Master Thesis in MSc.

Finance
Dan Xu Brentsen

The Impact of Supply Chain Finance on Corporate Performance: Improving Supply Chain Efficiency and Increasing Profitability

Advisor: Anders Thorstenson Submitted 19 April 2012

Acknowledgement

I am heartily thankful to my thesis advisor, Anders Thorstenson whose encouragement, guidance and support from the initial to the final level enabled me to develop an understanding of the subject and finish it successfully. It has been an honor to work with him. Anders, your contributions, detailed comments and insight have been of great value to me. I would specially like to show my gratitude to the coordinator at Siemens, Alexander Gorker who has been so supportive for giving me valuable suggestions, support, and insights. Thanks Alexander with your kind help for practical knowledge. I contacted you several times by emails for additional information and you always responded to me right away despite your busy schedules Thank you very much for that. Lastly, I offer my regards and blessings to all of those who supported me in any respect during the completion of the project.

Dan Xu Brentsen Business and Social Science, Aarhus University April, 2012

Table of Contents
Abstract ............................................................................................................................. 4 Chapter 1 Introduction ...................................................................................................... 5 1.1 Backgrounds and motivations ................................................................................ 5 1.2 Problem formulation .............................................................................................. 7 1.2.1 A general framework of research .................................................................... 8 1.2.2 Research questions ........................................................................................ 10 1.3 Research methodology ......................................................................................... 13 1.3.1 The research process ..................................................................................... 13 1.3.2 Hypothesis, testing methods and research questions .................................... 16 1.4 Delimitation ......................................................................................................... 17 1.5 Thesis outline ....................................................................................................... 18 Chapter 2 Literature review ............................................................................................ 18 2.1 The development of supply chains ...................................................................... 19 2.2 The link between supply chain and financial flows ............................................. 20 2.3 Supply chain finance ............................................................................................ 22 2.4 The integration of SCF into SCM ........................................................................ 23 2.5 Financing suppliers in the supply chain ............................................................... 25 Chapter 3 Financial supply chain management .............................................................. 26 3.1 Financial-SCM and the link to economic value added ........................................ 27 3.2 Integrating SCF into payable processes and cash flow cycle .............................. 28 3.3 FSCM performance indicators and profitability ratios ........................................ 31 3.3.1 FSCM performance indicators ...................................................................... 31 3.3.2 Key profitability ratios .................................................................................. 33 3.4 The impact of FSCM on corporate performance ................................................. 37 Chapter 4 Empirical Analysis ......................................................................................... 39 4.1 The sample selection and data description........................................................... 39 4.2 Hypothesis tests and testing methods .................................................................. 42 4.2.1 One-sample distribution tests and t test......................................................... 43 4.2.2 Correlation and regression analyses .............................................................. 44 4.3 Data analysis and interpretations ......................................................................... 45 Chapter 5 Case study at Siemens.................................................................................... 52
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5.1 Supply chain finance at Siemens ......................................................................... 53 5.2 FSCM indicators, profitability and growth at Siemens ....................................... 57 5.3 Recommendations ................................................................................................ 63 5.3.1 Updates in the ERP system ........................................................................... 63 5.3.2 Control of payment terms and SCF loans to suppliers .................................. 64 5.3.3 Extension to emerging markets ..................................................................... 68 Chapter 6 Conclusions .................................................................................................... 70 6.1 Criticism............................................................................................................... 70 6.2 Suggestions for future research of interests ......................................................... 71 6.3 Conclusions .......................................................................................................... 72 References ...................................................................................................................... 74 Appendix ........................................................................................................................ 78

Abstract
The thesis studies the application of supply chain finance (SCF) in supply chain management. The SCF is also called supplier finance, and mainly it is used to deal with the financial issues in supply-side value chain management. The impact of SCF on corporate performance reflects in the improved supply chain efficiency in terms of cost saving payable processes and payment term extension. The performance indicators derived from the financial supply chain management (FSCM) have influences on profitability. On the SCF program, decreased costs of goods sold (COGS) obviously can increase return on invested capital (ROIC) and return on equity (ROE) in short term. The cause-effect relationships between the FSCM performance indicators and profitability are established by the EVA model and tested in linear regression analysis. The popularity of using the SCF program is increasing after the financial crisis (2008) because of the imminent beneficial consequences. Small participants can take large participants credit ratings to finance their capital requirements on the SCF program. Together with early discount payment, the small participants are able to save financing costs as well as increase cash and speed up cash flows. Large participants can extend payment terms to attain positive cash flows and to increase economic value added. Additionally, the large participants can leverage the small participants cost savings to negotiate better price offers and in turn to reduce their own COGS. The supply chain finance is a financial solution that provides win-win outcomes for all the participants in the supply-side value chain. Particularly in the economic recession, the positive impact of SCF on corporate performance can increase corporate economic power in the marketplace and remain competitive.

Chapter 1 Introduction
In this chapter, backgrounds of financial shortages in international supply chains and motivations of using supplier finance to assist on supply-chain improvement are introduced. The problem formulation includes a general framework of research and research questions. The research methodology includes research methods and the research process. Delimitations about the critical choices are argued in order to magnify the accuracy of research results. The structure of this paper is outlined at the end.

1.1 Backgrounds and motivations Alongside the trend of globalization, companies are oriented to produce international product, which will be sold globally, thus coordinating with international suppliers all over the world is inevitable. With this trend companies increasingly focus on their core capabilities, effective and efficient supply chain management (SCM). It has become a key constituent of corporate strategy, competitive advantage, and success (Narasimhan and Talluri 2009). Since 2008 the financial crisis has resulted lots of banks or financial institutions in confronting serious credit risks, which subsequently bring liquidity tightening, bank runs and even bankruptcies. Absolutely, this issue will affect their financing activities to companies. In the meanwhile the international business has also faced to a big challenge, because trading partners are ought to seek for alternative capital financing sources or approaches. Dynamic discounting, early discount payment and lengthening payment terms are crucial for corporates to deal with insolvencies and remain competitive at the same time. In the history of trade finance, factoring and letter of credit are often applied to help the international business partners manage cash flows. However, the impact of financial crisis will amplify counterparty risks and increase transaction costs. Problems of aging payables and increasing credit risks have become the main reasons to cause inefficiency in operational and financial performances. The supply chain disruptions in relations to supplier defaults can have long-term negative effects on a firms financial performance. Hendricks and Singhal (2005) show that companies suffering decreases in 33-40% lower stock returns relative to their
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industry benchmarks because of supply chain glitches cased by suppliers. Furthermore, the impact of supply chain performance on financial indicators has also been revealed by Avanzo et al. (2003) from financial accounting points of view. The risks in the supply chain management associated with volatility and supplier failure had increased 54% between mid-2007 and mid-2008 (Kerle 2010).The importance of supply chain risk management is illustrated by the results of a recent survey, which reveal that 90% of films felt threatened by supply-side risks (Snell 2010). The whole supply chain contains the inbound and outbound logistics through business processes from suppliers to final customers. Here, the study focuses on inbound material activities with suppliers through manufacturing operations and financial services with suppliers through the upstream flow of cash. Accordingly, the financial issues caused by the level of supplier-buyer relationships are considered as basic assumptions to explore part of supply-side risks. An empirical Demica report (2011) studies the growth trend of a financial solution on supply-side trade relations. It is used to 1) improve cash flow management, 2) reduce risks of supplier failures in supply chains and 3) improve transparency of transactions between suppliers and buyers. Supply chain finance program has gained attentions since the financial crisis. The SCF program aligns the third party financial services, large and small participants through the open account. It is also called reverse factoring, and it is a process that the large participants help the small participants receive lower cost of capital financing by sharing credit lines. The SCF program provides also the early discount payment to the small participants. The introduction of SCF into SCM, i.e. financial supply chain management (Michael 2009) will help companies consolidate the competition in the marketplace by means of generating real cash flow benefits. Farris and Hutchison (2002) emphasize a cash-tocash cycle time as an important indicator in supply chain management metric. Additionally, Bhagwat and Sharma (2007) consider the total cash flow time as an element into the balance scorecard (BSC) measurement model. However the failure to relate key measures to performance drivers brings obstacles of applying BSC to track the cause-effect relationships between performance indicators and further improvement of corporate value.

Lambert and Pohlen (2001) use the EVA model to integrate the supply chain operational

processes to financial performance. Gomm (2010) embraces the key performance indicators for both supply chains and financial flows in to a single corporate performance evaluation based on the EVA model. The EVA model works also on capturing how the companies drive value and profitability including the cost of capital in the supply chain. Wang (2010) has conducted an empirical analysis to test the impact of the SCF program on corporate performance before financial crisis. The improvements of operational and financial indicators can be observed in short term. Kerle (2010) has further provided the evidences of maximizing the current scarcity of liquidity by applying the SCF program. IMDs survey (2009) shows over half of respondents have admitted the implementation of SCF to SCM can help improve supplier relations1. The positive outcomes by applying the SCF program in supply chain management are recognized. The study interests of this thesis are to explore the impact of the SCF program and the effects of development on short term corporate performance; the impact around the time period of financial crisis is considered. The EVA model will be used to identify the most important indicators and ratios, and build up their cause-effect relationships. The SCF program is initiated by the large participants in supply chains, so the improvement of their corporate performances is significant. Furthermore, reducing supply risks in terms of enhancing supplier liquidity are also expected to be investigated.

1.2 Problem formulation In this section, a general framework of research is created containing the financial issues in supply-side value chain and the application of a financial solution for improvement. The introduction of the SCF) program is able to help the international business partners conquer financial constraints and develop cash flow efficiency. The subsequent research questions are designed to explore the possibilities and to explicate the outcomes.

http://www.imd.org/research/publications/upload/PFM178_LR_Ralf_Daniel_Seifert.pdf Supply Chain Finance - Whats It Worth? , www.imd.org, no. 178 October 2009.

1.2.1 A general framework of research In the house of supply chain management in figure 1, there are two business partners under the roof, one is the supplier and the other is the buyer. The buyer is considered stronger than the supplier under the circumstances. The impact of financial crisis destroys the usual balance of inbound logistic business processes between them, in particularly the upstream flow of cash. Therefore, the lack of efficiency in supply chains causes the difficulties in the flows of financial resources between organizations. In order to increase liquidity, the supplier promotes terms on early discount payment with cost of money and the buyer applies dynamic discounting method with upfront cash reserves. This method works all right when the situation is not extremely downside in the financial crisis. When the bank runs occur often and in turn affect the financing activities to companies, the buyer starts to consider lengthening payment term in order to fulfill internal financing on working capital needs. Indeed, the dynamic discounting method is redundant for the sake of holding cash reserves. This phenomenon results the supplier in complexity of managing its account receivables. Eventually the supplier will borrow money from other financial factors with higher credit costs in order to further operate the business processes. In the meanwhile it is not rational anymore for the supplier to offer early discount payment, because the lower credit ratings may lead to bankruptcy at the end. The consequence of supplier failures in the supply chain is expensive; hereby the resolution to help the buyer and the supplier live on from the transitory overwhelming turmoil is a further contribution of this study. The introduction of the SCF program in the supplier-buyer trade relations breaks the door to the next level of supply chain management financial supply chain management (FSCM).

Figure 1: Financial issues on supplier-buyer relationships in supply chain management and benefits of applying the SCF program

Financial Resources Supply Chain Management Materials Supplier Cash Early discount Payment Higher cost of capital Worse credit risks SCF Programs FSCM Financial Institution

Financial Crisis

Buyer Dynamic discounting Lengthen payment terms Risks of supplier failures SCF Programs FSCM

Benefits for supplier Better financing cost (early discount payment according to buyers cost of money) Alternate source of liquidity (to securitize cash flow with buyers credit rating) Reduced disputes of payable processes More predictable cash flows Improved credit rating to avoid default risks

Benefits for buyer To negotiate payment term extension with suppliers and improve economic value added. Reduced operating process costs and increased standardization of process Better cash flow management Improved supplier-buyer relationships

Sources: Authors creation

We can see in figure 1, the application of the SCF program brings a new financial solution to supply chain management, considering the third party financial services. The reverse factoring allows the buyer to help the supplier receive better terms of capital financing through the IT platform provided by the financial provider. The SCF program is a superior solution for the supply-side value chain management. Both the buyer and the supplier can benefit on the SCF program. Most importantly, the buyer can pursue a tactic strategy to lengthen payment terms without extracting extra costs from the supplier as well as improving the economic value added (EVA). As for the supplier, lower cost of financing and speed-up cash flows are the most significant achievements. Supplier risks are mitigated as the supplier strengthens its cash flow and as a result it has a better liquidity which is especially helpful in the financial crisis; eventually the supplier can improve its credit rating and become stronger in the marketplace. The SCF program has the insight of becoming popular concerning the positive outcomes from the perspectives of both the buyer and the suppler. The financial crisis is seen as a significant driver of interest in SCF, because corporates as well as their financial institutions are seeking to free up cash flow in supply chains while reducing risks. Undoubtedly, the SCF program has the competence to develop the flows of financial resources in supply chain management.

