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Supplier payment

The high cost of extended payment

If your organisation makes suppliers wait longer to be paid, it can end up paying for the more expensive credit they need and disturb the equilibrium in your relationship

 

Autumn 2009

 

By Matthew Harrowing

 

If your organisation makes suppliers wait longer to be paid, it can end up paying for the more expensive credit they need and disturb the equilibrium in your relationship

No business is an island. It sounds like a statement of the obvious but we rely on our supply chains, which are often built on longstanding relationships. However, there is a tendency when things become challenging to become a little myopic. 


One of the more obvious and unhelpful examples of this is the tendency to increase payment terms. Last December, the UK’s Daily Telegraph reported that: “Some two-thirds of firms said they had seen at least one customer try to extend their payment terms in the past three months, with 61 per cent of those revealing that the demands applied to the payment of invoices for contracts already fulfilled. The remaining 39 per cent said that the terms applied to all future business with those customers.”  

Late business


This September, the UK’s Federation of Small Businesses stated that 4,000 business failures last year were caused by late payment and that one in three of its members now waits longer to be paid than a year ago. Despite the impact of this on the wider economy, the number of large companies electing to arbitrarily lengthen payment terms seems to be accelerating. 


As a supplier, I recognise and understand the rationale behind extending payment terms. Nothing I am about to say is in any way meant to criticise those organisations that are genuinely struggling with cash during this difficult time. I appreciate that many have had to take drastic measures to maintain some cash balance and secure the future for their many employees. 


Instead, my comments are directed at those companies that could raise money in other ways yet have elected to use what I would consider the crude and expensive instrument of arbitrarily lengthening payment terms. As I see it, this has a disproportionate impact on supplier relationships, is very expensive and ultimately becomes self-defeating.


During sourcing activity, contracts are often negotiated over protracted periods. Co-dependent relationships are formed based on mutual understandings. What should result from these negotiations is equilibrium of value and price. When a customer unilaterally changes payment terms, it changes the basis on which the relationship was formed, upsetting this equilibrium. In doing so, it undermines the principles of engagement and creates an adversarial environment, but why? 


As we know, supply and demand is partly how goods and services obtain value. The scarcer the supply of a given commodity, the more it is worth. So the more money that is in circulation, the less each unit of currency is worth. Put simply, a large organisation typically has a greater requirement for cash than a small organisation and therefore has more purchasing power and can negotiate better rates. 


According to government figures,  there are 4.7 million businesses in the UK, and 99.9 per cent of them are small and medium-sized enterprises. They employ 13.5 million people or 59.2 per cent of the total private sector workforce. They contribute as much as large businesses to UK output with 51.5 per cent of the turnover. 

Capital punishment


So whether you account for them by number, employees or output, a high proportion of most supply bases will comprise these SMEs. It also stands to reason that an SME will have less access to capital and would be paying a higher interest rate. By lengthening payment terms, this cost of capital is pushed down the supply chain. 
Your suppliers will have to acquire this capital but will probably pay a premium rate. They will then seek to maintain margin and reduce costs. This will result in either less attention being given to your account or the use of cheaper or less resources, affecting productivity and increasing costs. The impact on your business would be indirect but still carry a cost. It may not be readily visible to your organisation for some time, but whether it is waiting longer for the help desk to answer your calls or a slower internet connection, you will pay for it in the end. 


There are far more sophisticated and better ways to achieve your capital objectives rather than taking longer to pay suppliers. They will simply be forced to find new sources of finance. Because the majority of these companies will be smaller than the purchasing organisation, the alternative sources of capital available to them will often be expensive, requiring suppliers to look to compensatory measures to maintain margin, with a potential impact on the productivity of your organisation. In this scenario, the argument for lengthening payment terms becomes self-defeating, the buyer-supplier relationship is affected and existing relationships are simply undermined.


Instead, I suggest that you identify your real capital requirements and assess alternatives. If none are available, sit down with your suppliers, understand the symbiotic nature of the relationships and come to an agreement that fosters an atmosphere of mutual trust and idea sharing and one that maintains that all-important price-to-value equilibrium.

 


 

Matthew Harrowing (matthew.harrowing@etesius.com) is co-founder
of Etesius, a spend information company, based in Essex, UK

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