Trade plays a vital role in fuelling economic growth and fostering cooperation among nations. At the heart of global trade is supply chain finance, which manages financial flows, events, and processes among partners throughout a supply chain. However, traditional financing methods (such as cash-in-advance, letters of credit, open accounts, documentary collection, consignment, credit insurance, and factoring) have proven inefficient in addressing the growing $17 trillion financing gap.
The allure of technology investments lies in their potential to disrupt the status quo, foster groundbreaking innovation, and create unprecedented value. In this article, we explore the disruptive potential of supply chain finance and discuss an investment thesis for startups and investors in this space.
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The Problem with Traditional Financing Methods
The status quo in supply chains often involves a conflict of interest between suppliers and buyers. Suppliers want to receive payments quickly, while buyers aim to extend payment terms. This approach shifts the financial burden onto other parties involved, making it challenging to build trust and long-term business relationships. Traditional financing methods exacerbate this issue, leading to inefficiencies and financial strain.
Disruptive Potential of Supply Chain Finance
Historically, supply chain finance has not been an option for smaller suppliers, as bank-led programs are engineered to serve participants with high credit ratings. The disruptive potential in supply chain finance, therefore, lies in the ability of smaller suppliers to access credit tied to the buyer’s credit rating rather than the supplier’s, enabling non-investment grade and tail-end suppliers to access broader pools of capital. The ability of the tail-end suppliers to access credit changes the basis of competition and allows them to compete at a larger scale because of better visibility into payment processing and access to working capital.
Current areas of innovation within Fintech
The primary functions in fintech lending refer to new, technology-enabled business models related to deposit taking, credit intermediation, capital-raising, and the collection process.
Figure 1: Inclusive Fintech Lending
Accordingly, lending models typically innovate across four key dimensions:
- Origination: The ability to originate via some unique channel or where it would increasingly introduce more friction for a potential borrower to try and find some competing offer. Proprietary origination sources allow a lender to advance money to customers who will accept a non-competitive price because there are few alternatives. And these companies have low CACs, high margins, and are difficult to rip out, so they have high barriers to entry.
- Underwriting: The ability to innovate new forms of credit where financial market players find it challenging to catch up. As additional transactional data points are collected, and survivorship selection bias sets in, the cost of capital will come down, making it easier to offer cheaper advances to customers and more challenging for new competitors to compete.
- Sourcing Capital Differently: The ability to source capital differently, resulting in cheaper borrowing rates that can be passed to customers. Companies with access to alternative forms of capital have structurally cheaper COGS, offering savings to consumers, high margins, or both.
- Collections & Servicing: The ability to collect outstanding receivables better. Companies that are good at servicing can offer their loans at low rates knowing that their default rates will be low due to the repayment mechanism (such as embedded finance deductions), or they can offer loans at standard rates and earn a higher margin. Alternatively, they can lend to customers that other lenders would not consider, as, without the repayment mechanism, the borrower would not be credit-worthy enough.
Future technology-led models in Supply Chain Finance
As digitization continues to transform processes in a fragmented ecosystem, the following business models are likely to emerge and evolve:
- Model 1: Bank-led: Banks improve end-to-end delivery by reimagining client journeys, renovating technology, and delivering AI-enabled financing. By effectively drawing upon the strength of their corporate client portfolios and established credit decisions and provision processes, they resolve longstanding challenges such as onboarding, distribution across the full set of suppliers and invoices, and scaling their overall ability to provide credit.
- Model 2: Bank-led partnerships: Banks partner with platform providers to develop solutions (ERP integration, third-party data) but retain control of the customer interface. Banks then move beyond numerous (but often superficial) partnerships with fintech or technology platforms to create seamless and digital supply chain finance journeys spanning procurement, invoice creation, and financing. This is accomplished through APIs and connectivity across suppliers and buyers in the value chain spanning digitally native, invoice-agnostic supply chain finance platforms covering a buyer’s full set of suppliers and the seller’s full set of invoices.
- Model 3: Platform-led: Nonbank platforms scale to provide supply chain finance across the complete industry value chain of suppliers and buyers, linking into banks and nonbank financing providers. They draw on established capabilities, including rapid distribution and onboarding of suppliers’ invoices and platform flexibility to cater to different invoice types and supply chain finance products. They enable the platform providers to become the go-to source for invoicing data and financing. Banks and other ERP platforms serve as secondary sources and the underlying “pipes” in this model.
- Model 4: Diverse supply-chain finance ecosystem: A broad range of providers coexist, each catering to different needs. Given existing fragmentation, we can envision a continued niche-based evolution of supply chain finance (e.g., in e-commerce or textile distribution), catering to the full set of suppliers and specializing in credit assessment for selected industries. Platforms could build out digital, easy-to-use, self-serve management of invoices for SMEs, aggregating the range of supply chain finance products and financing sources.
For startups and investors interested in supply chain finance, I believe there are several principles to consider for long-term success:
- Platform-led models and diverse supply-chain finance ecosystems are more likely to incorporate all stakeholders, providing comprehensive solutions for buyers, suppliers, banks, platforms, and lenders.
- A verticalized software approach that solves key pain points in the supply chain finance value chain, such as invoice reconciliation and credit scoring, can be a competitive advantage.
- Leveraging off-balance sheet financing facilities through integrations with multiple financial service providers enables startups to access a larger capital pool and capture additional value as their customers grow.
- The ability to integrate with existing financial infrastructure, especially payments automation software, is crucial. While payment automation offers real-time settlement, supply chain finance remains attractive due to its trilateral relationship management and higher profitability in lending models.
Supply chain finance represents a significant opportunity for startups and investors. By disrupting traditional financing methods and embracing technology-enabled models, supply chain finance can bridge the financing gap in global trade. As digitization continues to transform industries, startups that focus on platform-led solutions, verticalized software approaches, and off-balance sheet financing are likely to thrive. With a diverse ecosystem of providers coexisting, the market offers ample room for innovation and multiple successful business models to emerge.