1.2.2 Research questions In this paper, two main research problems are expected to be answered: Does the use of the SCF program in supply chain management have a positive impact on short-term corporate performance in the time period of financial crisis? How come the contribution of SCF programs can help companies improve profitability as well as control supply-side risks? To answer these questions, studies on supply chain management in connections to financial flows and supplier/buyer relationships are required as fundamental knowledge. The deep understanding of integrating SCF into SCM has a decisive role. Furthermore, the link between performance indicators and financial ratios based on the EVA model
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provides a framework for cause-effect relationships. The strategic financial solutions provided by the SCF program can help build up a successful buyer-supplier partnership in terms of pricing, payment terms and controlling supplier risks. Several sub-questions are required to be studied regarding the main research problems: 1) What is the SCF program, and how to integrate SCF into SCM? 2) What are the performance and financial indicators on the program and how to derive the indicators? 3) Could the application of the SCF program have the impact on short-term corporate performance? 4) What are the relationships between financial supply chain management (FSCM) performance indicators and profitability? 5) What is the practical application of the SCF program in the supply-side value chain management? 6) How could large participants use the SCF program to cooperate with small participants? 7) What are the expected outcomes by the application of the SCF program? 8) What are the most significant benefits and achievements for business partners on the SCF program? The use of SCF program is new in the international business; therefore there are no standard procedures to measure the effects of corporate development with SCF. In this study, it starts with embracing this financial solution into supply chain management and derives important FSCM performance indicators and profitability ratios, in order to measure possible outcomes. The FSCM performance indicators are obtained by investigating the value drivers in accordance to supply chain business processes; the profitability ratios are derived by investigating the financial ratios corresponding to profit growth. The selection of the indicators and the ratios is based on the EVA model. The expectations on observing the impact of SCF on short-term corporate performance are settled, corresponding to the findings by Wang (2010). The time of perceiving effects of development is critical, because every financial and operational solution takes time to implement, sometimes mid-term and sometimes long-term. See the elicited paragraph from Novozymes annual report. It takes Novozyme 2-3 years to observe the effects of development on the supply chain finance.
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Cooperation with Suppliers The target for 2007 was to develop a step-by-step procedure for how and when to further develop cooperation with suppliers on issues of sustainability. In line with this target, we developed a new method in 2007 for responsible purchasing that considers the risks and opportunities in our supply chain. Our target for 2008 is to carry out a pilot test of this new responsible purchasing model in all regions with the aim of implementing it in 2009. Novozymes annual report (2007)

The contribution of this research is about to help business partners seek a superior financial solution for solving supply chain cash flow issues in the crisis (See section 1.2.1). The financial crisis in 2008 is not so far away from now, so the mid-term effects are difficult to detect at this moment. Additionally, some companies may adapt to the program after 2008. Furthermore, in Wangs paper two-year time interval outcomes are not different from the findings for one-year time interval. Therefore, the assumption of the short-term positive impact of SCF is logical. If this is true even around the financial crisis, then the expectation of using the SCF program is more realistic. The immediate positive outcomes are able to show that the SCF program is efficient to help the business partners live on from the transitory overwhelming turmoil. The EVA model is also used to build up the cause and effect relationships between the FSCM performance indicators and profitability. The exact correlations between them are expected to be explored by further empirical analysis. Concurrently, the significant FSCM performance indicators in terms of explaining the effects on profitability are drawn by statistical tests. Case study of SCF at Siemens provides the practical application of the program. Discussions at this stage embody further understandings of theoretical findings and modified explanations of empirical results. In the meanwhile, the achievements on supplier-buyer partnerships with SCF are argued from different points of views. The predicted benefits acquired with SCF for large participants are essential. It gives possibilities for using SCF to assist on the development of the value chain as a whole. It will lead to win-win outcomes to all the participants in supply chains. The large participants will support credit enhancement techniques to the small participants reducing default risks, which can cause supply chain shortfalls. The small participants can get lower cost of capital financing and speed up cash flows. The improved payment term negotiation as well as standardization of payable process can help consolidate long-term successful cooperating partnerships.
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Applying the SCF program is not only to achieve superior competences but also enhance the synchronized level between operational business processes and financial flows in supply chains. It is orientated to develop advanced inter-organizational collaboration and communication, meanwhile the competition of the value chain as a whole is more severe than individuals in the economic recession.

1.3 Research methodology Seen in last section, the research questions are outlined regarding the impact of SCF on corporate performance by supply-side value chain efficiency; the outcomes are able to be observed in short term. In this section, a sophisticated research process is designed in order to accomplish the research of interests. Research hypotheses, testing tools and analytical methods are introduced accordingly.

1.3.1 The research process The general research process of this study is shown in figure 2. It starts with defining research problems relative to previous research findings and theoretical framework for the SCF program. The inter-reactions at stage one contribute the formation of hypothesis tests and empirical analysis at stage two. The intention of stage three is to figure out the practical application and relate to previous findings as a result of feedbacks. Because there are no standard research procedures conducted so far for the SCF program, the combination of theoretical, empirical and practical researches are comprehensive to summarize the outcomes. The theoretical background is used to identify the FSCM performance indicators and the profitability ratios which will be used in the empirical analysis. The interpretation of the analytical results is used to confirm the significance of the selected indicators and ratios. Sometimes the analytical results do not provide the expected solutions, if so, then further discussions on the application of SCF will also rely on the practical application. All in all, the final conclusions of this research are determined based on various findings and arguments. The research methodology is designed in accordance to both qualitative and quantitative methods (Kothari 2011). Quantitative research is conducted by analyzing a random
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collected sample, in which certain research hypotheses will be tested. Qualitative research is conducted by case study at Siemens with interviews and Q&A. Designed qualitative research questions are outlined. The data are randomly collected from public resources (Hendricks and Singhal 2005). The events of signing the SCF program in companies are searched through the public resources by key words, such as supply chain finance, trade finance, agreement. The full text of articles should contain combinations of these keywords. Announcements from the websites of SCF financial institutions are options too. The data will be sorted by differentiating the key figures of the year after and before the event. The final dataset contains different variables in columns that used to present the selected indicators and ratios, and the companies in rows. The data analysis will be done by IBM SPSS Statistics version 19 and R-2.14 programming. The case study of SCF at Siemens depends on interviews and follow-up questions. The introduction of SCF at Siemens and the implementation of SCF to its suppliers are used as case references. Further communications regarding the qualitative research questions are required. The summary of qualitative research experience is about to provide sufficient practical conclusions besides the theories and the empirical results (Assadej et al. 2010). Financial accounting data is applied for both quantitative and qualitative research methods, because the impact of supply chain financial solutions on corporate performance is expected to be observed from the companys financial statement. The SCF program is used as financial solution to enhance supply chain efficiency, and the record of supply chain business processes are often related to operational figures. Furthermore, the focus of the study is to explore the impact of SCF on short-term corporate performance from both operations and financial flows. It explicates the processing procedures in organizations. It is more robust than studying the impact as an event on stock markets only, which cannot imply the effects of development on operational performance (Hendricks and Singhal 2005). The financial account data contain the information of corporate financial structure such as cost of debt, which is related to annual interest rate of corporate loans not the dynamic changes in stock markets (Berk and DeMarzo 2007). To improve the cost of
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money is a significant contribution by the SCF program because of cash flow efficiency in supply chains (Camerinelli 2009). The financial accounting data might be useful to analyze the events that reveal the corporate performance (Tomaso et al. 2010), and the measurement based on accounting may apply only within the context of a specific predictive purpose or prediction model (William et al. 1968).

Figure 2: The flowchart of research process with detailed tasks at each stage Feedback Review Concepts and theories Formulate Hypothesis Review Previous Research Findings

Define Research Problems

Collect, Analyze and Interpret Data

Applications and Practices

I
Clarifying research focuses in terms of research of interests and research problems. Understanding performance indicators and profitability ratios, the EVA model, the SCF, SCM, and the benefits of applying the SCF program. Designing a research process with statistical methods and qualitative research methods. The framework of empirical study is about to derive cause-effect relationships between FSCM performance indicators and profitability. The case study at the company is about to modify the usefulness of applying the SCF program. Linking possible outcomes to the research problems.

II
Formulating research hypotheses according to literature reviews in terms of the research framework. Conducting an empirical analysis with the quantitative research method, alongside descriptive statistics, t test, correlation tests, and regression analysis. Reporting analytical results which should give evidences to pursue research of interests and answer part of research problems, if not, preparing further reasonable statements. Summarizing useful results for further application.

III
Preparing a qualitative research to explore the use of the SCF program in practices in relations to theory and analysis. Applying significant outcomes from both qualitative and quantitative research to outline the most significant indicators for improving corporate performance. Referring to the research problems with the solutions of applications and practices in order to verify the quality of the study and the contribution of the research.

Sources: Authors design

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1.3.2 Hypothesis, testing methods and research questions Referred to the main research questions and sub-questions, the purpose of this study is about to figure out the positive effects of using the SCF program on the corporate performance. The verifications of selected FSCM performance indicators and profitability ratios, and their relationships are required. Seen in Demica paper (2011), the program has been well known since the financial crisis, so the year as a representative of increasing popularity is also important. In general, there are four research hypotheses will be tested on the subject of quantitative research method: : The application of the SCF program has a positive impact on short-term corporate performance in economic recession. : The FSCM performance indicators and profitability are correlated. : There are cause-effect relationships between the FSCM performance indicators and the profitability ratios. : The popularity of applying the SCF program is increasing. Descriptive statistics will be used to observe the basic shapes of all the selected variables. Following, to detect the sample outliers by Boxplot (John Tukey 1977) is fundamental. The existence of outliers can distort linear estimators. The first hypothesis can be tested by one-sample t test (Aczel 2006), which is used to discover the significant impact of SCF based on the selected variables. The correlation tests with Pearson, Kendalls tau_b and Spearmans rho are applied for testing the second hypothesis. The significant correlated relations are used to give the evidence of conducting linear regressions. The third hypothesis will be done by regression analysis in order to establish structured linear models for profitability. The cause-effect relationships are implied in cross-section estimation. The forth hypothesis is involved in the regression analysis. Case study of SCF at Siemens is done by qualitative research method. The endowment of qualitative research experience is vital to modify the analytical results in empirical studies. Four subsequent qualitative research questions are necessary: 3 Are the selected FSCM performance indicators and profitability able to present the impact of the SCF program in practices? 4 How could the SCF program benefit large participants?
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Can the application of the SCF program help small participants lower cost of financing and speed up cash flows and in turn control supplier risks?

Is the win-win outcome true?

All the practical questions are argued with respects to the theoretical and empirical findings. Together with a basic evaluation of the selected variables by Siemens accounting figures, the most significant FSCM performance indicators and profitability are able to be prioritized. The improvement of supply-side cooperation is studied by the methods applied at Siemens. At the end, the benefits for Siemens and its suppliers on the SCF program are highlighted. Qualitative data are gathered primarily in the form of spoken or written language rather than numbers. The data resources are from the interview and follow-up Q&A with the coordinator at Siemens. The interview focuses on the introduction and implementation of SCF at Siemens. The data from the interview will be transformed into written text for further analysis; the subsequent Q&A will be done by emails. The interpretation of qualitative data is not very complicated, and it is done by the self- reported technique.

1.4 Delimitation There are limitations to conduct the research of the SCF program on the corporate performance: 1 The study concentrates on companies instead of banks or financial service providers. The banks or financial service providers are responsible for the development of the SCF program in international business. From the companies points of view, applications of the SCF program and its contributions to the supply-side partnership improvement are fundamental. 2 The time period around financial crisis is very special, and the SCF program is just one factor that can help companies to recover from the economic recession. The influences of the program on corporate performance could be partial, even though the expected outcomes specified by literatures are optimistic. 3 Negative cash flow cycle technique is not covered in this research. The application of the SCF program is to optimize the capital utilization, but not to use customers and suppliers as sources to have interest-free cash financing in business processes.
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4 The announcements of supply chain finance are not easy to be found by public resources, so missing data in the random sample collection is unavoidable. Some announcements are lack of event year, so they cannot be used. By contrast, some companies may not announce the events in the public, although they have already applied it as a financial solution in supply chain management. 5 The dominant power in supply chains can be revealed by either suppliers or buyers. It depends on their company sizes. Usually larger/stronger participants on the SCF program are somehow prevailing to affect supply chain solutions.

1.5 Thesis outline The thesis outlines in six chapters. Chapter 1 is the introduction containing research settings; the problem formulation and the research procedure provide a guideline which is related to the follow-ups in coming chapters. Literature reviews are in chapter 2; main theoretical and empirical references are discussed here. Theoretical study of the SCF program in Financial-SCM is in chapter 3; FSCM performance indicators, profibatility ratios and their cause-effect relationships are derived based on the EVA model. Empirical analysis of the selected indicators and ratios is in chapter 4; the impact of SCF on short-term corporate performance and the effects of development on profitability are interpreted based the analytical results. Practical application of SCF is in chapter 5; the case study of SCF at Siemens provides in-depth understandings of the selected indicators and ratios, and the win-win outcomes of using the SCF program. Conclusions are in chapter 6; criticism and suggestions for future research of interests are stated.

Chapter 2 Literature review

In this chapter a framework of supply chain finance and its integration to supply chain management will be introduced first. The impact of financial crisis brings new challenges as well as new opportunities to the development of supply chains. The link between supply chain and financial flows is considered as an inevitable strategic solution while improving corporate performance. The introduction of supply chain finance to the supply chain management is able to help corporates remain competitive

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and increase economic value added. Ideally, the effects of development are possible to be observed in short term. Ultimately, the win-win outcomes will benefit both large and small participants.

