The COVID-19 outbreak has caused unparalleled disruption to supply chains and markets throughout the world. Goods have stopped sailing, factories are shuttered, and assumptions have been shattered as the world slowly reopens.

Businesses are now forced to rethink their dependence on China, how they manage their working capital, and how they can reduce supply chain disruption and improve resiliency.

In this webinar, LSQ's CEO, Dan Ambrico, shares data-driven strategies and insights to help businesses successfully emerge from the current crisis and how to improve their supply chains in the post-pandemic world.

Highlights from this webinar include:

  1. Understanding the Cash Conversion Cycle and how it can be used to improve working capital and cash flow management
  2. How to assess the financial health of your supply chain
  3. When to leverage "Just-in-Time" vs "Just-in-Case" supply chain strategies
  4. Is now the right time to diversify your supplier base away from China? If so, which countries can fill the gap?

Watch the Webinar

Webinar: Future-Proof Your Supply Chain Against Disruptions

Featured Speakers

Dan Ambrico, Chief Executive Officer
John Teixeira, VP of Marketing


Transcript

John (Host): All right. We're going get started. Hello and welcome to our webinar, Future-proof Your Supply Chain Against Disruptions, where we will discuss the impact of Covid-19 on supply chains, how businesses are adapting, and what you can do to build resiliency for you and your suppliers. Obviously, a black swan event like the corona virus is having an unprecedented impact on the economy and supply chains, and we are working hard to provide valuable insights and tips to help businesses navigate the pandemic. Let's start off with a little background on LSQ, who we are, what we do, and why we have a unique insight into the impact of Covid-19 on businesses.

About LSQ

John: LSQ is a leading provider of working capital solutions. We've been in business for over 20 years and specialize in products like invoice financing, supply chain finance, and other specialty finance solutions. Therefore, due to the nature of our business, we sit at the intersection of payment transactions between businesses and their suppliers. In fact, we have funded over 25 billion dollars to businesses throughout the United States, and work with over a hundred and forty thousand credit profiles. That gives us a pretty unique perspective on the financial impact of the coronavirus on cash flow, the supply chain, and more.

Now I'd like to introduce our panelists, starting with myself. My name is John Teixeira and I will be your host. LSQ is also fortunate to have some great financial minds with a long history of analyzing and managing risk. It’s my pleasure to introduce Dana Ambrico. Dan is the CEO of LSQ. He has spent over 15 years in the financial services industry with stops along the way including JP Morgan, Goldman Sachs, and Level Global.

Before we get started, I just wanted to let our audience know that you can submit questions at any time during the presentation about the content that we will cover, or about the current state of the economic environment. You can do this by entering your question into the chat or questions panel of GoToWebinar. And now without further ado, I will turn it over to our CEO Dana Ambrico to get us started.

Dan: Thanks, John. Good afternoon everybody. So I wanted to quickly share some objectives in our agenda today. I think we really had two primary objectives. The first was to provide some context on the impact that Covid-19 has had on global supply chains, and the second was to share insights into topics that we felt were relevant for treasury and procurement teams. As John mentioned before we sit between  suppliers and corporate buyers, so we have a really interesting lens into the impact so far and what we see as headwinds and tailwinds going forward.

Covid-19 Impact

Dan: So maybe we'll start with just more broadly speaking the macroeconomic impact. I think the right way to think about it is it's been very broad-based. Very few industries have been spared disruption. If you look at our own portfolio of clients you know the magnitude of volume declines has been anywhere from 10% to 50% depending on your industry profile. Some anecdotes here from Dun & Bradstreet. Virtually none of the fortune 1000 has had no disruption when you look across their tier one and tier two suppliers. Three-quarters of US companies have faced some sort of supply chain disruption in the last 90 days. It's safe to say this is somewhat of an unprecedented broad global disruption.

Impact On Global Trade

Dan: If we look at some data— if you think about the impact of global trade. A bear case scenario would have global trade dropping back to levels of 2010, which would be a 40% decline. If you're looking at foreign trade, expected to drop by a third potentially this year. 70% of US ports of had restricted travel of some sort you know. I think it's not just to look at these declines on an absolute level, but in the context of the fact that we have unprecedented government support also, otherwise it'd be probably far worse.

