Introduction to Procurement Finance

CHAPTER 1 Introduction to Procurement Finance ConCept of proCurement finanCe The financial crisis of 2008 brought strong competitive pressures on the organizations. Large organizations are challenged by small ones that are more specialized. On the other side, the small and medium-sized enterprises (SMEs) have difficulties in accessing to the credit. The aim of this book is to demonstrate how it is possible and useful to exploit the digital transformation to support and innovate the procurement organizations and the financial institutions. The aim is to demonstrate that all the actors involved in the procurement ecosystem can benefit from the digital transformation. To reach this objective, it is important to consider an integrated approach, including1: • trade finance; • supply chain finance; • payments management. This integrated vision is called procurement finance. It is represented by the dashed lines in Fig. 1.1. Procurement finance goes beyond the trade finance, supply chain finance, and payments management. It encompasses the entire extended procurement processes. To clarify this statement, it is useful to consider what has been defined as the ultimate supply chain.2 © The Author(s) 2018 B. Nicoletti, Procurement Finance, Palgrave Studies in Financial Services Technology, https://doi.org/10.1007/978-3-030-02140-5_1 1 2 B. NICOLETTI TRADE FINANCE TREASURY SUPPLY CHAIN FINANCE (Working Capital) Procurement Finance PAYMENT MANAGEMENT Fig. 1.1 Procurement finance More and more of the operations of an organization are network shaped rather than single flow shaped. Besides, the real objective of the process is to add value to the organization: the supply should involve co-design, codevelopment, cooperations, and co-marketing and sales. For all these reasons, this book considers procurement finance as an optimization of the value network processes rather than only of the supply chain.3 There are several pillars to consider in procurement finance (Table 1.1).4 All three components of procurement finance are challenging. In approaching procurement finance, it is necessary to consider the current global scenario. Globalization creates a complex combination among outsourcing, global supply, and distribution networks. This leads to an increase in the number of actors and of their relationships. Globalization of processes and relationships is commonly referred to as one of the underlying factors of the ever-increasing vulnerability of procurement for the organizations.5 In this new situation, multinational organizations, followed more and more by SMEs, need to take new approaches to better support the increasing global trade and at the same time to act on the new challenges and remediate to the risks. Organizations are adapting to the new competitive scenarios by managing complexity, disintermediation, innovation, networking, and flexibility. This is the base to rethink, restructure, and innovate all processes and relationships along the value network, starting with the procurement. It is important to take into account that an innovative solution brings benefits but can bring also several risks and uncertainty regarding the desired results with the actual ones. This aspect is one of the main barriers to inno- INTRODUCTION TO PROCUREMENT FINANCE Table 1.1 Financing 3 Pillars in procurement finance Risk management Available to all parties Risk sharing (buyer/vendor/logistical operator) Available at several steps Country, financial in the transaction institutions, and transaction risks Logistics risks Export credit Payment Information Secure Shipment and storing status Timely and prompt Quality of products shipped and services delivered Total cost of products shipped and services delivered Global Taking into account currency fluctuations Insurance Adapted by the author based on Malaket, A. (2014). Financing Trade and International Supply Chain. Gower Publish, Farnham, UK vate. It is essential to manage it. This book considers the ways to cope with these risks, by managing them and understanding the main key factors within procurement finance. The creation of value by an organization is determined by its ability to generate long-term cash flows through operational management.6 Cash flows are an indicator of an organization’s sustainable development capacity and the ability to remunerate and repay debt and capital. This is an objective measure of the organization performance. The digital transformation is introducing deep changes also in treasury tools, systems, and processes.7 Treasury needs to be prepared for these changes not only to capture all the potential benefits but also to manage possible challenges and risks. Treasury is the underlying asset of the correct cash inflows and cash outflows management. It is required to help maintain an efficient structure of working capital, given the increasing competitive environment. To maintain the proper day-to-day management, treasury needs to lean and digitize as much as possible its own processing. It must have secure systems and processes to minimize operational risks by maximizing efficiency in managing working capital and optimize liquidity. Technological evolution in payment systems is perhaps one of the most obvious aspects for procurement finance since scope, cost, and quality performance are perceptible in day-to-day business management. The main 4 B. NICOLETTI efforts are focused on shrinking payment execution times, visibility, and traceability of transactions.8 In addition, the digital transformation is deeply changing the architectural landscape of payment systems.9 It could turn towards distributed solutions that can potentially provide faster and traceable transfers between counterparts. New solutions bring improvements and benefits. They also bring operational risks and potential frauds that must be known, monitored, and mitigated. Being in an increasingly globalized ecosystem, the international trade transactions are increasing. With the slowdown in the world economic growth, the trade finance industry has also suffered a