2.1 The development of supply chains Nowadays the supply chains have been developed more complicated as the business has become more international. The term of supply chain management is first introduced by U.S. industry consultants in the early 1980s (Oliver 1982). The expansion of physical capabilities in international logistics has started since the early 1990s, and the trend of global economic integration becomes evident everywhere. With the development of ebusiness, communications between suppliers and buyers become instant by information systems. For example, the buyers can have access to any suppliers irrespective of location and available at any time. It reduces costs, improves service levels and increases profits. The improved communications through new technology are the enablers of supply chain integration. The popularity of international integration brings the new challenges to the management of multiple relations in the supply chain. This also leads to a broad inclusive view of logistics, which is not only responsible for one to one business, but a network of multiple businesses and relationships. It is extended to combine all related activities into a single integrated function Waters (2007). There are many researchers have studied on various processes of in supply chains. Lambert and Cooper (2000) point out that a successful SCM requires a cross-functional integration in the firm by coordinating activities of the key business processes. The links of business processes have direct effects on the levels of decision making, such as operations and financial planning, supplier risk and customer services management. Thus, analyzing and designing an efficient and effective supply chain have gained an increasing attention, and models of evaluating supply chain performance are diverse as investigated by Beamon (1998). He implies that a traditional supply chain is characterized by a forward flow a materials and a backward flow of information and finance.

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Farris and Hutchison (2002) have emphasized the cash-to-cash cycle concept to the supply chain management perspectives. It contains three important leverages which are account payables, account receivables and inventory. In the meanwhile, the idea of cash management has also been sentient in supply chain business processes. Badell (2005) addresses that the financial flow optimization in operation processes will satisfy shareholders as well as improve supply chain efficiencies. Cash flows are involved in each supply chain business process and the optimization of the financial flows is required at each stage. It shows the necessity of managing financial flows in the supply chain business processes, and it is significant to implement the financial-SCM strategic plan. It heightens the decision-making capacity of the CEO and the CFO in complex scenarios. The cash inflows and cash outflows in supply chains are strongly dictated to the capital capacities in companies. The synchronized level between supply chain management and the financial flows can be seen as indicator to measure the operational efficiency and as a result the financial liquidity in the companies.

2.2 The link between supply chain and financial flows There are many companies have not noticed the disconnection between overall business strategy and supply chain strategy in the organization; financial, information and physical flows are seldom synchronized. However, economic growth and capital utilization in the firm are expected to be optimized through the integration of information, financial and physical supply chains. The strong interdependency between operations and financial departments enables corporate to maintain competitive advantages in industries. Seen studies on financial flows in the supply chain, certain part of researchers are orientated to have applied cost models on the basis of accounting theory, such as Activity-based costing (ABC) that was introduced by Kaplan and Cooper (1988a,b). This has been broadly applied in multi-level, manufacturing organizations. In the 1990s many companies move their concentrations on competitions to reduce their own costs as well as those of related partners in supply chains. The competitions among companies rely on a more cost-effective chain a lower cost to serve the final marketplace and
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achieved in the shortest time period possible. The ABC tools are not used for the evaluation of financial performance, because delayed payment, return on investment/equity are not concerned as analytical indicators. Therefore, this evaluation tool is not satisfactory enough to be applied at the tactical stage for the overall corporate valuation (Ozbayrak 2004). Balance scorecard (BSC) is also widely applied when conducting performance measurement. Bhagwat and Sharma (2007) summarize some key performance indicators related to day-to-day business operations from four perspectives: finance, customer, internal business process, and learning and growth. Moreover he has considered the total cash flow time as the key measure in connection to the financial performance. However, the case-effect relationships of the key measures to performance drivers are lacking. So the supply chain balance scorecard is not sufficient enough to reveal whether the operation improvements have been translated in order to enhance financial performance. Financial performance in connection to supply chain activities are always seen as cost reduction, market share growth and profit increase (Chien 2007). There are positive relations between financial factors and the innovative supply chain practices: the improved supply chain business processes can benefit organizations through better financial performance; the increased corporation profit and market position are accompanied by an increase of the overall corporate performance. The integration of physical supply chain and financial management with the backward information flow should be done as a one package procedure in corporate. The synchronization is expected to be accomplished by the harmonization between strategic business processes and financial decisions (Guillen 2006). Weissenrieder (1998) has adapted the method of discounted free cash flow (DFCF) to calculate profitability and monitor the economic value added in the company. The analysis of profit or NPV determines implementations of certain projects. But using DFCF method to assess the strategic supply chain decisions cannot maintain sustainable competitive in case that the financial impact on different operational alternatives is not assessed in advance (Lanez et al. 2009). Normally, conventional organizations choose internal financing resources to finance the supply chain and the related business processes. Yet, retained earnings, depreciation,
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redistribution of capital from the balance sheet of a company do not have cash payments associated. Accounting earnings can present the economic value added in the firm but not the direct cash that are ready to be spent. Many academic researchers have described the differences between financial chain and physical chain in terms of inventory, process and cash management. Yet, the measures on the cost of capital regarding the impact of SCM solutions have not been explicitly considered2, because the financed assets as well as the cost of financing are not normally concerned on the bases of supply chain activities. As a consequence new tasks at the intersection of finance and logistics/SCM open new business areas for banks as well as financial and logistics service providers (Hofmann, 2005). The new concept about the integration of financial, information and physical flows brings supply chain managers new thoughts to concern the importance of the financial side of business activities. In turn, it gives the new challenges to supply chain executives of speaking the financial languages to communicate on board and in the mean while to build up cross-functional competences. The new trend of interorganizational interactions and cross-functional relationships provides new opportunities for the development of supply chain efficiency and financial performance.

2.3 Supply chain finance Supply chain finance (SCF) is an approach that aims to improve the supply chain efficiency. It is intended to improve payment terms, to reduce costs and to accelerate cash flows. Overall, the well-gained credit rating to the small/weak participants from the strong/large participants (Myers 2002) and the simplicity of payable processes (HartleyUrquhart 2000) will enhance the supplier-buyer partnerships. Collaborations between the financial side and the operating side need an encompassing approach. It should not be an isolated concept but rather as an aspect of a more integrated system or program to map the gaps between SCM operating performance and financial performance (Timme et al. 2000).

2 The cost of capital reveals credit risks overall the company. From companys point of view, the cost of capital, i.e. the weighted average cost of capital is an appropriate discount rate to use for cash flows with risk.

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The physical supply chain uses analysis and planning tools to meet and predict future demand as well as international logistics; the financial supply chain incorporates external financial service providers to jointly create value through means of planning, steering, and controlling the flows of financial resources. The SCF program aligns the operational flows with the financial flows (Camerinelli 2009). Pfohl and Gomm (2009) show the SCF program is profitable for both sides in organizations. Supply chain finance can be seen as a financial alternative for supply chain management to better operate a competitive project. The small participants obviously can receive the financial profits in accordance to the difference between the interests of refinancing from the larger participants. It can also help increase the operational benefits by the external financing services. The participants who join the SCF program can have comparative supply chain advantages through the transparency of information and the upgrade of payment terms.

2.4 The integration of SCF into SCM Reducing the financing costs and optimizing cash flows in the supply chain can be seen as the main functions of the SCF program. It is orientated to motivate supply chain development, risk adjustment and value creation through improved operational performances with respect to the reconfiguration of financial resources (Gomm 2010). The levers of the SCF program are volume, duration and cost of money. Benchmark financial indicators using supply chain operations reference (SCOR) model can help supply chain managers to visualize the link between operational performance and the financial statement (Ceccarello el at 2002). The use of Du Pont Model can assist managers to determine the overall impact of operation decisions with respect to cash flows and asset utilization (Kremers 2010). However, none of them is robust enough to cover the issues of capital costs. The use of economic value added (EVA) model in supply chain performance measurement introduced by Lambert and Polen (2001) captures how the firm drives value and profitability from operations inducing the cost of capital. Introducing SCF into SCM based on the EVA model can bridge supplier-buyer related procurement processes. For example, the improvement of cash conversion cycle time and supply chain velocity can enhance the economic profit of a company and additionally have the effect on cost of capital (Hofmann 2003).
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Nowadays, the supply chain management expands to a scope beyond the operational level of management. The task of SCF is to save the capital cost by means of integrated relationships of partners and advanced financing activities in supply chains. Applying this financial aspect to finance the supply chain gives us a new knowledge on the level of management - financial supply chain management (FSCM). The financial supply chain management is a specific set of solutions and services to expedite the flows of financial resources and information between trading partners (Michael 2009). The development of e-invoicing - paper-free transferring process of payment and the supplementary corporation with third-party financial institutions result in a simplified integrating supply chain procedure. Spoken of the impact of supply chain decisions on financial performance, we often discuss the lack of cross-functional coordination (Carter et al. 2005). Thus a more comprehensive integrated system is a consequence. It is also necessary to use the system exploring if the application of SCF can help corporates enhance the financial performances. Wang (2010) has conducted an empirical study on the impact of SCF on short-term corporate performance. KPIs for both supply chains and financial flows are applied to present corporate performances. He concludes the implementation of the SCF program is mostly used to solve short-term cash flow issues and to reduce operating costs. In the summary, inventory turnover, return on sales and return on equity have been increased at certain significant levels. In addition, the reduced cost of goods sold can increase profitability significantly. The selection of the analytical variables in Wangs paper relies on experience, so it is a kind of empirical analysis on common corporate valuation indicators and ratios by a consideration of SCF application. The introduction of the SCF program contributes financial services to business processes that relate to financial issues in supply chains. The collaborations are based on committing to share the resources, capabilities, information and risks on a contractual basis. Stronger/larger participants are orientated to concentrate on the process optimization and visibility between trading partners; smaller/weaker participants are expected to provide sufficient financial and operating information.

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Generally, the large participants who initiate the SCF program are intended to increase the economic valued added through payment term extension, and the small participants who join the SCF program are going to enhance the liquidity through financing costs reduction. The improved corporate performance can be observed from profitability, cash flows and credit ratings.

2.5 Financing suppliers in the supply chain The impact of financial crisis exacerbates corporate insolvencies and bankruptcy risks. It affects the progress on sourcing of products, services and capabilities, because of the risks of supplier defaults. The higher supply chain vulnerability with this setting makes supply chain risk management (SCRM) more difficult for many firms (Blome et al. 2011). Companies are oriented to continue tightening credit conditions when doing businesses with each other, thus the liquidity has become inadequate. Large corporations would like to extend payment terms deliberately, in order to maintain competitive for their supply chains. However, small corporations in the supply chains are unable to sustain further lengthening of payment periods because of the risk of insolvencies together with lower credit rating3. Instead, a mutual beneficial process is needed because of the growing intense between business partners. Changing suppliers is risky but essential and beneficial for the supply chain under certain circumstances. However, sometimes many supply chains rely on a set of specialized suppliers who are not easy to be replaced, and in the meanwhile it takes long time to build up the new mutual trust supplier-buyer relationships in a short time. Therefore, financing the supply chain is the most effective time-saving strategy. The perception of financing the supply chain has been lasting for decades in the developed economics. Factoring as a financial solution has existed by the form that a company sells its account receivables to a factor (a third party that can provide financing services to the seller) to get the advanced cash to run the business. Normally, it requires good credit information from the seller. But defaults of customers may cause
3

88% of UK firms and 55% of German companies have identified that key suppliers are unable to sustain further lengthening of payment periods (Kerle 2010).

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insolvency problems, thus the seller may not have enough reserves to repay the factor, which will pass the burden of default risks to the seller (Klapper 2005). The SCF program (reverse factoring) plays an important role in the progress of financing suppliers through the standardized payable processes. The saved financing costs from the payment terms on the SCF program are really beneficial to improve cash flow efficiency and subsequently improve supplier relations (Dyckman 2009). Reducing costs of capital financing as well as controlling credit risks is the most significant feature of the SCF program. Additionally, the application of open account rather than letter of credit (LC) in international trade condenses the transaction costs in terms of charge fees from banks and increases the cash flow speed in terms of a simplified payment process. By the means of letter of credit, a vendor/supplier has to prepare all the required documentation and then claim the payment from the bank with certain LC costs. The economic crisis brings pressures to both banks and corporates and in turn increases costs of transaction. Through open account alongside the endowment of the SCF program, the vendor/supplier can get paid earlier and foresee the account receivables to manage the cash flows in advance without extra charge fees (Appendix A3).

Chapter 3 Financial supply chain management

In this chapter, the application of the SCF program in supply chain management including payable processes will be exhibited. The selection of FSCM performance indicators and profitability ratios will be discussed according to the EVA model. Following, detailed arguments on how the changes of supply chain efficiency can have impacts on profitability should be stated. Overall, the whole chapter is extended to provide fundamental theoretical support for further empirical analysis on cause-effect relationships between the FSCM performance indicators and the profitability ratios.

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3.1 Financial-SCM and the link to economic value added The concept of financial supply chain management is derived from the introduction of supply chain financing programs from the bank or the third-party financial institution with new forms of payable processes and payment terms between business partners. The superior financial services provided by large participants and external financial providers assist on increasing supply chain efficiency as a whole as well as remaining competitive. Mainly it reduces the complexity of payable processes through open accounts and in the meanwhile let small participants take large participants credit ratings to reduce costs of capital financing. Overall it improves short-term liquidity in the value chain and consolidates long-term supplier-buyer relationships. The introduction of the SCF program to supply chain management can be seen as part of the design of financial flows in supply chains. As we know supply chain decisions are usually close to operational management instead of financial management. However the SCF program is a financial solution to develop the supply chain management, and in return the improved supply chain efficiency will enhance financial performance. To explore that, companies are ought to link operational drivers to top level financial indicators. The EVA model in figure 3 is used to link the value drivers from the operations to the financial performance. The EVA model tree leads to 1) the net operating profit after taxes (NOPAT), and 2) the cost of capital.
Figure 3: EVA value-driver hierarchy and levers of SCF

Sources: Gomm (2010), Supply chain finance: applying finance theory to supply chain management to enhance finance in supply chains.