The biggest challenge in our opinion is both not just managing the magnitude of the decline, but what happens going forward. You know it's hard to bring back workers and restart. We think that reorders and what we're seeing is lumpiness and choppiness burning off pre-Covid impact. So, the magnitude of the decline is one issue, but going forward and managing choppiness and uneven demand is entirely different issue.

Impact On Production

Dan: If you think about it from a production standpoint, one of the biggest impacts is the slow down deliveries and the impact that manufacturers have had— managing new safety measures, social distancing, having to shut down, having to restart. Right now we've seen durable goods orders drop about 30%. If you're looking at China, and if you're thinking about Chinese manufacturers, let's call it 30, 60, 90 days— some of them are only still operating at 60% of capacity. It's having material impact on delivery times, which is likely having an impact on both you and your suppliers, and ultimately on consumers.

Impact On Inventories

Dan: If we think about it from an inventory perspective, and that's a topic that we're going to go a little bit deeper into later. There's been a big buildup in inventory due to depressed consumer demand. Across retail, automotive, you're seeing it in the oil and gas industry as a second derivative. You're seeing it in certain pockets of food, and then certainly in the leisure industry. If you think about hotel rooms and spare capacity as inventory, they have meaningful excess inventory. If you look at inventory to sales ratios and you look at it over a decade time frame, we're at relatively unprecedented levels of inventory as a percentage of sales. The vast majority of companies have expected to increase inventory and run with higher levels of inventory to manage through disruptions and potential disruptions to their suppliers. All this has a tangible economic cost, and we'll get into that in a little bit.

Impact On Cargo Shipping

Dan: Think about it from a cargo shipping standpoint, and I think of this as a big input cost for many of you. One of the biggest problems is capacity has been coming off line. Volumes are down 10%, but you're also seeing capacity drop by what we see it as, let's call it four million containers. And if you think about air capacity, that's also off by a third. Passenger flights often are major source of shipping. As passenger flights have come offline, it has reduced the capacity for shipping, which has pushed up rates. So during a period where you're seeing depressed demand, you're actually seeing shipping rates go up, which is putting quite a squeeze and a cost headwind for everybody.

What's Changing?

Dan: If we were to just sort of take a high-level view or summary of sort of the macro backdrop and some of the themes we see the most important themes, I think the first would be how to think about decentralization or reducing concentration ranks, risk, and diversification within supply chains. So that can be a reduce dependency on China. That could be localizing sources of distribution. There's a shift in how everybody's thinking about inventory, and I'll get into that more depth, but a shift from sort of a just-in-time very efficient inventory structure to something where there just-in-case, where there's more redundancy.

Liquidity has also become incredibly important as corporates are solidifying their balance sheet, also thinking about the financial health of their suppliers, and disruption risk that may come from supplier liquidity risks. Just thinking more broadly about supply chain resiliency and risk mitigation, particularly in areas like medical equipment, has become something that I think is a broad-based theme. As I mentioned, controlling input costs— all this comes with, in our opinion, higher costs. So, shipping goods to the extent capacity continues to come offline, if we see demand come back quickly, that capacity does not come back at the same rate, which will push up rates.

Think of labor the same way— we've seen lots of workers furloughed or laid off in the last 90 days. To the extent those workers come back, oftentimes you're going to have employers competing with unemployment benefits. Unemployment benefits may be more generous than wages, which would push wages up. If you think about insurance and the level of disruption we've seen across not only supply chains, but business disruption, I think everybody should expect their premiums to go up. So, it's going to be a challenging environment where not only revenue is impacted, but the cost side as well.

Winners and Losers

Exodus From China

Dan: Winners and losers. We kind of want to talk a little bit about what are some of the shifts we're seeing globally across supply chains. Winners and losers may not be the right way to put it. Maybe let's think about it as long-term headwinds and tailwinds. One area where we see considerable headwind is in Chinese manufacturing capacity. A UBS study showed potentially 1/3 of Chinese exports were at risk of relocation over the next decade. If you look at sampling of US companies, 82% of US firms surveyed said they were looking to bring some level of production back to the US. 75% of CFOs were reinforcing their goal to diversify some of their production out of China. It's being exacerbated by some of the political instability and concerns about tariffs.