certain impact. It is still maintaining a relatively optimistic growth. There are several estimations not completely consistent for this potential growth. All of them confirm the growth of the market. Trade finance market size is expected to maintain the average annual growth rate of 10.58 percent from $25,290 million in 2014 to $34,200 million in 2017.10 BisReport analysts believe that in the next few years, trade finance market size will expand. They expect that by 2022 the market size of the trade finance will reach $54,890 million.11 With increased focus on global trade, the trade finance market is likely to witness a strong growth in the coming years. The global trade finance market is expected to reach USD 71,000 million by the end of 2023, growing at a compound annual growth rate (CAGR) of 3.0 percent between 2017 and 2023.12 For this reason, it is necessary to consider an advanced payments management taking into account especially the different currencies in the international transactions. New solutions are important in facilitating the cross-border transactions. In this international ecosystem, the actors require innovative solutions of procurement finance oriented to increasing value added. Innovative procurement finance solutions allow especially SMEs in financing their operations in an effective, efficient, and economical way. To deal with the changes in the current trade, it is necessary to consider not only the physical flow of procurement but also the financial and information flows with an integrated vision. It is necessary to bridge the gap between the business and financial worlds. An integrated approach is necessary while being useful for taking into account simplification and digitization at the same time. The development of smart approaches and collaboration in procurement can accelerate the modernization and transformation of the entire organization. The task of the procurement is to be a model of use of new solutions, encouraging its use intelligently to support collaboration.13 INTRODUCTION TO PROCUREMENT FINANCE 5 StruCture of thiS Book In the light of the analysis of the previous section, this book intends to focus on the management of the financial flows along the full procurement cycle. It shows how innovative solutions are able to play a relevant role in an integrated context supporting the procurement transactions, also international, in terms of agility, rapidity, visibility, flexibility, and compliance. The objective of this book is to emphasize some innovative areas useful in transforming procurement finance thanks to process optimization and digital transformation especially for SMEs. This book considers the entire procurement ecosystem, including organizations, financial institutions, and public central and local organizations. In this vision, the role of the financial institutions is more relevant. They should recognize their role as platforms.14 This book is structured through eight chapters. At their basis, there is the presentation, in a coordinated way, of new solutions. The first chapter defines procurement finance. This function is increasingly positioned as a strategic function within an organization. Considering the importance of this function and taking into account the dynamic, volatile, and global scenario in which the organizations need to operate, this chapter proposes the necessity of an increased agility in the organizations, especially in the procurement finance sector.15 The agility can be improved through new solutions. They allow adapting to a changing environment in a flexible and rapid way. New concepts are emerging, such as the ones connected with the fintech approach: the fusion between technology and finance.16 The fintech organizations often compete with the traditional financial institutions to provide innovative financial services in rapid, easy, direct, and transparent ways. They are able to satisfy the needs of a large number of customers and not only of a specific privileged range of customers of the financial institution. The digital transformation allows easier access to any organization which needs financial services. Some financial institutions have started to collaborate with the fintech ecosystem to create an environment able to satisfy all customer needs. The second chapter examines in depth the procurement processes. It describes and underlines the three important phases of the function: information/digital flow, physical flow, and financial flow. This distinction is important especially for the following chapters. It underlines the importance of the collaboration within and among organizations along the entire extended value network not only in regard to physical and information flows but also considering the financial flows. 6 B. NICOLETTI The third chapter describes the useful linkage between procurement, finance, and information and communication technology (ICT). It shows the possibility to get a shared objective and thus obtaining trusted relations among all the actors in the ecosystem. The physical and the financial flows in procurement need an alignment. Such an alignment helps to overcome the gap between the industrial vision and the financial vision under an integrated vision increasingly necessary in this current global scenario. This chapter describes the roadmap from trade finance to supply chain finance (SCF), and to procurement finance. It defines the transition from one to another. It stresses the importance of procurement finance in a market that is evolving globally. This chapter underlines the need for streamlining the processes supporting the information/digital flows and facilitating the access to financial support—trying to mitigate challenges and risks related to procurement, especially if global. Procurement finance is represented as a holistic vision of the procurement and finance considering it an ecosystem of relationships and not only a bilateral transaction. The payment times increase in all the chains, and the optimization of working capital is needed in the organizations. Considering these needs, procurement