More worrying evidence was seen in Chile, where the government limited the length of payment terms a large retailer could impose on small suppliers. In response, the retailer drastically reduced its volume of trade with these smaller suppliers and opted to source more from its own subsidiaries rather than from outside suppliers.
Reducing inventory and hurting finances: evidence from retailers in France
Looking at trade credit regulations through the lens of the supply chain, our recent research has focused on one major supply chain investment: inventory. A healthy level of inventory at every level of the supply chain is critical to managing various chain risks that range from changes in customer tastes to supplier disruptions. As such, inventory represents a substantial investment for businesses. For example, among public retailers, inventory accounts for more than a third of their total assets.
The link between trade credit and inventory is intuitive: by extending trade credit, the seller shares the cost and risk of the buyer’s inventory, which would otherwise be borne solely by the buyer. Such sharing incentivizes the buyer to hold a higher level of inventory, which, in turn, would better meet customer demand and ultimately not only increase the seller’s own sales, but also benefit the entire supply chain. Therefore, restricting the use of trade credit below the equilibrium level can undermine this link and lead to underinvestment in inventory and, therefore, degraded supply chain performance. Could such a phenomenon be observed due to the recent restrictions on trade credit?
To quantify this impact, we focused on the French LME, which limited the duration of trade credit to 60 days for most French companies. In order to isolate the impact of the legislation, it is necessary to identify a set of monitors that are comparable in all respects except their exposure to the LME. Since most French companies were subject to the new legislation, we grouped companies from other EU countries to create comparable synthetic “twins” of each French company.
Additionally, we sought to eliminate the potential impact of other confounding factors (such as the 2008 global financial crisis) that may have affected French companies differently than their non-French counterparts. Specifically, we use a subset of French firms and their respective European “twins” that were unaffected by the LME (their trade credit usage was already below the 60-day threshold) as a baseline for calculate a relative effect free of confounders. .
We found that the LME had a significant impact on retailer inventory investment. Taking hardware retailers as an example, the LME caused a 16% decline in trade credit, which then led to an 11% reduction in inventory.
A drop in inventory will not only lead to emptier shelves and more dissatisfied customers, but will also hurt retailers’ financial performance. Indeed, we have seen a 15% drop in revenue and a 3% drop in gross profit for retailers due to trade credit restrictions.
Supply Chain FinTech: Potential and Challenges
As our research shows, government regulations that directly limit the use of trade credit are not a panacea. In fact, one of the benefits of trade credit is that it is deeply integrated into supply chain transactions and allows for more flexible allocation of working capital among different stakeholders. Rigid government regulation kills such flexibility.
Instead, we advocate for a market-based approach that incorporates “supply chain fintech”, which uses digital technologies to facilitate financial flows in the supply chain. By enabling greater visibility and price flexibility, supply chain fintech could not only better incentivize large companies to pay their suppliers when they need capital, but also address other funding challenges. Trade.
For example, a headache faced by credit-starved SMEs is that banks or their big suppliers won’t lend to them. The Asian Development Bank has estimated the global “trade finance gap” at $1.7 trillion, with small and medium enterprises accounting for half of the total.
The reasons for this financing gap vary: lack of collateral; asymmetry of information concerning the condition of the potential borrower; difficult regulatory requirements for lenders to meet, such as know-your-customer; and low profitability.
Digital technologies could help overcome these difficulties. The Internet of Things could help monitor inventory, allowing companies to unlock their collateral value. Blockchain-based consortia work to break down information silos and provide end-to-end supply chain visibility. Finally, big data and analytics provide the opportunity to better identify supply chain actors in need of credit and assess their risk.
Offering such suggestions is inevitably reminiscent of the 2021 collapse of Greensill, the supply chain finance firm that hired former British Prime Minister David Cameron, among others. Greensill’s collapse, however, was not a failure of trade finance in general or technology in particular, but of risk management and corporate ethics.