The overarching theme I think though is reduced dependency on China as a source of manufacturing capacity. The questions we have are— is this just a short-term overreaction, and will this lead to a real level of disruption to the Chinese export sector, or is it short-term and there will be very little disruption If we look at it through a longer-term lens? And then there's the unintended consequences of a decision to diversify manufacturing away from China. There's lots of skilled labor. There's lots of domain knowledge. There's compliance and standards that have been hammered out over the course of the last twenty-five years. These transitions tend to take time, and there's lots of consequences, and therefore, we think it'll happen slower than people think.

But if there were to be a shift and there were to be some sort of diversification away from China, like a China plus on strategy, which we've heard a lot about— we wanted to address where would some of that capacity go, and what industries are most likely to move if there were to be movement. I think some of the potential beneficiaries first would be the United States, and bringing some of the manufacturing capacity back to the US. Certainly I think we've heard about it most frequently in the pharmaceutical and medical supply space, but that could broaden out to a lot of other industries.

A couple of other countries that are strong from a pharmaceutical perspective are Pakistan and India. India also has textiles and high-tech manufacturing, and hardware, which could lead which could drive some benefit if you see diversification away from China. Vietnam from a machinery Footwear a textile standpoint, certainly Mexico from a textiles and machinery standpoint. All could benefit from diversification if US-based and European-based companies decide to move some of their manufacturing and supply chain away from China.

Industries Likely To Be Repatriated

Dan: If you think about industries likely to be repatriated— pharmaceuticals obviously one of the ones most likely mentioned. The concentration risk for certain pharmaceuticals is very high and highly exposed to China, and so there's potential to bring some of that manufacturing capacity back to the U.S. The semiconductor industry is one that frequently gets mentioned. The vast majority of semiconductors come from Taiwan, Korea, China, Japan. We've started to see some movement on moving semiconductor manufacturing back to the US. Intel announced the facility they're going to be building in Arizona, and I think you may see more of that. Auto manufacturing, certainly Mexico and China are two big areas of manufacturing capacity for the automotive sector.

Do we see some of that repatriated back to the US which still has lots of capacity? Mining and rare earth elements. I think everybody's probably seen this data point that 90 plus percent of rare earth elements come from China. Obviously the U.S. is sitting on quite a bit of rare earth capacity in states like Nevada. The question is whether we will repatriate some of that. And then ventilators and medical supplies. This one makes the most sense and we think will happen the quickest. Certainly as we looked at PPE— masks and ventilators, most of that capacity is coming from Asia. I think you're likely to see, in potentially government-funded capacity, built here in the United States.

Just-In-Time vs Just-In-Case

Dan: Some of this has impact on how companies think about inventory management. We thought this would be a very important topic. Inventory has for a procurement team one of the most important strategic responsibilities.

Just-In-Time (JIT)

Dan: If you look at where inventory  has been, starting really with sort of e-commerce and the popularity of e-commerce going back let's call it 25, 20 years, has really driven sort of this just-in-time concept of inventory. The themes there are efficiency, cost reduction, real-time matching of supply and demand. Very popular in the retail industry, but it's certainly broadened out to a lot of other industries. You know, I think that what Covid is exposing is the fragility of this model. It’s really good at containing costs. It's not good at building redundancy. It's not necessarily good at tail risk disruption.

Just-In-Case (JIC)

Dan: So an alternative that's being talked about is something called just-in-case. Just-in-case is really kind of exactly what it sounds like. It's building up redundancies. It's carrying more inventory. Your strategy is really aimed at managing through major disruptions. There's certainly going to be strategic reasons for industries that provide critical goods and services to think about adjusting case model, but it comes with trade-offs. With redundancy comes higher carrying costs, storage costs, and labor costs. There's unintended consequences of that, but we think for medical, pharmaceutical, cleaning supplies, certain areas within food— just-in-case may become more popular over time.

If you look at the two side-by-side, I think the right way to think about it is, just-in-time is really about being lean. It's about being efficient, it's about managing space effectively, it's about pairing supply and demand, it's about not having inventory be a major drain on liquidity and potentially also being a little bit more nimble to smaller changes in demand. Just-in-case— it's more expensive; it reduces fragility.

From a capitalism standpoint, if you want to think about that more broadly, just-in-time is very much about doing more with less, and just-in-case is more about building in longer-term redundancy, potentially at the expense of efficiency. I think some other ways to think about some other implications from an inventory standpoint— I think less concentration risk from a packaging standpoint. If you look at the meatpacking industry, it’s become very concentrated over time, which has made it very susceptible to disruption risk. If you look more localized distribution centers, or certainly proximity to production being another major theme.