finance is presented as an innovative approach able to optimize the working capital and the cash flows along the value network through the collaboration among partners. Procurement finance is a new integration concept that includes trade finance, supply chain finance, and payments management. It supports the organizations with an integrated vision related to the linkage between finance and procurement. The final part of the chapter deals with the key performance indicators (KPIs) to monitor and support the implementation and management of the new solutions. The fourth chapter describes the vision of this book of an agile procurement finance. Agility is essential in the current volatile environments, to be able to adapt and catch all the opportunities which might arise. Agile procurement finance is based on an integrated lean and digitized approach to take into account at the same time the improvements in the processes and their simplification and digitization.17 The fifth chapter describes in depth the new solutions supporting procurement finance. It reports several examples of concrete applications. The examples are classified based on the following sections: portals, marketplaces, risk management, advance payments, and document management. It shows how the digital transformation can support each of these aspects. It highlights the opportunities offered by the new solutions to INTRODUCTION TO PROCUREMENT FINANCE 7 optimize payment times, dematerialize documents, improve transactions’ traceability, and mitigate risks. The vision is of an increasing digital future. The sixth chapter has a longer-term perspective. It provides examples, which should find in the near future many practical applications. These applications move towards an integrated ecosystem which sees a role of platforms for the financial institutions. This chapter focuses on the organizational and technological procurement finance solutions. Fintech organizations are the paradigm of organizational innovations, while some of the relevant innovative solutions are connected with blockchain, cloud computing, and artificial intelligence. The combination of these solutions leads to a procurement finance 4.0 fully embedded and supportive of the Industry 4.0 initiatives. This chapter clarifies how all these innovative solutions can be increasingly exploited to obtain benefits especially in the financial aspects but also from an organization point of view. The seventh chapter focuses on the role of SMEs in the economy, and the difficulty for them to access to the credit from the financial institutions. This chapter reports an empirical study on the application of procurement finance in large European organizations. This study supports a new vision which is important also for the SMEs. It is a vision of the procurement finance as a collaborative platform which allows the SMEs to get substantial benefits. It is useful to reach an integrated credit rating that considers a procurement perspective and not only partial financial perspectives. The eighth chapter draws the conclusions of the book. The final part of the book contains an extensive glossary, reference, and website lists. The book is full of business cases relative to the concrete applications of the concepts described. ConCluSionS Looking at a single organization may not be enough to provide credit to the organizations for supporting them in times of difficulty while at the same time growing procurement finance as part of the digital transformation. By considering the ecosystem allows organizations to find new and rewarding opportunities. It is only necessary to reap and manage them in the proper way. 8 B. NICOLETTI noteS 1. Nicoletti, B. (2016), Innovazione e Tecnologia nel Procurement dei Servizi Finanziari, The Procurement, 2(2), Apr./Mag., 26:27. 2. Mentzer, J. T., DeWitt, W., Keebler, J. S., Min, S., Nix, N. W., Smith, C. D., & Zacharia, Z. G. (2001). Defining supply chain management. Journal of Business Logistics, 22(2), 1–25. 3. Nicoletti, B. (2017), Agile Procurement. Volume I: Adding Value with Lean Processes, Springer International Publishing, London, UK. ISBN 978-3-319-61082-5. 4. Adapted by the Author based on Malaket, A. (2014). Financing Trade and International Supply Chain, Gower Publish, Farnham, UK. 5. Rao, S., & Goldsby, T. J. (2009). Supply chain risks: a review and typology. The International Journal of Logistics Management, 20(1), 97–123. 6. Morden, T. (2017). Principles of management. Routledge, London, UK. 7. Coleman, S., & Thomas, B. (2017). Organizational Change Explained: Case Studies on Transformational Change in Organizations. Kogan Page Publishers, London, UK. 8. Nicoletti, B. (2014). Using operational analytics to achieve a digitized, visible supply chain. Inbound Logistics, 1. 9. de Reuver, M., Sørensen, C., & Basole, R. C. (2017). The digital platform: a research agenda. Journal of Information Technology, 1–12. 10. newshawktime.com/trade-finance-market-with-manufacturers-application-regions-and-swot-analysis-2022/. Accessed 20 June 2018. 11. www.bis.org/publ/arpdf/ar2018e.htm. Accessed 25 June 2018. 12. industrytoday.co.uk/finance/trade-finance-2018-global-market-to-reachus%2D%2D71000-million-and-growing-at-cagr-of-3-0%2D%2Dby-2023. Accessed 02 August 2018. 13. Laudon, K. C., & Laudon, J. P. (2016). Management information system. Pearson Education India, Noida, India. 14. Nicoletti, B. (2017), The Future of Fintech, Springer International Publishing, London, UK. ISBN 978-3-319-51414-7. 15. Nicoletti, B. (2017), Agile Procurement. Volume II: Designing and Implementing a Digital Transformation, Springer International Publishing, London, UK, ISBN 978-3-319-61085-6. Nicoletti, B. (2017), Agile Procurement. Volume I: Adding Value with Lean Processes, Springer International Publishing, London, UK. ISBN 978-3-319-61082-5. 16. Nicoletti, B. (2017), The Future of Fintech, Springer International Publishing, London, UK. ISBN 978-3-319-51414-7. 17. Nicoletti, B., (2012), Lean and Digitize: An Integrated Approach to Process Improvement. Gower Publishing, Farnham, UK. ISBN-10: 1409441946.