Emerging market SMEs are losing out in the fight for business within the global value chain because of unequal access to finance.
Trade finance companies like PrimaDollar offer a potential solution.
This short article sets out some of the trends and explains how trade finance solutions can be developed to boost SME exporters across South Asia.
What is going on?
The global value chain converts raw materials, labour and capital into finished products that consumers buy. But in recent years, the rules of the game have been changing. A number of factors are creating important shifts in the way that products are being sourced with implications for the structure of emerging market economies.
Here are four trends, amongst a number, that we might highlight:
1. Efficient markets: pricing pressure
The internet has increased price transparency and the ability of consumers to shop around. Price transparency has led to increased pressure on margins and a diminution in customer loyalty
Consumers demand a high a quality product at a price which offers value. They can easily test any price in the market for value, and they do.
So price is becoming an ever more important consideration in sourcing, leading to changes in the way that supply chains are being operated. Buyers are being forced to move supply chains into lower cost locations.
2. Finance is less available and is less flexible
Increasingly banks are finding it harder to work cross-border and to deal with customers that they do not know well. This is principally driven by the cost of regulation and the cost of making mistakes. Fines for non-compliance can wipe out decades of profitability in transaction banking. Many banks are withdrawing from markets or declining trades that ten years ago they would have easily executed. Transactions that do happen often take longer and cost more.
This is leaving large gaps in financial support for the global value chain.
But many buyers are finding that their legacy cost structures are under pressure whilst SME suppliers in lower cost locations are struggling with cash flow issues.
3. Supply chain as an asset
Many buyers (especially retailers) understand that their supply chain is one of their biggest assets, and a significant competitive advantage. This understanding changes the way in which responsible retailers work with their suppliers.
This is leading many larger buyers to develop supply chain finance programs intended to provide financial support to the supply chain; this is to ensure that the supply chain is efficient, stable and can work with deferred payment terms. Supply chain finance programs, once implemented, lead to wholesale changes in trading terms, which many retail buyers seek to apply across their supply chains.
But supply chain finance is often unavailable to smaller suppliers in lower cost locations, or simply provides the payment too late.
4. SMEs in emerging markets are finding it harder not easier
SMEs are getting are squeezed by these trends. Supply chain finance programs often do not address the needs of emerging market suppliers very effectively.
Funds are available, but typically too little and too late. An emerging market supplier has usually borrowed local funds to support the purchase of materials and to pay wages; the SME supplier needs to be paid before shipment (to clear pre-shipment finance) and not 30 or 45 days later when invoices are approved by the buyer’s finance department.
Moreover, the finance providers behind these supply chain finance programs (usually banks) are often unwilling to on-board smaller suppliers who are located in “in hard to check” locations (the so-called “long-tail problem” in SCF).
Traditional trade finance solutions, such as letter of credit, are expensive and buyers are unwilling to provide them, especially if they have a supply chain finance solution in place.
This leaves SME suppliers largely unsupported.
SME suppliers are unable to compete with larger and better capitalised competitors who can live with the new financial realities.
There are a number of implications of these trends – and there are considerations for both ends of the global value chain.
PrimaDollar works with exporters, including many SMEs, across South Asia who serve international buyers.
In many countries we can see business consolidating in the hands of the larger suppliers at the expense of SMEs (who move into sub-contracting). This is driven principally by unequal access to finance.
Without a thriving SME sector, wealth will not trickle down efficiently and economic growth is unlikely to be maxmised.
Solutions are available
There is a new breed of trade finance platform emerging from the 2008 financial crisis and taking advantage of the shifts in the financial landscape that have followed. PrimaDollar is one such company, and there are quite a few new players entering this space.
Trade finance is a low-cost alternative to the traditional LC, allowing suppliers to be paid at or before shipment whilst allowing buyers to pay later.
Trade finance is better and cheaper than “factoring”, which does not work well for emerging market suppliers because of cost and low advance rates. Trade finance is also “democratic”, as it is equally available to suppliers of all sizes.
The system works quite simply: The trade finance company:
- purchases the shipping documents for cash upfront, often settling against copy documents which means that control over the goods can remain in the hands of a local bank until payment is received.
- collects from the buyer later and takes all the risk of non-payment.
This arrangement allows even SME exporters to work without risk on Open Account with deferred payment (also called working on “sale contract” or working on “DA terms”). The cost and availability of finance for the trade is driven by the credit quality of the buyer, not the supplier.
We are in a period of transition, as supply chains move looking for lower cost locations and whilst financial support of the global value chain moves from the banks to the new breed of trade finance companies. This period is not without pain, but opportunities are emerging everywhere as a result.
More attention needs to be paid to the role of finance in the global value chain – as the unintended consequence of ignoring the new financial realities can result in lower economic growth and greater inequality in the supplier countries because SMEs are deprived of the oxygen of finance that they need.
The good news is that trade finance solutions generally work across South Asia without changes being needed to local legislation, bank regulations or foreign exchange controls. The bad news is that the finance gap is huge and getting larger – there is a lot of work ahead for everyone.
CEO, PrimaDollar Group, London
This article originally appeared in the Indian Global Economic Summit handbook, 2018. Click here for information about GES.