improve overall working capital management, as well as their overall perception within the organization.
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