Financing the Chain

Financing the Chain

Copyright 2004, Traffic World, Inc.

When the semiconductor industry went into a demand meltdown in 2002, at least one California bank thought it had a novel way to help chipmakers out of their steep descent. The bank purchased the growing inventory from the manufacturers, stored the goods at logistics hubs and resold the semiconductors to end-users.

Suppliers and buyers both benefited from the practice by seeing inventory-carrying costs reduced and the manufacturers'' kept their balance sheets shored up. But the Federal Deposit Insurance Corp. put an end to the practice when it forbade the Silicon Valley Bank of Santa Clara, Calif., and other banks from taking title to the inventory.

The semiconductor industry has since recovered from its 2002 problems - Rosemary Farrell of iSuppli Market Intelligence Services said that the inventory balance is in "a state of equilibrium."

But for the logistics industry, the incident provided a ready example of the weight manufacturers place on their inventory costs and the need they have not only to manage the goods but also the financing of inventory on a shipper''s books.

The handful of logistics companies that started offering inventory financing options to shippers in the 1990s are stepping up their financing services. They see inventory financing - not the inventory ownership model - as an important area for global logistics players looking to bundle more supply chain related services into one-stop-shop portfolios.

"We want to provide business solutions, not just financial or transportation solutions," said Richard Bradshaw, global sales manager of UPS Capital, an arm of the parcel-carrying giant founded in 1998.

Inventory financing - using current inventory as collateral for a secured loan - has traditionally been the province of banks such as CIT Group and Bank of America.

Logistics companies are offering inventory financing through banking subsidiaries or in partnership with third parties. Even companies with ties to major asset-based operations see inventory financing as integral to a deeper array of supply chain management services. APL Logistics, for instance, includes inventory financing as part of a range of asset management skills it brings to shippers.

UPS Capital''s Bradshaw said that as a provider of both supply chain and financial services, UPS has an advantage over traditional asset-based lenders that can''t bring the financial component to the table.

Having physical possession of the inventory allows UPS to offer advance rates of between 55 and 60 percent of the value of inventory instead of the traditional rate of around 50 percent, he said.

UPS Capital also claims to have an advantage in the loan syndication market where large loans are shared by a number of banks. Because UPS is not looking to offer cash management services, only supply chain management and transportation, it is an attractive partner to other banks in loan syndication deals, Bradshaw said.

PB Capital, a wholly owned subsidiary of Deutsche Postbank, is developing industry-specific products that combine the firm''s banking power with the logistics expertise of DHL, also a member of the Deutsche Post World Net Group. Thomas J. Leissl, senior managing director of PB Capital, said the new financing services got off the ground last year when DHL restructured and expanded in the United States.

"It developed from talking to each other," Leissl said. "PB Capital didn''t know much about logistics and DHL didn''t know much about financing."

PB and DHL have developed an alliance with a large manufacturer/distributor of airplane parts to create a financing and logistics option for airlines, a deal the companies expect to announce formally in a matter of weeks.

The industry is a prime candidate for the niche offering, Leissl said, because it is under huge financial pressure and airlines want to shed assets in order to improve cash flow and short-term financial performance. DHL will provide the logistics and transportation, PB will bring the financing component and the distributor will purchase the parts from the airlines, manage the inventory and sell them back to the carriers on an as-needed basis.

Leissl said airlines can get the inventory off their books, which can add up to hundreds of millions of dollars. "It helps the short-term financial picture in a big way," he said.

The plan helps carriers get out of the business of managing spare parts inventories, which is not their core competency. DHL can manage the inventory and ship the parts much more efficiently.

The advantage for the third-party partner is additional overhead coverage. It currently own more than $1 billion in spare parts inventory; increasing that number to $1.5 billion gives economies of scale and diversifies product line. It also can rely on DHL to warehouse and ship parts as needed.

Even with glowing reviews from providers, financing really hasn''t swept through the logistics industry since companies began packaging the services in the 1990s.

Some target it to specific lines of business, such as in the high volume movement of automobile parts. But some logistics operators say the offerings are limited for a reason. "How can I claim to the shipper that I can get them a better rate than a bank can?" asked C.K. Lee, president of Exel Asia.

But Henri Duhot, senior director of multinational customers for DHL Danzas Air and Ocean, Deutsche Post''s freight forwarding arm, said that customers know the true landed costs of inventory when one company provides financing, logistics, information technology and ancillary services.

"In vendor-managed inventory programs we can go down to the supplier level in Asia and bundle all the elements of the supply chain together, including finance," he said.

Financing up to 90 percent of inventory in vendor-managed inventory programs also allows clients to keep more cash on hand for core activities such as manufacturing.

Duhot said that DHL Danzas works with many of its clients in the automobile and electronics industries on a project basis. For example, the company has an alliance with Avnet Electronics Marketing, a Phoenix-based electronics parts distributor in which DHL finances the components and handles all the logistics on both ends of the deal, from Avnet to the contract manufacture to the customer.

Mark Kadar of Mercer Management Consulting said logistics companies that offer financing options have a competitive advantage over those that don''t because of shippers'' increasing sophistication in all aspects of supply chain management.

Still, Kadar said he is not seeing a lot of hybrid financing/logistics products involving third parties outside of the automotive and electronics industries and those involving other categories of fast-moving consumer goods.

"Most of the rest of the world is still focused on shipment costs," he said.

Bradshaw said that the cornerstone of the company''s inventory financing services is using inventory as collateral. The company does not purchase inventory and has no plans to develop any hybrid financial products or services involving the purchasing of inventory by third parties. "It is not a market we choose to play in," he said.

Leissl dismisses the inventory ownership as too risky given the risk of fraud and deflation of the value of goods. "I agree with banking regulators that banks shouldn''t have that kind of risk on their balance sheets," said Leissl. "I am a lender, not a trader."

Assuming more risk also would diminish the advantages of a logistics/financing hybrid, which greatly reduces risk for both parties. Being in physical control of the inventory virtually eliminates the risk of fraud and increases oversight of the types of products prone to rapid deflation, such as computers.

In addition, financial institutions are under scrutiny in the wake of corporate scandals involving special vehicles designed to disguise ownership to improve short-term financial outlooks. The regulatory climate has changed dramatically since passage of the Sarbanes-Oxley Act of 2002, with auditors looking askance at off-the-books transactions.

In initial talks with clients about the new logistics/financing services, Leissl said they expressed interest in getting product off the balance sheets. However, he said that talk has died down as companies became aware that regulators are suspicious of those kinds of models.

"We are focused on adding efficiency as opposed to another trick to shorten the balance sheet," he said.

Having a financial arrangement with a leading logistics company can help firms in providing the kind of visibility and compliance with stricter accounting standards that had been promulgated in the wake of Sarbanes-Oxley, said Duhot. Such deals are approved at the CFO or CEO levels of all the companies involved, are scrutinized by internal auditors and serve as proof statements as to what is on or off the books.

Ultimately, financial services are a value-added product that provides differentiation in a crowded marketplace. By providing all of the components that define the supply chain - goods, information and funds - logistics companies lessen the risk of having to fight to retain customers each time a competitor offers lower shipping rates.