Transitioning To "Just-In-Case"

Dan: All of it in our opinion comes with various consequences. What we think is the biggest consequence is inflationary pressure and impact to unit economics. There's no question that as supply chains face material disruption and companies build in some redundancy to manage through it, that comes with higher costs. Higher cost of labor to manage it. Storage costs, insurance costs. You're going to have more liquidity tied up in your inventory. There's going to be more pressure to forecast more accurately. You're potentially looking at moving and distributing your supply across a broader range of suppliers, which means more relationships to manage.

So really what  this is about is being less reactionary. Being a little bit more stable, but at the expense of you know potentially liquidity in markets, which is the last topic we wanted to cover with everybody today— how to think about liquidity; both your own balance sheet liquidity and your supplier's health.

Liquidity and Supplier Health

Corporates Reinforce Their Balance Sheets and Liquidity...

Dan: So maybe just starting with a more macro picture. What we've through the first half of the year is a race by large U.S. corporates to access the credit markets. We're on a run rate from a credit issuance standpoint halfway through the year to exceed the vast majority of what we've seen over the last 25 years. My guess is we may by the year-end see double the credit capacity issue in calendar 2020 than we did throughout the last decade.

Really, it's about corporates reinforcing their balance sheets and making sure that they are liquid heading into a period of demand disruption; and while credit markets and the government is providing a backstop, and while rates are where they are, I don’t disagree with the decision.

... While Enterprises Want to Hold Onto Cash and Enhance Liquidity

Dan: Another way to think about it is— liquidity in the cash conversion cycle across industries. Various industries have various impacts to their liquidity. If you look at the healthcare industry, what really constrains their liquidity is their receivables. Most hospitals, pharmaceutical companies get paid by insurance companies, and insurance companies tend to pay very slowly, which slows down their cash conversion cycle.

If you're in the material space or the retail space, it's likely how quickly you can produce and turn inventory that impacts your cash conversion cycle. Then there's industries that have more predictable cash flow, like a utilities company or an energy company, but the point we're trying to make on this slide is every industry has different liquidity needs and different pressures on their liquidity, and you only have so much control over it.

Cash Conversion Cycle

Dan: We just spent a bunch of time talking about inventory and how we don't think inventory will be a liquidity tailwind for many going forward as supply chains get disrupted. You're looking at diversity diversification. You're holding more inventory. That's likely going to be a net drain on your cash conversion cycle.

From an accounts receivable perspective, you have less control over how quickly your customers pay you. That’s always something that's very important if you're in a consumer facing business. It's certainly less of a problem if you are in an enterprise facing business, it can be a big challenge. If you square off with an insurance company, it can be a very material challenge. It's just something you have less control over.

The one lever that we think most procurement and treasury teams do have a lot of control over is payables— how quickly you pay your vendors, and that's really what we wanted to focus on— how to think about your payment terms with your vendors, both the impact it will have to your balance sheet and what it means to your suppliers.

How To Extend Payment Terms

Dan: One way to drive improved the liquidity is to extend payment terms to your vendors. The problem with that is that for every term extension you give, it boosts your liquidity and impacts their liquidity, so it's a bit of a zero-sum game. Your gain is their loss. If you're thinking about extending payment terms or you're considering a more broad-based early payment program, there's a few things we thought you should keep in mind as you communicate with your vendors.

Before you speak to anyone, you should probably analyze your AP spend. There may be some interesting data that shows you behaviorally how you pay across suppliers, how you pay within a certain supplier relationship, what your days to pay looks like against your actual terms, where you have concentrations and you may have less leverage and critical suppliers versus your long tail with your smaller suppliers. There's a lot of very interesting data probably trapped in your AP spend that will tell you stories and provide you good guidance on how to think about evolving your payment terms with your supplier base.

The second thing you should think about is what would be the consequence in assessing the impact to your suppliers how should you choose to extend payment terms? I think this is really about communication and starting to understand your suppliers financing access to capital and liquidity, and some of their own challenges with how they are managing potentially lower volumes. So this is really doing some due diligence, having conversations with your suppliers, building up anecdotal data that “yes they can support an extension of payment terms” or “no you potentially may tip some of them over”. I think it's important to think about your supplier's health within the broader context of extending payment terms.

