Secure & Agile Procurement

Taking a flyer on a supplier

Most manufacturers and whole-sale distributors are dependent on a regular flow of goods through import, often from far away. For this type of ‘flow’ traditional security documents, if at all appropriate, are often a bureaucracy that can slow things down. What are the alternatives? It would help the business dependent on a regular and steady flow of raw material (in terms of frequency and volume) to be able to quickly change suppliers if one of its established relationships fails to deliver – potentially due to events beyond the control of this supplier (covid being a prominent recent example). When suddenly having to deal with an alternative supplier relatively unknown to the buyer, he would benefit from a flexible security arrangement that can be set-up quickly, to mitigate any lack of comfort that a longstanding relationship brings.

Supply chain problems

Having looked into the aftermath of the covid crisis a few issues have come to the forth: as officials in China locked down large parts of the country manufacturing came to an instant hold (mostly still on hold at present as 80% of staff seem to be infected with the virus in some areas). Recovery is uncertain as many manufacturing hubs are still without enough staff today. Businesses have hence become more and more sceptical about their reliance on Chinese manufacturing. As supply chains are integrated and currently very much reliant on manufacturing facilities in China, there does not seem to be a quick way out. However, some businesses have taken the risk to try out new manufacturing hubs previously seen as unknown entities in places such as Vietnam, India and Indonesia. In particular the latter has been pushing Western businesses hard to start producing there. In November 2022 over 20,000 Tier 1 suppliers to US businesses were still shut down; overall, including Tier 2 & 3, the number stood at approximately 250,000. If production processes are put on ice due a lack of supply companies cannot possibly fulfil customers’ expectations.

Agile Procurement

As a result of this experience more and more businesses are thinking about being more agile, less integrated. One important issue here is trust. Suppliers that have become part of a supply-chain that was established long were deemed reliable partners (notwithstanding the impossibility to deliver). Suddenly changing tack into the unknown requires taking risks. The question is how businesses can create a set-up that mitigates these risks. The biggest risk is the payment risk. If a manufacturer far away claims he can deliver to the specs required, he may have ‘bitten off more than he can chew’. This is not rare. It happens very often, as in times of stress competitors abroad will oversell themselves to pick up new business. In these situations there is often a stampede to the alternative suppliers, perceived to be able to get the flow going again. Decisions have to make very quickly, which frequently compromises the security aspect.

The traditional way of creating security in trade is by means of a Letter of Credit (LoC). However, when the buyer is asked to make upfront payments (being put under pressure in competitive situations), the main risk is not one of ‘non-payment’ by the buyer, typically mitigated by the LoC, but one of ‘non delivery’ by the seller.

So, apart from the fact that banks are usually not willing to shift to different counterparties within 48hrs or so (the required window that it sometimes takes) LoCs are not really meant for this purpose, either.

So, what are the alternatives? What can be implemented in real time and will offer the protection during these times of procurement stress?

Flexible Security

It should be some kind of mechanism that would allow for settlement when it is as clear as can be that both parties will have delivered on what they agreed on. So, how could this delayed or conditional settlement be effected and how could this be done safely and efficiently? The mechanism described here is called ‘Escrow’.

Escrow means that payment only takes place against delivery and that an independent party controlling the money flow will check whether this has been the case (by looking at the terms and conditions of the agreement). Are there ways of setting up an Escrow agreement quickly? Yes there are. There is a platform run by Mercurion that allows the input of the trade agreement on-line.

Once the terms are finalised between parties, which is done through the platform, there is a record of what needs to be done and the buyer can pay the purchase price to the Escrow agent. The latter being the independent party that will test whether both buyer and seller will have fulfilled the conditions in the agreement.

The Mercurion platform uses the Baltic Exchange as the Escrow Agent. Being an over 300 year old London based institution owned by Singapore Exchange, one of Asia’s premier institutions when it comes to the settlement of financial assets (Aa2 rated), financial security should not be an issue. A digital Escrow arrangement backed by the strength of a strong Escrow agent provides the required security, is accessible instantly and can be set-up in a very short time-span; ideal when changing tag is required in times of supply uncertainty!