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The EVA model seen in figure 3 provides the linking path that takes us from the highlevel financial performance towards more specific operational tasks. The EVA model considers the value after subtracting the cost of capital. The capital cost rate is usually defined as the weighted average cost of capital (WACC) which is the minimal required return on the company sustained by both investors and creditors. NOPAT and other corresponding operational and financial indicators will be discussed in the section of FSCM performance indicators and profitability ratios.

3.2 Integrating SCF into payable processes and cash flow cycle By the impact of the financial crisis, the tied-up working capital has become crucial because of the long cash flow cycle time from procurement to sales. Companies are seeking an essential financing method to their own as well as trading partners. However, the conflicted goals between buyers and suppliers increase the complexity to build up a mutually beneficial process. The buyers wish to delay payment for their specific financial situations and the suppliers want to accelerate collections. The application of the SCF program in supply chains can create win-win outcomes for the collaborating partners through simple and fast payable processes. Figure 4 shows how the payable processes work in supplier finance. As seen in figure 1, the buyer is supposed to be the large participate and initiates the upgraded payable processes in the financial supply chain management. Here, the same assumption of company sizes for the buyer and the supplier is used. Mainly figure 4 presents the internal financial and operational management through ERP system in companies4. The agreement established between the buyer and the financial institution contains legal issues, such as transparent data transforming in processes5. In the meanwhile, the buyer has to provide detailed and timely financial and operating information to the financial institution regarding the supplier.

The ERP application is business management software and helps in centralizing all data and processes of an organization. It is mentioned here in order to assist on presenting how FSCM works in the organization; however it is not the focus in this thesis. 5 The function of financial institution is very important in SCF processes; however the detailed argument and research are left as future research of interests. The statement related to the financial institution in this thesis is limited in how it can help the participants on the program establish a sufficient financial supply chain, indeed improve supply chain efficiency.

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Figure 4: Account Payable financing application in accordance with supplier finance

1. Buyer issues a purchasing order to supplier 3. Buyer approves suppliers invoice data and sends payment instructions 6. Buyer remits the full payment on the due which settles the transaction

2. Supplier ships the goods while transmits invoice data to buyer Financial Institution 4. Supplier is notified for future payment through the financial institution 5. Supplier may convert the future payment to cash directly

Descriptions: 1) Buyer updates its ERP system to reflect the issuance and terms of the purchasing order (PO) accordingly. 2) The invoice data should be matched with the PO data subsequent to the delivery. When the shipment of goods is verified, again buyer updates its ERP system to reflect the receipt of the goods. 3) Buyer vouchers the account payable (AP) in its ERP system and transfer payment instructions to financial institution for future due payments. 4) Once buyer updates its ERP system to reflect the verification of AP, financial institution is able to get the access to extract supplier profiles and calculate the future payments for supplier based on buyers credit rating and publish them before the due. 5) Supplier admits the early payment option to get cash inflow or receivables with an attractive discount rate. 6) The financial institution sends a payment notice to buyer, and buyer confirms the payment of full amount paid on the due date. Sources: Authors drawing according to the Hartley-Urguhart (2000).

Overall it is important to consolidate the financial supply chain into a synchronized system through high degree of information sharing and trust. Financial institution must follow in all the payable and business processes, especially the receipt of goods. It is the trigger for the financial institution to pursue future payment to the supplier. The payable processes built up on the basis of SCF platform have simplified the upstream cash flows in the supply chain between the buyer and the supplier. It liquidates also the tied-up working capital in business processes. The supplier gets paid from the financial institution before the maturity and the buyer pays to the financial institution regarding a lengthened maturity. Generally, the cash cycle time from procurement is defined as the elapsed time between the payments of cash for materials up to the receivables for sales of the finished products, seen in figure 5. The cash flow cycle time highlights how quickly a company
29

can convert its products into cash through sales. A rising trend of the cycle over time specifies the company may be facing a cash flow crisis in the near future. So the cash flow cycle is an indicator to specify the condition of working capital, and it is used to detect non value-adding processing time in the supply chain (Hofmann 2003). In figure 5, from the buyers point of view (blue dotted line) lengthening the days in payables is rational to shorten the cash conversion cycle. From the suppliers point of view (red dotted line) shortening the days in account receivables can help the company lower the cash conversion cycle. The shorter the cash conversion cycle, the healthier a company generally is, because less time capital is tied up into business processes.
Figure 5: The operating cycle and its improvement by applying the SCF program

Order Place d

Delivery + Invoice Days in Inventory

Sale + Delivery + Invoice Days of Sales Outstanding

Actual Payment

Time Days in Payables (time period to payment of supplier) Days in Receivables (customer payment time) Expected Payment Date

Cash Payment Date

Cash Conversion Cycle

Cash Flow Cycle

Operating Cycle Sources: Authors drawing.

The improved financial-supply chain performance will lead to an efficient and effective operating cycle with less time consuming (See figure 5). The improved operating cycle can also help generate additional cash flows to pay off the liabilities on time. It provides visibility to a higher quality of earnings, which enables the company to receive a better
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corporate bond rating, indeed lower the cost of debt. It counts to the improvement of the cost of capital rate i.e. the WACC (See figure 3). Figure 4 and figure 5 have exhibited the application of the SCF program on the basis of cash flow management in supply chains. There is an important outcome on the program. The supplier is possible to receive better offer for the cost of capital financing from the buyer. See the EVA model in figure 3, from the suppliers point of view the lowered cost of capital financing (cost of debt) and shortened cash conversion cycle will indirectly decrease the cost of sales and directly reflect in the cost of capital. If we discuss the savings orientated to the buyers opportunity costs, then it is possible for the buyer to negotiate a better price offer in procurement which will also reduce the buyers cost of sales. The win-win outcomes can be seen from both parties.

3.3 FSCM performance indicators and profitability ratios In this section, operational and financial indicators regarding the SCF program will be discussed broadly based on the EVA model. The selection of important FSCM performance indicators depends on the features of SCF and the value drivers in supply chains. Profitability ratios are chosen in accordance to the key figures that can present growing profits in companies. The cause-effect relationships between the FSCM performance indicators and the profitability ratios are derived by considering the overall impact of supply chain improvements on corporate performance.

3.3.1 FSCM performance indicators Key performance indicators (KPIs) are also known as key success indicators. There are various KPIs that are used for the measurement of financial supply chain management. FSCM performance indicators will be defined from both supply chain operations and financial flows (See section 3.1). Some of the KPIs are determined according to supply chain solutions; some of the KPIs are derived with respects to financial-SCM connection. Timme et al. (2000) summarize that supply chain solutions can relate to annual revenue growth, profitability and capital utilization. They specify profitability as the percentage of profits after subtracting from revenue total operating expenses. Cost of goods sold
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(COGS) as the percentage of revenue and selling, general and administration (SG&A) as the percentage of revenue are defined as the operational value drivers to improve the financial performance. Capital utilization is the area with the greatest potential for SCM solutions to improve the overall financial performance. The optimization of inventory, account receivables and account payables are the main elements to be considered regarding the features of SCF. Cash conversion cycle seems having the character to build up the connections for these elements (Farris and Hutchison 2002), and it is also one of the value drivers of SCM to improve the financial performance in the EVA model (See figure 3). The long cash conversion cycle requires large working capital in operations, thus to keep this value as low as possible is what the SCF program is ought to contribute (Hofmann 2003). The cash conversion cycle covers the whole period from the cash outflow of paying for production and cash inflow of selling products to customers, seen in figure 5. There are three import components in the process: 1) Days Inventory Outstanding (DIO), 2) Days Sales Outstanding (DSO), and 3) Days Payable Outstanding (DPO)6.

Where:

thus we have

The CCC metric covers the value drivers from both supply chain and financial flows. We can see that shortening the days in inventory, reducing days in average receivables, and extending days in average payables can result in the decrease of working capital requirement in operations. Cost of goods sold is used as a denominator to obtain DIO
6

Jim Mueller: Understanding the Cash Conversion Cycle, Investopedia, May 16, 2010.

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and DPO, because DIO and DPO are the values related to supplier relationships. DSO is paired with revenue, because customer relationships generate sales/revenue. Inventory is also a value driver to influence the financial performance (See figure 3). Inventory value (IV) is usually recorded as cost, because it is what the company has paid for not sold. Besides the inventory value, inventory turnover (IT) gives more meaning to specify the efficiency of SCM solutions. IT indicates the frequency of replacing or clearing inventories in a company over a period. The higher this ratio is, the better the company uses of inventory and the shorter the time between sales and cash collections.

The way of using average value is about to achieve a more conservative estimate during the period of cash cycle (Simchi-Levi et al. 2002). Cost of goods sold is applied to derive inventory turnover, because inventories are purchased from suppliers as part of goods for production. Till now CCC, IT, CR (COGS% of Revenue) and SR (SG&A% of Revenue) are summarized as main performance indicators for measuring financial supply chain management. Based on the EVA model, they are ought to have impacts on the corporate financial performance. The indicators are selected corresponding to the value drives in figure 3. However some value drives are excluded, for they are not related to the study focus and the features of the SCF program (See section 1.1). Later in this chapter, the relationships between the selected FSCM performance indicators and profitability ratios will be argued on the basis of the EVA model as well.

3.3.2

Key profitability ratios

First of all, let us see how operating processes and financial structure can be integrated based on the EVA model. The net operating profit after taxes (NOPAT) and invested capital are seen as independent of the companys financial structure and non-operating assets. It is a kind of component that purely symbolizes the impact of operations on financial figures. It can be used to calculate the return on invested capital (ROIC) which assesses how well a company is using its money to generate returns (Koller et al., 2005).

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If we expand the equation into details including considerations of profitability maximization, capital efficiency optimization, and tax minimization, then we have

where

is equal to revenue less

operating expenses (e.g. COGS, SG&A, depreciation). All the profits included in NOPAT are available to both debt and equity holders. ROIC is a financial indicator, but it solely focuses on a companys operational drivers, over which the manager has control. The ROIC tree in figure 6 expands the derivation into different operational components. All the operational value drivers are exhibited on the right side of the tree. Operating margin is equal to the gross margin (GM) less SR and depreciation/revenues. Further down, the average capital turns is equal to operating working capital/revenues less fixed assets/revenues.
Figure 6: The tree of return on invested capital (ROIC)

Gross margin

S.1

Operating margin Pre-tax ROIC ROIC Cash tax rate Average capital turns 1/(S.4+S.5) S.1-S.2-S.3

SG&A / revenues Depreciation/ revenues Operating working capital/ revenues

S.2

S.3

S.4

Fixed assets/ revenues

S.5

Sources: Koller et al. (2005), Valuation: Measuring and Managing the Value of Companies .

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The operating working capital is achieved by subtracting current liabilities from current assets7. It is a broad concept to show short-term liquidity in the company. Referred to the arguments in section 3.2, the cash conversion cycle is involved in cash flow cycle (See figure 5), which can be used to specify the condition of working capital in the value chain (Hofmann 2003). Cash-to-cash cycle, inventory and processing time are used to specify the working capital conditions on the SCF program (See figure 3) and all these value drivers are used to derive the cash conversion cycle (See section 3.3.1). Gross margin is obtained by deducing COGS from revenue. GM implies operational gains by the impact of financial-SCM solutions, and its positive relation to the financial performance is expected. The SCF program helps the company improve supply chain efficiency from financial point of view, thus elements that can be influenced by SCF will be prioritized. Here, depreciation and fixed assets are not explored for further analysis, because they are accounting figures in accordance to asset consumptions in the company. The other part of the EVA model includes a companys financial structure. The capital cost rate is usually represented by WACC, which is the companys opportunity costs of funds and embodies a combined required return from both operations and financial markets. The value of a company is driven by ROIC, WACC, and growth (Koller et al. 2005). If we write the cost of capital in connection to the EVA model as follows:

and the EVA in figure 3 could be obtained by subtracting the cost of capital from NOPAT,

so we have

A strong ROIC indicates high growth. When ROIC is greater than WACC, the company creates value to both stakeholders and shareholders, and when ROIC is less than
7

Koller et al. (2005).

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WACC, the value will be destroyed. The simplest form of WACC is the market-based weighted average of the after-tax cost of debt and cost of equity8.

D/V = Target level of debt to enterprise value using market-based values E/V = Target level of equity to enterprise value using market-based values = Cost of debt = Cost of equity = Companys marginal income tax rate Mainly WACC contains the market-based values; however the accounting figures are used to study the impact of SCF as a financial-SCM solution on the corporate performance. It is irrational to merge accounting data and financial market data together conducting empirical analysis, because the financial market data is more dynamic than the accounting data to reflect on the company events (See section 1.3.1). The inefficiency in the analysis will generate biased solutions. Fortunately, the cost of debt has relations to the cash flows of business processes (See section 3.2). So, further improvement of WACC will rely on the studies of the cost of debt. Other financial ratios that represent the growing profits are outlined as return on equity (ROE), return on sales (ROS) and return on assets (ROA)9:

Return on sales is related to the determination of NOPAT in the EVA model. Although the associations between ROS and supplier finance are not apparent, the net income as the numerator to obtain this ratio explains the significance of reducing SG&A and COGS by the use of the SCF program (See section 3.3.1).

8 9

See Koller et al. (2005), chapter 7. See Chen and Shimerda (1981) and Wang (2010).