The third thing is of course, you can introduce an early payment program— something we do here at LSQ. Supply chain finance is a way to introduce something that can be mutually beneficial, allow you to extend your payment terms without negatively impacting your suppliers. Obviously a lot of that is going to depend on cost of capital and your credit profile, but that is one way to I guess maybe have your cake and eat it too, is you can extend payment terms while offering an early payment program that allows your suppliers to access cash flow on demand.

Certainly if you decide to go down that road, collaborating with treasury who's managing the liquidity, and your accountants who are thinking about your balance sheet and trade payables, and making sure you continue to get trade payables classification, should you introduce an early payment program— and that's not treated like debt on your balance sheet. Those are all really important things.

Lastly should you choose to introduce an early payment program, and that is a route that makes sense to you, think about the supplier experience. Think about what they will have to do to access that liquidity. Is there going to be a lot of paper involved? Is it going to be a manual process? Is it going to take multiple weeks? Does it take you 30 days to approve an invoice, therefore the supplier won't be able to access the liquidity for 30 days when you only may have 60-day terms. So those are all things you should think about as you think about it in the broader context of whether to extend payment terms to your suppliers.

Supply Chain Finance

Dan: Should you choose to do that, and should you choose to look at supply chain finance— a way to think about it is simply put an average, let's just use a hypothetical supplier that's invoicing you 10 million dollars annually and you're paying them on 120 day payment terms, or perhaps you're paying them on 90 and now you're paying them on 120. It's going to have an immediate impact on their liquidity.

To the extent you offer a supply chain finance program, it is a way for them to access the liquidity not in 90 or 120 days, but when the invoice is approved. That can be anywhere from a day to five to ten days after invoice submission when you approve the invoice. So they are potentially pulling forward 90 day's worth of liquidity at what we think is a reasonable cost of capital, and allowing you to keep your payment terms at 90 to 120 days without impacting your supply chain. Those are the fundamental mechanics.

Buyer Benefits

Dan: Thinking about the benefits and how to think about this image through both the lens of corporate and a corporate treasury / procurement team and then through suppliers— if you're thinking about it as a corporate, the right way to think about it is it's a way to do something nice for your suppliers. You're offering them liquidity. It's on demand, so they can access it when they need it. It's allowing you to potentially provide a lift to your working capital.

Like I said before, there are only really three levers you have when you're thinking about working capital– it’s how quickly you get paid, how quickly your inventory turns, and how quickly you pay your suppliers. And that's the one you have the most control over, and so if you want to turn that lever, you can provide a working capital lift, which will potentially reduce your utilization of debt and potentially lower and have a tangible economic benefit via lower interest costs.

It may also allow you to diversify your supplier pool. It depends on the type of industry, but to the extent you work with smaller suppliers who potentially provide you very bespoke prep materials, or you're relying on potentially craft providers and you're thinking about diversifying your own products that you probably have a very diverse supplier pool. Diverse supplier pool likely means you have smaller suppliers. Smaller suppliers have less access to traditional financing . With less access to traditional financing, it's very hard to put them on extended payment terms. To an extent that you have a very diverse supply chain and it's a long tail of suppliers, an early payment program can help you preserve that diversity.

Supplier Benefits

Dan: If you look at it from the other side, and you think about it from a supplier standpoint, it provides a little more predictability. To the extent that they have various ordering needs, or raw material sourcing needs, or production needs that impact their own liquidity. Getting paid faster can mean more predictable delivery of product to you. Also, you can think about it from a longer-term payment certainty standpoint, meaning suppliers can choose how and when they want to get paid. They have more visibility and certainty into their own liquidity, which allows them to better align their production with your demand needs. By preserving their liquidity, you're protecting their long-term health, which is allowing you to maintain diversification within your supplier base.

If you think about an early payment cost and whether that cost will simply get passed back to you, which is a question that we frequently get— hypothetically, if I pay my supplier and charge them 1% to get paid 30 days faster— are they simply going to add that 1% to the overall margin? Typically, you're already paying their financing costs. Most suppliers will probably have access to some liquidity, and that liquidity may cost them more than your supply chain finance program. So you may already be bearing that financing cost.

This may actually allow you to have more control over the cost of their financing via leveraging your credit profile versus their credit profile, which in an environment like we are in today, where banks are pulling back liquidity for all but the largest companies, you may end up seeing and bearing the burden of higher financing costs should you not have an early payment program. If you want to offer a supply chain finance program, that will give you a lot more control potentially over that cost.

