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Our COO Magda Rozczka explores the opportunity cost in relation to working capital optimisation and supply chain finance and looks at what can be learned from case studies.
Microeconomics focuses on the decision-making processes of businesses and individuals looking to increase their rate of return. The concept of “opportunity cost” is a core driver of any significant decision. Business leaders seek to maximise the rate of return on good decisions and minimise the impact and risk of bad decisions.
The basic definition of “opportunity cost” is the value of what you will lose (or miss out on) when you choose one possibility over another.
The economic calculation is always the same and important to consider. How much does it cost you to do things – or, more importantly, in many cases – not to do things? In a world of increasing change and economic uncertainty, what is the cost of inaction or deciding against a course of action which could vastly improve your business? Could hesitation cost your business in real terms?
The true opportunity cost based on our experience working with corporates
At Crossflow, we have experienced many examples of this and the true cost of a lost opportunity, both with clients and other corporates we have met. For example, we have seen some cases where a company didn’t make a decision about supply chain finance (SCF) on time – when the business was healthy – but instead waited until the business was in serious financial difficulty.
Unfortunately, many businesses take another loan as a quick solution. The fact is that when a ship is sinking, you don’t load more items on to it. When a business has significant amounts of debt and the business net worth value is below zero, it seems difficult and oftentimes reckless to burden it with additional debt to keep its operations afloat.
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Effective supply chain finance and working capital optimisation
Effective and innovative SCF is about working capital reorganisation. Supply chain finance empowers companies to utilise existing channels to reduce their overdrafts and to create positive cashflow for them and for their suppliers. Companies can strengthen the position of their entire supply chain and their relationships by using SCF instead of burdening themselves with another term loan or other form of overdraft.
It is all too common for businesses to delay a decision about implementing a supply chain finance programme. They often hope to fix their working capital problems with another loan or a capital injection from their holding company. A more pragmatic, efficient and cost-effective solution can be found within their organisation and their supply chain. In a case like this, what is the cost of the missed opportunity? It is the cost of the next loan and the impact of an increasing overdraft or other form of debt.
Retail case study: SCF vs a long-term loan
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A UK retailer approached us in 2016 with a strong financial position and credit rating. At the time, they considered a SCF programme but decided it wasn’t a priority. Instead, they took a long-term loan, which cost them £10m, to improve their working capital.
A few years later, they decided to implement an SCF programme to reduce their overdraft. What was the cost of the missed opportunity in 2016? It was £10m. They could have avoided the loan and secured the same amount by implementing a Crossflow SCF programme earlier.
Construction case study: increasing competition to secure contractors
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A construction company approached us in 2015. They were proud of their successful financial performance and the fact that the construction sector was booming on the back of large number of readily available contractors and sub-contractors, whom they paid within 30-60 days. They decided not to pursue a SCF programme.
Two years later, the need to accelerate payments to their contractors and sub-contractors became a major issue. This was a significant obstacle to completing projects on time since they needed to secure the right contractors and get prioritised over their competitors. They were now facing increasing competition and were no longer the preferred client. What was the cost of the lost opportunity in this case?
The opportunity cost was their reduced margin, which went from 15.5% in 2015 to 12% in 2018. This reduction represents a loss of £17m in potential returns for the business. This was the cost of not making a critical decision on time and delaying an opportunity to generate returns for the business and enable the business to secure the right contractors to complete projects on time. As a result, they had to take on the additional cost of finance to cover their need for faster payments to their suppliers.
The right time for SCF
When is the right time to implement a SCF programme? This depends on many variables and is unique to each company. From our experience, when a corporate’s financial outlook is increasingly worse, it is more challenging for a SCF programme to return the same benefits that it could deliver when a business has a strong position and solid reputation with its suppliers and contractors.
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The returns on implementing a modern SCF programme are cheaper and more beneficial when you make the decision timely and from a position of strength. If you delay the implementation process until your financial state is so dire that the programme is seen as a last resort for a sinking ship, you run the risk of making a reactive decision that may impact your long-term strategic objectives. You might also face more resistance from all parties involved in the implementation process if a SCF programme is not part of a broader strategic decision. The cost of waiting could be greater than you anticipate.
At Crossflow, our vision is to transform the financial efficiency, transparency and sustainability of global supply chains. We help corporate buyers and their suppliers improve their financial performance, health and growth and access affordable capital through our marketplace of global funders. If you are interested in learning more about our working capital programmes, please get in touch.
Magda Rozczka is COO at Crossflow. After completing her postgraduate MBA, Magda led product development within the insurance sector at ING and Zurich. Magda represents Crossflow on the Bank of England decision maker panel, which influences UK interest rates, and has represented Crossflow as part of HM Treasury’s Women in Finance initiative.