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Return on assets gives both stakeholders and shareholders an idea on how efficiently the company is earning more money on less investment in operations. The increase of ROA indicates that the company can convert the liabilities it has to invest into net income proficiently. In a sense, we may expect companies who are with SCF can amplify the utilization of liabilities by the improvement of payable processes and payment terms. Return on equity measures how a company can generate profits by shareholders investments. It shows the hard fact that if there are enough profits to compensate the risk of being in the business or not. It reveals also the shareholder value in the company. Talking about shareholder value and supply chain solutions together, the design of the flow of financial resources in supply chains can affect return on equity (Hofmann 2003).

3.4 The impact of FSCM on corporate performance The endowment of SCF in supply chain management brings benefits for both suppliers and buyers, including the less time consuming operating cycle and the improved cost of capital financing. The EVA model has been used as theoretical references to derive FSCM performance indicators and probability ratios. It covers both operational and financial performances in corporate valuation. Supply chain value drivers such as IT and CCC, operational value drivers such as CR, SR and GM, and profitability ratios such as ROIC, ROS, ROA and ROE are selected to present the impact of the SCF program on the overall corporate performance.
Table 1: The cause-effect relationships between selected FSCM performance indicators and profitability ratios CR Profitability SR GM + IT + CCC -

Sources: Authors derivation

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Table 1 shows the possible cause-effect relationships between the FSCM performance indicators and the profitability ratios. The selected FSCM performance indicators measure the progress based on the financial supply chain solution. They are possible to have influences on the financial performance, which is exemplified by ROIC, ROS, ROA and ROE. The overall corporate performance is expressed by both operational and financial performances. All the measurements are under the consideration of the SCF program. The positive and negative signs explicate the effects of the FSCM performance indicators on profitability. For example, the decrease of CCC achieved by the application of SCF can probably increase profitability. CR and SR are reflected in operational costs, and they are negatively related to profitability. The supply chain efficiency ratio IT is expected to bring positive impacts on profitability. GM is expected to have positive effects on the financial performance. Once the significant levels of FSCM performance indicators and their relationships with profitability have established, companies are possible to apply the result as a reference to focus on developing in certain business processes. For example, if the impact of SCF on CCC and ROE is significant and moreover CCC is able to explain the changes of ROE, then CCC becomes an important indicator to get improved by using SCF. The tests on the significance of all the selected indicators and their cause-effect relationships will be done in next chapter. Except for ROIC other indicators and ratios have also been tested by Wang (2010) under the assumption of short term time interval before the financial crisis. Here investigations on the selected indicators and ratios are also based on the short term time interval but around the financial crisis. If the impact of SCF on corporate performance is true and certain cause-effect relationships are valid, then the application of the SCF program is considered efficient to help business partners live on from the transitory overwhelming turmoil (See section 1.2.1). Different form Wangs empirical paper (See the arguments in section 2.4), the selection of the indicators and ratios are based on the financial-SCM connection in the EVA model (Lambert and Pohlen 2001) and the features of SCF (Camerinelli 2009). Thus, the analytical results should be more dedicated to interpret the impact of SCF on corporate performance under the circumstances.
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Chapter 4 Empirical Analysis

The set up of this chapter is referred to Wang (2010), Aczel (2006) and Wooldridge (2002). First, the method of collecting and sorting data will be discussed again based on the design of research. Second, the hypothesis tests and the testing methodology are conducted to provide statistical support for specifying if the use of SCF in supply chain management can improve short-term corporate performance. At the end, the interpretation of analytical results to cause-effect relationships is used to explain the fact that the FSCM performance indicators have influences on profitability.

4.1 The sample selection and data description The data is collected randomly by searching announcements on internet (Hendricks and Singhal 2005). The financial service companies PrimeRevenue and Ariba are the primary resources for collecting the firms, which have signed the SCF agreement with their suppliers. The search covers the time period from 2006 and 2009, for the focus of the study is to figure out the outcome of applying SCF around the financial crisis. In addition, the dataset of short-term performance is attained by one-year differenced figures, before and after the event. Thus companies who have adapt SCF in and after 2010 are not possible to be analyzed at this moment. To be included in the analytical sample, firms with SCF announcements must satisfy the following criteria: 1) The common stock is listed on stock trading market: the New York Stock Exchange (NYSE), the American Stock Exchange (AMEX), or the NASDAQ exchange. 2) The firm must be the large participate who is responsible for initiating SCF programs in supply chains. 3) The firm has not made an announcement to leave the program within one year.

Criteria 1 and 2 are imposed because some raw financial accounting figures are needed from annual reports in order to calculate the indicators and ratios. The financial statements of non-listed companies are not easy to get from public resources. Large companies are usually listed in the stock market and provide their financial reports to the public. Criterion 3 is imposed to avoid the missing values and to make sure of the
39

consistency in the analysis. The sample consists of 23 announcements. Examples of some announcements can be seen in Appendix A4. Hendricks and Singhal (2005) use financial market data to prove the impact of supply chain events on shareholder values, and the stock data is collected from public resources. By contrast, Wang (2010) applies financial accounting data to analyze the effects of development; the SCF events and financial accounting data are collected by questionnaires and interviews. In this study, the methodology of data collection refers to both literatures. The events are collected from the public resources but financial accounting data are used for empirical analysis (See section 1.3.1). The final dataset contains the figures of short-term corporate performance . If the

announcement year is 2008, then the analytical data should be calculated by subtracting the figures in 2007 from the figures in 2009. Table 2 presents the descriptive statistics of the sample based on the target time period. IT and CCC are described by numbers; other indicators and ratios are described by percentages. The dummy variable gives 1 to the year 2009 and 0 to the years from 2006 to 2008. The use of dummy variable is to show the increased popularity of aligning the SCF program after financial crisis.

Table 2: Distribution of the announcement year for the sample of 23 firms of supply chain finance
Year 2006 2007 2008 2009 2006-2009 Number of firms 2 6 3 10 23 % of firms 8,70% 26,09% 13,04% 52,17% 100%

Table 2 presents the number of firms with the announcement of SCF by year. Nearly 40% of the announcements in the final sample are made during 2007-2008, and over 50% of them are made in 2009. Obviously, most announcements are occurred after the financial crisis.

40

Table 3: Descriptive statistics for the sample of 23 firms of supply chain finance
N ROIC ROE ROA ROS CR SR GM IT CCC Dummy Valid N (listwise) 23 23 23 23 23 23 23 23 23 23 23 Minimum -0,46 -0,47 -0,26 -0,38 -0,20 -0,09 -0,06 -5,77 -204,52 0 Maximum 0,18 0,53 0,38 0,25 0,06 0,20 0,20 344,62 66,96 1 Mean -0,03 -0,04 0,01 -0,02 -0,01 0,01 0,01 14,25 -10,91 0,52 Std. Deviation 0,14 0,23 0,14 0,11 0,05 0,06 0,05 72,04 47,14 0,51 Skewness -1,24 0,20 1,12 -1,19 -2,09 1,69 2,09 4,79 -3,21 -0,09 Kurtosis 3,11 1,23 3,06 5,57 5,53 4,57 5,55 22,97 14,01 -2,19

In table 3 we can see that the kurtosis of variables IT and CCC are relatively high and the standard deviations are also very large in comparison with other variables. In this situation, a consideration of outliers in the sample is essential (Barnett and Lewis 1994). Outlier is an observation that is distant from the rest of the sample data. Mostly, the extreme observation may be show as sample minimum or sample maximum. The existence of outliers in the sample will bias the efficiency of linear estimators i.e. the coefficient or the slope of the trending directions are not reliable. Therefore, the relative effects of dependent variables corresponding to independent variables are not precise.

Figure 7: Outliers in the sample of 23 firms of supply chain finance

Sources: Graph from SPSS

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To conduct the descriptive statistics is one way to check on the outliers. Boxplot invented by John Tukey (1977) is widely used to detect the outliers. Figure 7 shows the median, quartiles, and the extreme values within a category. The function of simple boxplot with summaries of separate variables in SPSS is applied; the extreme outliers need to be extracted from the sample. In table 3 we can see the outliers may exist in IT and CCC in the sample, and in figure 7 there are two extreme outliers that are appeared in these two variables. Case 16 is a negative extreme outlier with the value -204.52, and case 20 is a positive extreme outlier with the value 344.62. The modified sample size used to conduct statistical tests is 21 by removing case 16 and case 20.

4.2 Hypothesis tests and testing methods See section 1.3.2, hypotheses include the impact of SCF on the short-term corporate performance, and the cause-effect relationships between the selected FSCM performance indicators and profitability. Before we move on to the test hypotheses, statistical tests on the conditions of the sample data are expected to be done first. We have to know distributions of variables, in order to determine either parametric or nonparametric statistics should be applied. The cause-effect relationships are acquired by the tests on linear regressions. Endogenous variables are not allowed in linear regression analysis. Correlation analysis is used to help notice the endogenous variables (Wooldridge 2002). Furthermore the structured linear models are obtained based on sample p value test statistics.

In spite of the described logical procedure to attain the linear models, exceptions may occur. For example the distributions of the variables are various; there are few significant correlations between dependent and independent variables. So the nonparametric kernel-based model specification tests are applied to check the correct linear specifications of regression models (Hsiao et al, 2007). The analytical software IBM SPSS Statistics and R-2.14.1are used for data analysis. SPSS is limited with linear models; however the nonparametric package of R is possible to test the null hypothesis of linear specification by applying nonparametric estimators.
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In SPSS, the analytical tools such as one-sample nonparametric tests, one-sample t test and bivariate correlation tests are used. The interpretation of the analytical results is based on the significant levels 1%, 5% and 10%. 10% is the highest tolerant level to accept in the analysis.

4.2.1 One-sample distribution tests and t test Different from nonparametric tests, parametric test methods require assumptions of distributions. The collected sample size here is not large enough to predict the shapes of the variables, additionally the distributions of the variables in the sample are unknown. Nonparametric tests such as one-sample Binomial, KolmogorovSmirnov and Wilcoxon sign-ranked tests are applied to check if the variables in the sample are distributed normally or asymptotically normally. If the test results tell us that the variables are not failed to be rejected at least as asymptotically normal distributions, then the parametric statistical methods are expected to be used for further analysis. The asymptotical normal distribution as well as binomial distribution will approximate to the normal distribution when the sample size is getting larger and larger, but not vice versa. If the null hypothesis on distribution is failed to be rejected, then the parametric linear regression analysis will be used.
Table 4: The null hypotheses and assumptions of distribution tests

Null hypothesis
Binomial test (Clopper el at. 934) The two categories of a dichotomous variable are equally likely to occur The observed cumulative distribution function for a variable with a specified theoretical distribution.

Assumptions
Random sample The shape of the underlying distribution is not required Random sample The test distribution is specified in advance, such as normal, uniform or Poisson (normal distribution is assumed). Random sample The assumption of normal distribution is not required.

Kolmogorov-Smirnov test (Birnbaum et al. 1951)

Wilcoxon signed-ranked test (Bauer 1972)

The population distribution of the paired differences from median is symmetric.

The one sample t test is used to compare the mean difference between the sample and the known value of the population mean. The sample is usually considered as the randomly selected sample from the population. The use of t test is to examine if the
43

selected sample is sufficient enough to interpret the real population. Tested variables are assumed to be normally distributed. If the test statistics are significant, then the variables in the sample can explain the truth of the population, i.e. the impact of SCF is true. The application of the SCF program in companies is new at the moment, so the test value or the population mean of the indicators is unknown. Thereby zero test value is used in one-sample t test (Wang 2010). If the impact of SCF cannot be observed, then the consideration of enlarging sample size is crucial to obtain better analytical results, or the extension on determined time period of cause-effect development is required (See section 1.2.2).

4.2.2 Correlation and regression analyses There are three bivariate correlations in SPSS as well as in Wangs paper (2010) used to test the correlation coefficients. Pearson is a parametric test; Kendalls tau_b and Spearmans rho are non parametric tests. The Pearson correlation analysis is influenced excessively by outliers because of its parametric feature, but not the other two. Thus, we should conduct the test by the modified sample without the outliers (See section 4.1). The correlation tests can provide two solutions for further regression tests: 1) the significant correlations between dependent and independent variables are preferred, because the explanatory power of the coefficients in linear models is expected to be high; 2) the significant and high correlations among independent variables are not allowed to appear in the same linear regression, otherwise the estimators will be biased and inconsistent. Suppose few independent variables are significantly correlated with dependent variables, and we are not sure if they are linearly related. In this situation, the test on linear specification is required in order to validate the parametric linear regression models with efficiency and consistency. The sample contains both qualitative (discrete)

44

and quantitative (continuous) variables (Wooldridge 2003, p. 226), and the use of kernel smoothing methods can smooth them in a particular manner10 The null hypothesis of parametric linear regression is:

If there is significant linear relationship between dependent variable and independent variables, the regression coefficients (the slope) will not equal to zero. The null hypothesis in linear regression states that the coefficients are equal to zero, and the alternative hypothesis states that the coefficients are not equal to zero. Therefore, the rejection of null hypothesis is expected to be achieved according to the test statistics. Fstatistics explain the rejection or the failed rejection of linear regression at different significant levels. As long as the p value is smaller than 0.1, the coefficients of linear regression are not equal to zero (10% is the highest tolerant level). Equivalently the null hypothesis is rejected at 90% confidence interval. R square and adjusted R square together explain the power of the linear models. The significant variables in regression analysis will be considered in the construction of linear models. Suppose the structured linear model of ROIC is efficient with some of the independent variables. We can conclude that the changes of ROIC are caused by some independent variables, and the dependent variables should be recognized and improved by a consideration of the SCF program.