What we wanted today was give you a little bit of perspective on the macroeconomic backdrop, which the word unprecedented came up number of times. It's unusual to talk about a 40% decline in global trade volume. There are going to be direct consequences via lower revenue, and managing fixed overhead, and disruption, and insolvency risk that comes with it, but what we wanted to do was sort of frame what's coming next. How should you think about inventory management? How should you think about liquidity, and managing your supplier relationships, and some of the unintended consequences of decisions both on the inventory front and the payment terms front, which are two things that I think are top of mind right now for most procurement and treasury professionals. I'll leave it there. I want to make sure we have plenty time for questions.


Watch the webinar to learn how businesses can future-proof their supply chains against disruptions


Q&A

John: All right. Thank you, Dan. Yeah at this time I'd like to invite all the attendees. If you haven't already during the presentation, we did have a couple of questions submitted. You can open up your GoToWebinar control panel and there should be a section where you can ask questions and we will relay those to Dan. Dan during the presentation we did get a question regarding just-in-time, just-in-case. The question is regarding what types of industries may actually see success using a just-in-time strategy during the pandemic?

Dan: You know, I think that just-in-time has been very much a retail consumer driven inventory management philosophy for many years, and as consumer demand is being materially impacted, probably a good way to think about managing inventory. One of the problems is the level of recovery and volumes is very uncertain. You're seeing right now states reopen. You're seeing cases reemerge that could lead to shutting down again. That could lead to very choppy demand, and so to the extent you are trying to minimize your inventory overhead, your inventory cost, and you're not trying to get caught with too much inventory for retail driven businesses that are driven by consumer demand, I think just-in-time will probably always be the predominant philosophy.

If you're thinking about areas like medical equipment, pharmaceuticals, I think that they're going to move to a more just-in-case / more redundancy model. They may even face regulation which forces them to do so. And so I think that ship has sailed despite the fact that we may see an ebb and flow of Covid, which impacts demand. I just think you're going to see the market demand more resiliency and redundancy in markets like that.

John: All right. Thanks, Dan. Our next question— someone's asking if we're expecting to see another round of supply chain disruptions due to Covid?

Dan: Well, I think that it highly depends on whether the reopening / higher caseloads leads to further shutdowns, and if those further shutdowns will be both tolerated and sustained, and the impact on overall both enterprise and consumer demands. I think that's an important question too. We have 15% unemployment, and that's going to lead to suppressed demand regardless of whether we reopen or not, that's going to be disruptive to supply chains in the form of lower volume, increased capacity. So, I think it's going to be very choppy.

From what we see in our own portfolio— we are not seeing V-shaped recoveries. We are seeing some businesses that were down 50% year-over-year that are now operating at down 25% year-over-year, but we're seeing very few get back to where they were in the January / February timeframe. I think you could see increased deterioration post short-term lifts, so I think choppy is probably the right way to think about it.

John: Dan, we have another question about shortcomings of early payment solutions. What roadblocks might you encounter?

Dan: It's a good question. I think one would be how the communication, the outreach, and the onboarding of suppliers is something that requires a lot of planning. Communicating the extension of payment terms, if that's one of the goals. Handling the onboarding and making sure your suppliers understand the cost and how the program works. To the extent that they may have another lender involved, there's a third-party communication that may or may not need to take place depending on structure. That's certainly one set of challenges. Costs is definitely another.

You want to think about what's the optimal cost for your suppliers versus what's available to them in the marketplace. Simplicity is another one. Transparency— make sure you give them plenty of lead time to think about it. The biggest problems we tend to see are the process tends to be very manual; it tends to take time, and suppliers just don't have the resources, or they don't understand the program effectively. It's not communicated clearly to them the cost isn't transparent. Those are probably the two biggest barriers to adoption in our opinion.

John: Our next question is, someone's asking about supplier liability. What happens if a buyer doesn't pay LSQ? Is the supplier liable for that payment?

Dan: It's a good question. The way to think about the mechanics of a supply chain transaction is typically the way you would think about any normal buyer supplier relationship. LSQ pays the supplier on behalf of the buyer, and the buyer agrees to pay LSQ upon due date. LSQ then would have recourse to the buyer should they not pay on the due date, similar to how a supplier would have recourse in an unsecured claim to the buyer should they not pay. Now, to the extent there are disputes or offsets, and that may be the reason for non-payment or short payment— those typically happen outside the context of the supply chain finance program.

