Asian Review of Financial Research Vol.26 No.2 pp.123-151
A Study on the Economic Effects of Supply Chain Finance(SCF) through the Win-Win Payment System
Key Words : Payment System,Supply Chain Finance,Win-Win Growth,Reverse Factoring,SMEs
This study analyzes potential economic effects the supply chain finance (SCF) framework may have on subcontract transactions using theoretical modeling and numerical analysis. The outcome of this study is expected to shed further light on more effective ways in which the supply chain finance (SCF) can be introduced in the market. This attempt aligns with the partnership with and shared growth between large and mid-sized companies, in the formation of a “win-win” market environment. Recently, the opportunity to optimize the financial flow in the whole supply chain processes between financial institutions and business enterprises has increased as most of the commercial transactions are being done through electronic system. This directly links the business flow externally to subcontractors and the like; the flow is no longer limited within the enterprise. This means that the number of targets to be optimized in the supply chain management (SCM) has exponentially increased. Accordingly, such extensive and complicated business ecosystem raises the impact supply chain finance (SCF) has on the businesses. Despite such rapid growth in electronic business transactions, the alternative payment method including electronic account receivables are rather limited. Although there have been some policy efforts to vitalize the electronic transactions, the channels are reserved to, for instance, buying companies and dealings with the companies' tier 1 subcontractors whose credit ratings are relatively high. This evidently creates problems. For one thing, those subcontractors that belong to tier 2 or below in supply chain still very much at disadvantage in the current framework. When they have to liquidate their account receivables, they are but to choose between high discounted prices or an underground money market. On the other hand, more than 70% of the account receivables issued to tier 1 subcontractors are held up to maturity in the banking sector. To resolve this unfair practice, we propose a “win-win payment” system in subcontract transactions to mitigate difficulties faced by small and medium size companies. The system basically extends the reverse factoring mechanism for the sub-tier 1 enterprises. By granting credit supports to those smaller subcontractors, the system helps to decrease the cost of capital and create new incentive structures for suppliers to improve their quality. By so doing, the buyers can also expect to increase their sales and profits from the operation. This approach stands out from the previous studies that have mainly focused on the optimization of cost of capital at the level of the entire supply chain. We think that our approach better reflects the reality in view of the present domestic affairs. According to our analysis, the buying companies have an incentive to induce the suppliers to improve their quality by offering credits to the whole supply chain with the win-win spirit. With the expectation to raise the efficiency in supply chain management, they can also extend the deadlines of account payables, thereby increasing the expected profits as a result. However, we have verified that the system we had proposed operates only in the case in which the credit spread between buying and supplying companies exceeds a threshold. This may explain why the current system, a kind of reverse factoring with recourse only in two firms, is not working well between a buyer and its tier 1 subcontractors. We have also found that, in general, more credit is provided to the supplier whose quality has relatively higher impact on the market demand, which ultimately generates more expected profits. Further, we have proved that the business profits are maximized when the credit is offered to the tier 2 companies when the quality of tier 2 subcontractors has a decisive effect on the cost of the tier 1 firms. By adopting the new payment system, supplying companies are able to strengthen their financial solvency through decreasing the capital cost and holding period of the account receivables. And business continuity with the buyer can be stronger because of their quality improvement. Meanwhile, as for the financial institutions, they also have an incentive to participate the win-win payment system. They can acquire new customers without taking additional risks, often embedded in cross selling and lending. Ultimately, the benefit of the new system can be shared by all as the probability of fallouts in subcontract transactions can be reduced. Consequently, this can further strengthen the national economy as more tax revenues can be expected from commercial bills, which are to be curbed from the discounted underground market into the official banking sector. To make this system work, of course, a set of supportive policies from the government is required. For instance, various tax benefits and credit guarantees can be offered to the buying and supplying companies as rewards to adopting the new payment system in their business transactions. To induce the financial institutions to create more financial products to promote the system, the government can subsidize the expenses for the account receivable insurance. In addition, the watchdog's thorough monitoring against buyers' moral hazard is needed to ensure that the suppliers are free from the right of recourse.