4.3 Data analysis and interpretations In this section, the outputs of distribution tests will be discussed first. There are three distribution testing methods involved in table 5. The one-sample t test is used to prove the selected variables can explain the significant impact of SCF on corporate performance in short term. Furthermore the coefficients of correlation regressions are summarized in table 7 containing both parametric and non-parametric tests. At the end, the linear regression analysis generates the significant structured linear models regarding the sample (See section 1.3.2).
10

See R tutorial for non-parametric kernel smoothing methods at http://cran.rproject.org/web/packages/np/index.html, and Wooldridge (2002).

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Table 5: The distribution tests on FSCM performance indicators and profitability

One-Sample Binomial Tests Exact Sig. (2-tailed) ROIC ROE ROA ROS CR SR GM IT CCC Dummy a. Based on negative ranks b. Based on positive ranks 0.001 0.189 0.001 0.001 0.000 0.000 0.000 0.001 0.383 1.000 One-Sample KolmogorovSmirnov Tests Z 0,740 0,883 1,273 1,182 1,222 0,911 1,230 1,016 0,747 1,594 Aspymp. Sig. (2-tailed) 0,644 0,417 0,078 0,122 0,101 0,378 0,097 0,254 0,632 0,012 One-Sample Wilcoxon Sign-ranked Tests Z -2,659 -0,156 -0,956 -0,817 -1,303 -0,956 -1,373 -4,015 -1,616 -2,167
a b a b b a a a b a

Aspymp. Sig. (2-tailed) 0,008 0,876 0,339 0,414 0,192 0,339 0,170 0,000 0,106 0,030

By looking at the significant levels of distribution tests, we can observe that some variables are not asymptotically distributed. In the Binomial tests, ROE, CCC and Dummy are failed to be rejected at 10% level, because the statistical p values are larger than 0.1. In the K-S tests, Dummy is rejected as normal distributions at 5% level; ROA and GM are rejected at 10% level. In the Wilcoxon sign-ranked tests, ROIC and IT are rejected as asymptotical normal distribution at 1% level and Dummy is rejected at 5% level. The data outputs are quite satisfactory, even though they are various in connections to different testing methods. Most variables are proved as normally or asymptotically normal distributed. The assumptions of linear regressions do not require all the variables to be normally distributed but the residuals; F statistics in regression analysis indicate the significance of the normally distributed residuals (Aczel 2006). In table 6 we can see IT is significant at 10% level but not the other selected FSCM performance indicators and profitability ratios. Though the dummy variable is significant in the sample, it is the control variable to indicate the year differences but not the variable to present the short-term corporate performance. Recall the statement of the effects of development over time in section 1.2.2, this outcome is not very surprised. Additionally, the time period around the financial crisis is also special and there should be many other issues that can interfere with the progress of corporate performance. So
46

the impact of SCF on the corporate performance are rarely observed in one-year time period, because the test statistics do not show the evidence that the values of variables are higher or lower than the test value of their respective scales.
Table 6: The one-sample t test on FSCM performance indicators and profitability
One-Sample Test Test Value = 0 t df Sig. (2-tailed) Mean Difference 95% Confidence Interval of the Difference Lower ROIC ROE ROA ROS CR SR GM IT CCC Dummy -0,807 -0,741 0,737 -0,687 -1,084 1,142 1,106 -1,842 -1,614 4,264 20 20 20 20 20 20 20 20 20 20 0,429 0,467 0,469 0,500 0,291 0,267 0,282 0,080 0,122 0,000 -0,025 -0,034 0,021 -0,018 -0,013 0,015 0,014 -0,524 -5,402 0,476 -0,091 -0,129 -0,038 -0,071 -0,039 -0,012 -0,012 -1,117 -12,384 0,243 Upper 0,040 0,061 0,079 0,036 0,012 0,041 0,039 0,069 1,580 0,709

IT has been decreased significantly according to the test statistic; however it is expected to be improved according to the theories. Suppose the changes on inventory values are minor or constant regarding supply chain finance, we perhaps can explain it in a way that the decrease of COGS is obvious and as a result IT is decreased significantly (see the calculation of IT in section 3.3.1). The SCF program is part of financial services to improve the financial flows in supply chain, so the days in inventories and inventory management are seemed out of the scope. By contrast, the interpretation of IT is sensitive to the financial-SCM related indicators. Overall, we cannot deny the impact of SCF on corporate performances, even though the testing results are not absolutely evidenced in a short time period. If we still assume the impact is true based on the theories of SCF and the EVA model, then the test on causeeffect relationships between FSCM performance indicators and profitability is inevitably important. We need to find out if the selected FSCM performance indicators have significant influences on profitability, either positively or negatively. If their relationships are established, then the improved supply chain efficiency can have effects

47

on profitability implying that the impact of SCF on enhancing the overall corporate performance is possible. Table 7 combines the testing results from both parametric and non-parametric correlation analyses. The variables are separated into dependent variables and independent variables. The dependent variables represent profitability ratios and the independent variables represent the FSCM performance indicators. First, the certain correlated relations between profitability and the FSCM performance indicators should be observed, in order to provide possibilities to conduct linear regressions. Second, the correlated relations among the FSCM performance indicators should be noticed, in order to avoid endogenous variables in regression analysis. The parametric Pearson correlation coefficients show that there are no significant correlations between ROA and independent variables. The significant correlations between other dependent and independent variables are also rare. However, the nonparametric correlated coefficients achieved by Kendall's tau_b and Spearman's rho tests show relatively more significant relations between dependent and independent variables but still occasionally. Therefore, the tests on linear specifications of regression models have become primarily necessary (See section 4.2). CR and GM are almost perfectly and significantly correlated to each other in all the tests, for in the raw dataset GM is calculated by subtracting COGS from revenue/sales. Here, COGS is kept for further analysis rather than GM. The COGS has been used in deriving cash conversion cycle and it directly relates to suppler-buyer trading processes, so it can better explain the consequences of using SCF. Furthermore, GM is also significantly correlated with Dummy in all correlation tests. CCC and IT are correlated with moderate significant coefficients; therefore one of them might be excluded while running regressions. We can leave this issue when checking the goodness-of-fit by R square and adjusted R square for linear regressions. If the presence of CCC and IT in the same regression distorts the power of the model, then one of them should be removed. If the linear specification of the model is correct at a certain level and the removal of either of them reduces the power of the test, then we could keep them in the same regression. As long as the test statistic of the linear regression is significant, there will be no problem to have these two variables in the same model.
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Table 7: Parametric and non-parametric correlation tests

ROIC ROE ROA ROS CR SR GM IT CCC Dummy

Dependent Variables
ROIC Pearson Kendall's tau_b Spearman's rho ROE Pearson Kendall's tau_b Spearman's rho ROA Pearson Kendall's tau_b Spearman's rho ROS Pearson Kendall's tau_b Spearman's rho 1,000 1,000 1,000 0,758** 0,705** 0,805
**

1,000 1,000 1,000 0,797** 0,800

**

0,603** 0,695
**

1,000 1,000 1,000 0,332 1,000

**

0,756** 0,146 0,406

*

0,921** 0,388 0,549

**

0,520

1,000 1,000

0,494*

0,755**

0,709**

Independent Variables
CR Pearson Kendall's tau_b Spearman's rho SR Pearson Kendall's tau_b Spearman's rho GM Pearson Kendall's tau_b Spearman's rho IT Pearson Kendall's tau_b Spearman's rho CCC Pearson Kendall's tau_b Spearman's rho Dummy Pearson Kendall's tau_b Spearman's rho -0,326 -0,352
*

-0,468* -0,343
*

-0,426 -0,429
**

-0,220 -0,387
*

1,000 1,000 -0,807** 1,000 -0,286 -0,358 -1,000

** **

-0,491* 0,044 -0,076 -0,106 0,328 0,371

*

-0,521* 0,145 -0,143 -0,165 0,470 0,362

* *

-0,573** -0,550** 1,000 0,263 -0,076 -0,068 0,427 0,448

**

0,078 -0,081 -0,063 0,221 0,387

*

1,000 1,000 0,807** 1,000 0,286 1,000 1,000 0,030 0,076 0,096 1,000 1,000 1,000 1,000 1,000
**

-0,981

0,506* 0,489 0,190 0,308 -0,284 -0,190 -0,282 0,332 0,303 0,362
*

0,535* 0,307 0,352* 0,482

*

0,597** 0,329 0,362* 0,523

*

0,544* 0,246 0,301 0,421 -0,511* -0,377

*

-0,996** 0,357 -0,026 -0,076 -0,086 0,177 0,171 0,219 -0,460* -0,355 -0,425 -0,060 -0,143 -0,222 -0,055 0,029 0,040 0,432 0,316 0,378

-0,195 -0,219 -0,316 0,353 0,276 0,331

-0,140 -0,267 -0,336 0,390 0,263 0,315

-0,180 -0,464* -0,171 -0,524 0,466* -0,129 0,368* 0,039 0,441* 0,047

-0,487* 0,158 0,317 0,378

-0,219 -0,690** 1,000 -0,385 1,000 -0,276 1,000 -0,331 1,000

(**) Correlation is significant at the 0.01 level (2-tailed). (*) Correlation is significant at the 0.05 level (2-tailed).

Linear regressions of probability (ROIC, ROE, ROA and ROS) on all the independent variables (CR, SR, IT, CCC, Dummy) are expected to be tested. If the linear parametric model is failed to be rejected, then the significant estimated coefficients achieved by running the linear regression analysis are reliable. Before conducting regression analysis, we should be aware that non-parametric regression analysis might be used because of the resolutions from the tests of distributions and correlations; in addition the sample size might be not large enough to specify linear relations.
49

Table 8 illustrates the tests on correct linear specification of regression models and the power of the structured linear models, along with the estimated coefficients. As we know, the regression analysis is conducted to figure out the relationships between the FSCM performance indicators and profitability. Table 8: Results of linear regression for effects of FSCM performance indicators on profitability 11
ROIC Intercept SR CR IT CCC Dummy R square Adusted R square F Test statistic Correct Model P value 0.366 0.644 0.145 0.491 (**) Coefficient is significant at the 0.01 level (2-tailed). (*) Coefficient is significant at the 0.05 level (2-tailed). () Coefficient is significant at the 0.1 level (2-tailed). -0,041 -1,652* -1,582* 0,069** 0,003 0,141* 0,575 0,434 4,065* -0.551 ROE -0,065 -3,302* -2,547* 0,068 0,004 0,169 0,535 0,379 3,446* -0.668 ROA -0,001 -1,085 -0,635 0,053* 0,003 0,127 0,451 0,267 2,460 1.041 ROS -0,031 -0,624 -0,281 -0,003 -0,004 -0,029 0,298 0,064 1,272 0.599

All the regressions are failed to be rejected as correct specifications according to the test statistics and p values, so the parametric linear regression is applied to analyze the cause-effect relationships between the FSCM performance indicators and profitability. By looking at F-statistics in table 8, structured linear models of ROIC and ROE are failed to be rejected at 5% level, ROA is failed to be rejected at 10% level, and ROS is rejected even at 10% level. Therefore, we cannot apply the analytical results in the linear regression of ROS for the interpretation of the effects of SCF on performance indicators and profitability ratios. Even though CCC is negatively significant in the structured linear model of ROS, we cannot rely on the cause-effect relationship between them. Moreover the change of CCC is too small (the decrease of 0.004 day in CCC), so its effect on profitability is negligible as well. Next, let us look into the details of the structured linear models ROIC, ROE and ROA. The power of different models will be discussed first following by goodness-of-fit
11

Referred to correlation analysis, the tests on removal of either CCC or IT, or other possible correlated independent variables have been checked, in order to obtain higher power of the regression models. To keep all five independent variables in regression analysis provides the best statistical results.

50

diagnoses (R square and adjusted R square). The influences of both qualitative and quantitative independent variables on dependent variables are argued based on the positive and negative changes. At the end, the link between empirical results and the findings from previous literatures is outlined.

The R square is 0.575 and adjusted R square is 0.434. The statistical explanatory power of the linear model ROIC is moderate (Aczel 2006). SR and CR are negatively significant, and the coefficients are -1.625 and -1.528. It means that the decreases of SR and CR one year after the adaption of the SCF program can have influences on ROIC obviously. The 1% increase of ROIC can result in the increase of IT 0.069, so the frequency of clearing the inventories is expected to be increased 0.069 times. The dummy variable is positively related to ROIC at 5% significant level. The result explains that companies who have adapted SCF in 2009 have 14.4% higher ROIC than companies who have adapted SCF during 2006-2008. The average ROIC for companies who have adapted SCF in 2009 is 10% (14.1% 4.1% = 10%, but the intercept is insignificant). The result indicates the accelerated growth on ROIC by the impact of SCF, in particular after the financial crisis. In the meanwhile, it signifies the popularity of using SCF because of the imminent beneficial consequence.

The R square is 0.535 and adjusted R square is 0.379. The statistical explanatory power of the linear model ROE is moderate. The significant coefficients of SR and CR signify that the decreased SR and CR in comparison to one year ago can have influences on ROE apparently. The increase of ROE relies also on the increase of IT with 0.068 times in short term.