If there is an offset, or a credit, or a short pay needed, we would typically advise the buyer to apply that to a future invoice, not one we've already paid. To the extent the buyer does not have the financial capacity to ultimately pay the invoice, that would be an identical claim that a supplier would normally have on a buyer for not paying.

John: All right. We have another question. This is regarding what types of suppliers would be more receptive to accept charges in exchange for early payment? Larger suppliers, smaller suppliers?

Dan: I think that the further you go down your supply chain, the less access there is to traditional forms of financing. Your largest suppliers, and it depends on the size business you are, typically have access to traditional sources of liquidity. Therefore, they may like the predictability of an early payment program and choose to opt in for that reason, even though the cost may be the same or more for what they're paying, but they don't necessarily need to from a liquidity standpoint whereas smaller suppliers may have limited access to liquidity and will adopt at a higher frequency.

Even though 20% of your suppliers may make up 80% of your span, the 80% that make up that 20% may be where the most pain is. We always suggest that you try and include all suppliers in these programs because the smaller ones often need it the most, and some of those smaller suppliers may be incredibly important because they provide very specialized product.

John: Hey, Dan. In regards to global suppliers, how typically do companies handle exchange rate fluctuations?

Dan: Yeah, it's a good question, and I don't think I have the perfect answer, but the way we think about it is larger companies— some will support major currencies, so you bill in local dollars, they'll pay in local dollars, meaning you may build them in pesos and they'll pay you in pesos. Some force to bill and accept payment. The way we've thought about it is we want to support some of the major currencies.

If you're thinking about sort of exchange rate risk, typically the buyer and the supply chain finance provider, if you're thinking about it in the context of a supply chain finance facility aren't taking exchange rate risk. So the supplier can either hedge from a currency standpoint, or choose to accept potentially some volatility with exchange rates.

John: Another question here. Dan, do you see a shift in the risk of the credit rating model as the result of the high amount of uncertainty and volatile situations within supply chains?

Dan: If you look back to 2008, 2009— credit ratings agencies took their lumps for being very slow to downgrade or acknowledge risk within a lot of these mortgage-backed securitization tranches that were out there, and subsequently, the derivative impact it had on financial institutions. They moved very slowly and investors paid the price.

I think you're seeing somewhat of a similar dynamic take place now, where we're seeing lots and lots of corporates that in my opinion are over-levered, particularly and the sort of let's call it middle market, and you're seeing once again credit ratings agencies be slow to move, and there's lots of companies sitting at that very lowest rung of investment grade. I think that's a problem. I think that many of them are not investment grade and transparency would be beneficial, but we're not seeing it. They may be falling into the same trap they fell into during the last cycle, which is just being very slow to react and slow to make decisions.

Look, I understand that once ratings agencies make a move, it creates a lot of volatility in the market markets, and perhaps that's part of this— is that politically they just don't want to make a lot of noise right now while the government's providing liquidity, but at some point I think we're going to need to acknowledge credit risk where we see it, particularly in the corporate market, which is over-leveraged. The sooner we see it, the more people can react to it, and we can get on with how to resolve it. I think once again what I see out there is it's just really slow.

John: All right. I think we have our last question. Dan, do you see any benefits to technologies like blockchain or tokenization in terms of supply chain finance, and do you see LSQ possibly adopting those technologies?

Dan: In the near term no. I think that it's really about stability and in theory, ledgering technology probably will play a role in trade finance. It should. I think that it's just not stable or mature enough to do so. We kind of look at it but, it's playing very a very limited role in our development process to date. It has promised in theory and potentially could be very disruptive to trade finance as it matures. I just don't see it short-term.

John: All right, Dan. Well, I don't think we have any more questions, so I'd like to thank our audience for attending today. Just a reminder that if you're curious to learn about our solutions including invoice finance, supply chain finance, and other solutions— please come and visit lsq.com. Also, for the latest insights surrounding Covid and supply chain finance, we invite you to come visit our blog at lsq.com/blog, and we will be sure to promote and keep you informed of any new webinars or any blog posts that we have regarding supply chains and the coronavirus. So thank you everyone for attending. We appreciate your time. We hope to see you again soon. Thank you so much.