The Future of Supply Chain

Significant value in the global supply-chain finance (SCF) market remains untapped.

Nearly 80 percent of eligible assets do not benefit from better working-capital financing, and the remaining one-fifth of assets are often inefficiently financed. Despite improvements made in recent years, advances have been largely incremental. We now see change accelerating in the market in response to a convergence of factors: an increased focus on working capital, structural changes in financing for small and medium-size enterprises (SMEs), a step change in digital adoption, and the potential geographic relocation of $2.9 trillion to $4.6 trillion in spending on cross-border supply chains (for 16 to 26 percent of global goods exports) over the next five years. Could these events spur the long-anticipated transformation of the landscape? The answer may be yes. In this chapter, we outline key drivers and how they could lead to real change in access to and availability of SCF. We then offer a vision of what such a transformation could look like and what it would mean for market participants. 

Supply-chain finance: An age-old need

Supply-chain finance may well be one of the earliest commercial-payments activities. It has enabled every major trade and supply-chain flow through time, from trade exchange in early Mesopotamia to receivables credit in the 1800s Industrial Revolution, to letters of credit and even blockchain for global supply chains today

The industry fulfills banking’s basic promise of financing the working capital necessary to run any business. When successfully delivered, supplychain finance benefits the entire ecosystem: it enables corporate buyers to secure inventory by extending payments terms, and it improves certainty on forward orders for suppliers. Banks and nonbank SCF providers generate stable, shortduration (and hence lower-risk), often recurring transaction volumes while creating an avenue for broader offerings such as foreign exchange, cash management, and capital-markets products. SCF has only partially delivered on this promise, however. Often it is focused on larger, well-financed multinational corporations and their supply chains, whereas smaller and less well-financed enterprises face barriers to access. Many catalysts—including digital delivery, fintech innovation, industry utilities, blockchain, and API technologies—could stimulate cheaper and more accessible SCF, but change has been slow. Now in 2020, the impact of COVID-19 has contributed to accelerating digital adoption and reconfiguration of trade and supply chains—for example, to improve resilience and diversify sourcing.1 

A promise made but not (yet) kept

While supply-chain finance fulfills an age-old need, its potential continues to be limited by its complexity. We can measure this complexity along four major axes: fragmentation of delivery, fragmentation of the underlying assets, limited credit and expertise, and geopolitical turmoil

What is supply-chain finance?

The overall trade finance market can be roughly differentiated into three segments, each with unique product dynamics —

Documentary business includes traditional off-balance-sheet trade finance instruments, such as letters of credit, international guarantees, and banks’ payments obligations. These instruments are typically used to cover the two corporate parties against potential transaction risks (e.g., an exporter protecting against country-related risks of its importer’s domestic market).

Seller-side finance includes two main financial instruments: factoring and invoice finance.2 These instruments address the financing needs of corporate sellers by anticipating liquidity related to commercial transactions.

Buyer-side finance (referred to as supply-chain finance throughout this article) is typically aimed at large buyers and their suppliers. It covers the financing needs of suppliers originated by large buyers, like reverse factoring, where suppliers can access third-party financing for buyer-approved invoices, as well as dynamic discounting, where buyers pay suppliers early in exchange for discounts on the invoice. This has traditionally been a smaller and more fragmented market (roughly $500 billion of turnover financed), but is now growing at double-digits, driven by increasing interest and new offerings by players

Why this time is different

While many of the drivers of SCF growth are longstanding, ongoing changes might signal a structural shift in the ecosystem. Corporates, both small and large, have structurally increased their use of supply-chain finance, systematically considering how to support smaller suppliers’ working-capital needs. In a May 2020 McKinsey survey, 93 percent of global supply-chain leaders expressed plans to increase supply-chain resilience, with 44 percent willing to do so at the expense of short-term savings. This could double historically low SCF eligibility and uptake levels from below 40 percent to as much as 80 percent. Unsurprisingly then, the recent supply shock from COVID-19 led to the increased use of supply-chain financing. For instance, Prime Revenue saw growth of more than 25 percent in the number of corporate users in the first half of 2020 relative to the prior year, with the share of financed invoices exceeding 90 percent in some months, compared with the more typical 70 to 75 percent. 

Supply-chain diversification as a catalyst for holistic SCF

A once-in-a-generation supply-chain diversification creates a catalyst for modern, holistic SCF solutions. The McKinsey Global Institute estimates that up to $4.6 trillion of global exports (26 percent of the total and up to 60 percent in industries such as pharmaceuticals) could be in scope for relocation over the next five years. This will structurally shift the ecosystem, likely in favor of players with holistic offerings across receiving corridors, whether in intra-domestic trade, in regional trade, and/or across a more diverse set of global corridors. This may result in additional support for solutions catering to the needs to domestic bank customers. Examples include Deutsche Bank and Commerzbank targeting automotive value chains.

Tackling fragmentation with digitization Digitization resolves issues arising from fragmentation of delivery as corporates are actively focusing on their supply chains. The aforementioned 2020 survey across industries identified 79 percent of respondents planning investments in digital supply chains. One corporate executive stated that COVID-19 has forced “a change of mindset” from the historically slow pace in digitizing supply-chain activities. Similarly, banks are forced to develop truly end-to-end digital capabilities, from onboarding and application through approval and execution to improve servicing, capacity, and ability to automate underwriting and risk management.

Changing competitive forces Many nontraditional players are aggressively targeting attractive niches in this business, threatening banks’ revenue streams:

Fintechs are developing value propositions centered on digital platforms to provide non-financial services, directly connecting corporates. For instance, fintechs (e.g., Us-based C2FO) are offering dynamic discounting, an innovative nonlending-based supply-chain finance product enabling buyers to make early payments to suppliers in return for a discount. Tradeshift, another example, offers an integrated platform to large buyers and SME suppliers spanning the procurement value chain. Recent partnerships and investments in companies like these are signs that model is catching on.