The R square is 0.451 and adjusted R square is 0.267. The statistical explanatory power of the linear model ROA is relatively low. IT as well as Dummy has positive influences on the increases of ROA. The increased 0.053 times to sell the inventories on hand result 1% increase in ROA. The average ROA for companies who have adapted SCF in 2009 is 12.6% (12.7% 0.1% = 12.6%, but the intercept is insignificant). The significant outcome of the dummy variable in the linear structure model of ROA is the
51

similar to ROIC. The positive outcomes are amplified when the SCF program becomes more common and standardized after the financial crisis. Generally, the analytical results are reasonable in connections to the theories of SCF and the EVA model. Most of the selected FSCM performance indicators are significant in the linear regressions, and their certain positive and negative effects on profitability are compliant to theoretical foundations. CCC is the only insignificant indicator in these three valid structured linear models. No matter in which regressions, the changes of CCC are not obvious enough to give the evidences of the substantial effects on profitability. Dyckman (2009) mentions the saved costs of financing for suppliers by aligning the SCF program in supply chains can be used for buyers to renegotiate the purchasing prices. We can see in the empirical results that the reduced COGS can obviously increase ROIC and ROE. It implies that the impact of SCF on COGS is supposed to be vital, and the improvement of COGS is also essential in order to enlarge the company value. Hofmann (2003) studies the design of financial flows in supply chains can change the shareholder value. Unfortunately, the empirical results have not shown any evidences about that, because the indicator CCC is not significant. It is similar to the empirical findings in Wang (2010). He has also concludes that the effects of CCC on profitability should be ignored and the significant positive sign of CCC is incorrect. The Demica empirical paper (2011) states the increasing popularity of using SCF after 2008. Here the significance of dummy variable in the structured linear models supports the findings in the Demica paper. However, the improved profitability is not precise in the sample because of the insignificant intercept values. This inefficiency affects the level of interpretation but not the evidence of predicted beneficial outcomes.

Chapter 5 Case study at Siemens

Siemens AG is a German multinational company, operating in the fields of industry, infrastructure, energy and healthcare. Besides these four sectors, it is also organized into another three divisions: Siemens IT Solutions and Services, Financial Services (SFS)

52

and Equity Investments. Siemens has 360.000 employees as of September 30, 2011 all over the world and business activities in around 190 countries. Because of the solid corporate organizational structure and sufficient financial services, Siemens has recovered from the economic recession fast and gained profits more than expected. Therefore, it still maintains leading market positions worldwide in the majority of business areas and has outscored key competitors in the Diversified Industries sector. The case study of SCF at Siemens focuses on the division of Financial Services (SFS), because SCF is part of Siemens Treasure in SFS. The descriptions on how SCF works at Siemens will be exhibited first and following the benefits at a glance for both Siemens and its suppliers. Next, linking theoretical and empirical studies to Siemens SCF program provides a basic idea for perceiving practical applications of SCF. At last, certain suggestions on expanding FSCM network and integrating inter-organizational functions will be outlined, in accordance to the perspectives of SCF and future development of the company.

5.1 Supply chain finance at Siemens Siemens has initiated the supply chain financing in the Treasure department in September 2008 in the United States. Actually, Siemens has already started working on launching the program before the financial crisis, because they believe funding suppliers and providing them earlier payments are not only needed in a crisis. It is also necessary for Siemens to develop their own supply chain financing services, in order to satisfy customers without adding costs to suppliers. For example, on the SCF program the pressures from the customers with lengthening payment terms allow Siemens to extend payment terms with the suppliers, and the suppliers are able to receive cash earlier instead.

53

Figure 8: Payable processes of supply chain finance at Siemens

Sources: Alexander Gorke: The presentation of supply chain finance at Siemens for suppliers, SFS, Siemens Treasury GmbH

Figure 8 specifies the payable processes with SCF at Siemens and it contains six steps. It is similar to the payable processes in figure 6. There are no conceptual differences between these two processes. Siemens uses multibank approach established by Orbian as the third party financial institution. First, it is difficult for Siemens to have the agreement with only one bank satisfying different suppliers. Second, Siemens does not need to link its ERP system to a particular banks platform. It reduces the counterparty risks, because Siemens can still have other banks on the SCF program financing the supply chain if the bank exits the business. Last, the price competition among banks is advantageous for Siemens to receive cheaper interest rate for capital financing.

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Figure 9: Early payments with and without the SCF program at Siemens

Sources: Alexander Gorke: The presentation of supply chain finance at Siemens for suppliers, SFS, Siemens Treasury GmbH

In figure 8, we can see it takes Siemens 8 days to approve invoices from suppliers in the ERP system from step one to step five; the suppliers can get paid 2 business days after Siemens transferring the instruction of early discounted payment to Orbian. In connection to figure 9, suppliers who are with SCF get paid 10 days after invoicing. If we say the maturity is 90 days, then the suppliers will have 80 days cash advantageous in comparison with the suppliers who are without SCF. As for Siemens, it pays the invoices at the maturity in both ways. In previous chapters, the discussions of early discount payments highlight that the small participants can take the large participant credit as the cost of capital financing to cash flows. Undoubtedly, Siemens as the large participant on the program can provide shared credit lines to its suppliers. The suppliers will be benefited by increasing cash and speed-up cash flows (Lawrence et al. 1979). First, assuming the cost of capital financing to a supplier with SCF at Siemens is 2.6% (EUR LIBOR + 1.3%) as annual interest rate, and the supplier can get paid 10 days after invoicing even though the maturity is 90 days. Second, assuming a supplier without SCF offers an early payment term 3/10 net 90. The term means if Siemens pays the supplier in 10 days after invoicing, then only 97% of the whole amount will be charged. The reason why the supplier offers this term is because they are facing liquidity shortages and they need cash right now. See in figure 8, the 3% Skonto can be seen as
55

the discount interest rate from the supplier to Siemens for getting the money 80 days in advance. Third, assuming the account receivables is $1.000.000, 360 calendar days and the cost of borrowing money for the supplier from its other creditors is 6% annually. Now, let us look at the same information from different perspectives: 1) the annual interest rate 2.6% with SCF versus the annual interest rate without SCF by early discount payment terms; 2) the discount rate 3% in 10 days without SCF versus the discount rate in the 10 days with SCF. The supplier without SCF is giving Siemens $30.000 (1.000.000*3% = $30.000) for getting the money 80 days in advance. Now look at another scenario. What if one of Siemens partner banks makes a deal that, they will give Siemens $30.000 on the principle of $1.000.000 if Siemens let them have the money for 80 days. These two offers are one and the same. If such a bank existed, then Siemens might as well as deposit $1.000.000 for 80 days, and earn that $30.000, and then pay the supplier on the 90th day with $1.000.000. This is the same as paying the supplier $970.000 on the 10th day. What is the annual effective interest rate for such a bank account following this approach? For 80 days, Siemens got 3%. Therefore, for 360 days, Siemens would get 14% (3%*(360/80) = 14%) interest12. In other words, the supplier offers Siemens 3/10 net 90 term is giving Siemens an opportunity to earn 14% annual interest rate on cash. However, the supplier is already borrowing money at 6% from other creditors. Offering early payment discount to Siemens is more than twice expensive as borrowing money from the other creditors. Obviously it is not profitable for the supplier at all, and offering early payment discount should be the last resort, if it is still possible to borrow money from other source at a rate less than 14%. If the supplier with SCF gets paid in 10 days, the discount rate will be much lower than 3% Skonto. In the SCF program, the supplier can take Siemens credit 2.6% as the cost of capital financing. For 10 days, the supplier would get 0.58% (2.6% *(80/360) = 0.58%) discounted interest rate. In this situation, the supplier can receive $994.222 ($1.000.000*(1 - 0.58%) = $994.222) from Orbian, which is more than without SCF in 10 days ($994.222 - $970.000 = $24.222). In this situation, the suppliers discount rate is 0.58% versus 3% speaking of early payment discount in 10 days.
12

See Hull (2003) Chapter 4.

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With the SCF agreement, suppliers can take buyer's cost of debt as their own cost of money. On the other hand, the early discount rate can be seen as the investment in competitive advantages. If the suppliers can predict the cash inflows and get account receivables earlier, then the supplier can have better opportunities to work on other short-term and long-term projects in comparison with their competitors. The cost of money to sell receivables to Orbian is definitely lower than to other creditors in this case. If the financial supply chain solution can bring more profits and make business processes more efficiency for the supplier, then its own credit ratings are able to be improved. Eventually the suppliers cost of borrowing money from the other creditors will also be improved (See the arguments in section 3.2). Generally, it is not a good idea for the supplier to offer early payment discount in order to increase cash and speed up cash flows. With SCF the early discount payment is provided by the large participant cooperating with the third party financial provider. The advantages of joining the SCF program for the supplier are a) predictable and faster cash flows, b) simplified and transparent payable processes and c) lower cost of capital financing.

5.2 FSCM indicators, profitability and growth at Siemens The set-up of this section is to illustrate a general picture of the growth at Siemens including the period of financial crisis13. The 10-year historical investigation and analysis at Siemens are exhibited by the selected FSCM performance indicators and profitability. In during, the statements of the outcomes are connected to both the theoretical backgrounds and the empirical findings. Mostly, the arguments in this section discuss 1) if Siemens has become better off in short term by the help of the SCF program, 2) the most important indicators and ratios in practical applications besides theories and empirical analysis, 3) the SCF program can provide fundamentals for future development in the company. The liquidity ratios are considered in the 10-year historical investigation, because the financial crisis in 2008 is an important inflection point of the worlds economy evolution. Including the liquidity ratios in the investigation is in order to clarify if the

13

See the arguments about the time period in section 1.4.

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application of SCF in the company can help maintain short-term capital efficiency. Cash ratio, current ratio and quick ratio will be use to present the financial liquidity at Siemens14:

The use of cash ratio is related to cash conversion cycle. The cash ratio directly indicates the liquidity of short-term cash assets; however it is not sufficient enough to explain the liquid condition in the company. High cash ratio may be seen as poor asset utilization, because the cash can be used for other investment opportunities generating extra returns. The Current ratio and quick ratio are more robust and conservative because it includes inventory and receivables (the receivables are in current assets), in which the inventory is the least liquid asset in corporate. The application of the SCF program is able to encourage the short-term liquidity condition in corporate and maintain sustainability in the economic recession. So the increasing trend of the liquidity ratios after the event is expected. Figure 10 shows the changes of CCC at Siemens from 2002 to 2012 together with the cash ratio, which is a measure of company liquidity. The cash ratio has been increased dramatically after 2007 and continued to 2010. The fluctuation occurs in 2011, but it up trends again in 2012. The cash ratio reflects the ability of paying back current liabilities. Theoretically, the design of financial flows in supply chains can help shorten the cash flow cycle. However, the decreasing trend cannot be observed in short-term regarding the financial crisis in 2008. It takes time to implement the SCF program technically and to negotiate payment terms with suppliers. It seems declining after mid-term; however it is increased again in 2012. Additionally, the empirical results have not shown the changes of CCC can influence the profitability significantly in short-term. Thus, the control of CCC as a whole by SCF may not generate comparative advantages to improve corporate performance.
14

See Ciprian 2009, and www.investopedia.com

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Figure 10: The cash conversion cycle and cash ratio 160,00 140,00 120,00 100,00 80,00 60,00 40,00 20,00 0,00 2002 2003 CCC 2004 2005 DSO 2006 2007 DIO 2008 2009 DPO 2010 2011 2012 Cash Ratio 0,45 0,4 0,35 0,3 0,25 0,2 0,15 0,1 0,05 0

Sources: Authors calculation

The cash conversion cycle consists of DSO, DIO and DPO. These three elements share a similar trend in 10 years. If we say DIO and DSO are the indicators to explain companys operational efficiency, then DPO is completely under the management control. Clearing inventories is involved in the processes of DIO and DSO; however the application of the SCF program is not used to control inventory and sales. The program provides a financial solution to help supply chain control supply-side cash flows. Therefore, payment term extension is more reliable for the company to improve the economic value added on the SCF program. Siemens use DPO as a management control variable to increase EVA as well as compete with main competitors. The success of savings in cost of capital or the increase of EVA is:

Positive Cash Flow (Increased Account Payables)

Sources: Siemens model

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Lengthening payment term in turn increasing EVA is the most direct benefit of using the SCF program at Siemens. The SCF program is seen as a financial solution improving upstream flow of cash with suppliers and it does not have any power to control inventories as well as the sales to customers. But at least with SCF, if Siemens customers are extended to lengthen the payment terms, then Siemens can negotiate with suppliers for payment term extension in order to offset the financial pressures from sales. After all, the control of DPO instead of the complete CCC metric makes more sense to generate economic value added to the company. DIO and DSO are operational processes, which are difficult to be manipulated by the improvement of financial flows in supply chains. Therefore, reducing CCC as a whole by the SCF program is not guaranteed if considering the inventory management and customer satisfaction.
Figure 11: The inventory turnover and relative liquidity ratios 6,00 5,00 4,00 3,00 2,00 1,00 0,00 2002 2003 2004 IT 2005 2006 2007 2008 2009 2010 2011 2012 Current Ratio Quick Ratio 1,6 1,4 1,2 1 0,8 0,6 0,4 0,2 0

Sources: Authors calculation

Figure 11 shows the changes of IT and relative liquidity ratios in 10 years. Inventory turnovers have been decreasing since 2008; the outcome is opposite from theoretical statement. Even in the empirical studies, the results indicate the positive cause-effect relationship between IT and profitability. Siemens has tried to keep inventory values in a certain range these years, so the changes of inventory value (IV) are seldom. If assuming the fluctuation of IV is constant, then the dynamic movements of COGS can become a key factor to determine IT as well as DIO (See section 3.3.1). Seen in empirical findings, the influences of COGS on profitability with SCF are obvious. Subsequently, the arguments in
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connections to the decrease of IT and the increase of DIO are not limited to inventory control only but also the reduction of COGS. Both current ratio and quick ratio trends up after 2008, but the fluctuation occurs in 2011 which is similar to cash ratio. Quick ratio considers inventory as an element to measure the liquidity, because inventory is the least liquid of all the current assets15. If we say the holdings of inventories at Siemens bring insolvency problems, then we can perceive it by quick ratio. By contrast, the movements of cash ratio, current ratio and quick ratio are alike. So we can conclude the inventory value at Siemens is under control and varies in tolerate levels. If we assume the inventory value is constant, then the changes of DIO and IT according to COGS can be explained in another way. The decrease of COGS at Siemens results in the decrease of IT and the increase of DIO. So the negative relation between IT and profitability is not totally incorrect if we consider COGS as the dominant factor and IV constant. It also explains the significant decrease of IT by the impact of SCF (See the onesample t test in section 4.3). The decrease of IT and the increase of DIO can be used to indicate the improvement of profitability under the circumstances. Again, the indicator CCC is not sufficient enough to specify the effects on profitability by the application of SCF.
Figure 12: Growth in Siemens 100.000,00 90.000,00 80.000,00 70.000,00 60.000,00 50.000,00 40.000,00 30.000,00 20.000,00 10.000,00 0,00 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Revenue Sources: Authors calculation
15

30.000,00 25.000,00 20.000,00 15.000,00 10.000,00 5.000,00 0,00 COGS SGA GM

See Ciprian 2009.

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Figure 12 and figure 13 illustrate the growth and profitability at Siemens. GOGS is closely related to the inbound material activities with suppliers through manufacturing operations. GM is moving in the gap between revenue and COGS; however there is a peak occurring in 2009. It could be the reason that the implementation of SCF helps Siemens lower the costs of purchasing and productions. SG&A in connection to supply chain management reflects in customer service, supply chain administration and information technology. As we know, the disputed payable process through ERP systems will reduce costs of SG&A generally. The loss of shareholder value, seen the decline of ROE in figure 13, is resulted by the impact of economic uncertainties due to the debt and financial crisis (Siemens annual report 2012). ROS has been decreased since 2011 and ROA is sustainably increased. The sharp increase of ROIC indicates the sustainable efficiency in operations (See section 3.3.2), and it implies that the company is expected to achieve economic recovery in the near future. The overall economic environment regarding financial crisis can result in diminishing trend of profitability and growth, however the advanced operational and financial solutions in the company are more determinant to the future development.

Figure 13: The key ratios of profitability in Siemens 30,00% 25,00% 20,00% 15,00% 10,00% 5,00% 0,00% 2002 2003 2004 2005 ROIC 2006 ROA 2007 2008 ROS 2009 ROE 2010 2011 2012

Sources: Authors calculation

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5.3 Recommendations In this section, suggestions of improving the use of SCF program at Siemens are discussed from different points of view. Mainly, fundamental ideas are enthused by the previous theoretical and empirical studies. Practical applications of the recommended ideas are argued according to the future perspectives of the development of the company and the qualitative research experience with the coordinator from Siemens. The purpose of including a section for practical recommendations is to propose feasible future development of the financial supply chain management in international business. Even though some issues such as advanced IT solutions and penetrations to emerging markets are not emphasized in the thesis, the high-level integration between organizations and extended supplier-buyer cooperation are implicated in order to explore the future improvement in corporate performance.

5.3.1 Updates in the ERP system The SCF program at Siemens is one of the successful financial solutions to motivate the inter-organizational financial and operating activities. The integration level between SFS and procurement organization is adequate at Siemens. Indeed, the commodity managers are the main contact for suppliers; they need the support of SCF program to contact with the suppliers. By introducing the SCF program to strategic suppliers, Siemens can negotiate with the strategic suppliers lengthening the payment terms in order to increase the EVA. The development of the ERP system in terms of the SCF program is essential for the use of selecting strategic suppliers. The approaches to find a strategic supplier to promote the SCF program have been discussed between the author and the coordinator. The author suggests finding the strategic supplier in the ERP system and then contacting the supplier for further corporation, or holding event days that Siemens invites potential suppliers and then presents the SCF program to them. Basically, there are lots of negotiation required between Siemens and its suppliers. The different Siemens entitles decide on using different approaches to contact suppliers. The coordinator has pointed out that the best approach to use would for a Siemens entity: technically implement the Supply Chain Finance Program in the ERP-System,

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define the strategic suppliers, inform them about the need for longer payment terms, offer Supply Chain Finance as a solution for them and then negotiate. It is analogous to one of the suggestions from the author. Siemens is still working on implementing the SCF program in the ERP system. We both agree that the development of IT solutions to help enlarge the financial supply chain network is advanced and mandatory. Financial banks, Obrian and procurement should understand the importance of overall cooperation and synchronized integration between organizations. This progress will increase standardization of processes at Siemens and save costs of supply chain administration.

5.3.2 Control of payment terms and SCF loans to suppliers The payment terms which are actually on the SCF program at Siemens are in a wide range between 45 and 150 days. The determination of payment extension depends on various analyses and evaluations, such as supplier-buyer relationships and liquidity issues. Nonetheless, the boundary of payment extension should be noticed and restrictions on the basis of financial calculations are essential. Figure 13 illustrates the approximate break-even of terms extension, including the terms with and without early discount payments. The assumption of the original payment term is 60 days in this section; others are the same as in section 5.1. With early discount payment term, the total financial cost has become the mixture of suppliers own bank draft and the discounted amount. The supplier is always paid at about 10 days after invoicing, but the discount charged differs according to extended payment terms. For 60 days maturity, the discount cost is $3611 ($1.000.000* (6010)/360*2.6% = $3611); for 125 days, the discount cost is 8306 ($1.000.000* (12510)/360*2.6% = $8306). Siemens can extend payment term to 138 days without adding cost to the supplier, and with early discount payment the extension of payment term is limited in 125 days without adding cost to the supplier. The extension of payment terms can increase trade payables at Siemens. The positive cash flow for Siemens with 65 days extension is $180.556 ($1.000.000*(125-60) = $180.556), and the savings in cost of capital i.e. the increase of EVA is $4694 ($180.556*2.6% = $4694), see section 5.2.
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Figure 13: Terms extension break-even 13a) Compare cost of debt from other creditors and cost of financing with SCF
Loan

Total financing cost: $1.000.000 / 60 days / 6%

$ 10.000 138 days after delivery (Maturity date)

Invoicing Supplier Finance

Total financing cost: $1.000.000 / 138 days / 2.6% Approximate Break-even

$ 9967 $ 33

13b) Compare cost of debt from other creditors and cost of financing with SCF early discount payment
Loan

Total financing cost: $1.000.000 / 60 days / 6% 125 days after delivery (Maturity date)

$ 10.000

Invoicing

SCF early payment after 10 days Supplier Finance

Financing cost (10 days): $1.000.000 / 10 days / 6% Payment discount cost (10 days): $1.000.000 / 60 days / 2.6% Total financing cost: Loan& Discount (60 days maturity) Savings for the supplier

$ 1667 $ 3611 $ 5278

$ 4722

Extension of payment term: Payment discount cost (10 days): $1.000.000 / 125 days / 2.6% Total financing cost: Loan& Discount (125 days maturity) $ 8306 $ 9973

Approximate Break-even

$ 27

Sources: Authors calculation

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The management control of trade payables is on the one hand the chance to increase EVA significantly and on the other hand the opportunity to remain competitive advantages of DPO compared with core competitors. Furthermore, Siemens can leverage suppliers savings to negotiate for COGS reduction. However, the increments from 60 to 125 days will embrace the possible reserves less and less.
Figure 14: Borrowing money via the SCF program versus other creditors
Loan

Total financing cost: $1.000.000 / 60 days / 6%

$ 10.000

Invoicing

SCF early payment after 10 days Supplier Finance

60 days after delivery (Maturity date)

Total financing cost: $1.000.000 / 60 days / 2.6% Savings for the supplier

$ 4333 $ 5667

Early discount payment: Financing cost (10 days): $1.000.000 / 10 days / 2.6% Payment discount cost (10 days): $1.000.000 / 60 days / 2.6% Total financing cost: Loan& Discount (60 days maturity) $ 722 $ 3611 $ 4333

Sources: Authors calculation

Figure 14 shows the possible financing activities to the supplier with the application of the SCF program. The deal is done between financial banks provided by Siemens and the suppliers; Orbian is not involved at this stage. Without extension of payment terms, savings on capital financing for suppliers with SCF is larger. In this situation additional early payment besides SCF loan is irrelevant, because it is the same as supplier borrowing via the SCF program. Although it is not possible for Siemens to increase EVA by payment term extension, the possible reduction of COGS can also add values to economic growth of the company. Recall the empirical results in section 4.3, the decrease of COGS can increase ROIC and ROE obviously. Therefore, the improvement of COGS by the impact of SCF should be counted significantly under the circumstances.
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This strategic approach is expected to be beneficial for a small supplier who does not have liquidity issues relatively, because early discount payment may not be an option; to get cheaper loans on the program is more beneficial for the small supplier. If such suppliers exist in the supply chain, then negotiations of GOGS reduction instead of payment term extension are suitable for the practical application of supply chain finance at Siemens. Additionally the suppliers cost of borrowing money according to the business contract with Siemens is 2.6% on the SCF program, so the total cost of debt is expected to be decreased16. Seen the example in table 9, the financial bank provided by Siemens is going to become one of the suppliers creditors. The small business owner probably borrows money from several sources with different annual interest rates. If the small supplier can get cheap loans on the program, then the overall financing costs will be decreased subsequently. Moreover, the straightforward improvement of WACC is also attractive to the supplier joining the SCF program (Section 3.3.1). Further negotiations for early discount payments would be considered based on the improved cost of debt for the small supplier in table 9 Panel B. This strategic approach of sharing credit lines on SCF loans can help the supplier improve credit ratings directly from the third party financial services on the program. In particularly, if Siemens can get cheaper price offers from the supplier, then the pricing advantages compared with main competitors are recognizable. This is an ambitious tactic strategy. Conventionally, Siemens can align the SCF program only for the purpose of reverse factoring and negotiate the COGS reduction based on that. This approach is oriented to generate the benefits for the supplier by early discount payment with the low cost of financing. So, the improved operational process eventually can help the supplier reduce cost of debt in terms of the cash enhancement and the speed-up cash flows. In the meanwhile, Siemens is able to improve economic value added by the negotiated payment term extension.

16

4 simple steps to calculate the Cost of Money for your small Business https://www.ordoro.com/blog/2009/12/15/cost-of-money-calculation/

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Table 9: Cost of debt for small businesses with and without the impact of SCF17
Panel A) Cost of debt without the impact of SCF A Source Comercial Bank SBA American Expresss Visa Total Cost of Debt Amount $10.000.000 $750.000 $135.000 $67.900 $10.952.900 $657.174 / $10.952.900 = 0.060 = 6.00% B Annual Interest 5.85% 4.74% 16.94% 19.97% C AXB $585.197 $35.542 $22.874 $13.561 $657.174

Panel B) Cost of debt with the impact of SCF A Source Bank (Siemens)* Comercial Bank SBA American Expresss Visa Total Cost of Debt Amount $1.000.000 $9.000.000 $750.000 $135.000 $67.900 $10.952.900 $624.654 / $10.952.900 = 0.057 = 5.70% B Annual Interest 2.60% 5.85% 4.74% 16.94% 19.97% C AXB $26.000 $526.677 $35.542 $22.874 $13.561 $624.654

*The small supplier borrows $1.000.000 from the financial bank provided by Siemens with credit rating 2.6%, and the other $9.000.000 from its own Comercial Bank with credit rating 5.85%.

Sources: Authors calculation

5.3.3

Extension to emerging markets

Siemens has achieved a big success by implementing the SCF program in Europe and America in these years. In the meanwhile, Siemens has also been aware of the development in emerging markets, so expanding the range of SCF to Asia and Eastern Europe has become a resolute progress in coming years. Right now, Siemens focuses on adding more currencies to the program and convincing more and bigger suppliers to join the program. International finance corporation (IFC) established in 2010 provides short-term capital financing services to emerging market suppliers and small-medium sizes exporters. The so called global trade supplier finance (GTSF) provides post-shipment finance to the suppliers. IFC works with large organizations across industries that source goods in emerging
17

The example is for illustrative purpose only. The applicability of these calculations to specific situations is not guaranteed.

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markets. This will help reach thousands of small-medium sized suppliers in targeted countries. IFC also helps banks offer supply chain finance and at the same time increase their presence in the emerging markets. Overall, IFC works on increasing access to supplier finance and supporting technical skills for the emerging market suppliers through partnerships with banks and third-party platform providers. It seems suitable to employ the third-party financial institutions that are dedicated to provide supply chain financing services in emerging markets, because they are more experienced in implementing supplier finance to local enterprises. This approach requires Siemens linking its ERP system to the IFC IT platforms besides Orbian. Seen in figure 8, the SCF program at Siemens will not be powered by Orbian only but also other IT platforms; concurrently more banks will be involved regarding the diversified IT platform. It is an ambitious financial management strategy. Although it may result in speed-up penetration of the SCF program into the emerging markets, the sufficient IT solutions at Siemens are required to develop as well. Sometimes it is expensive to implement new IT solutions. Conservatively speaking, Siemens is possible to expand the SCF program to the emerging markets by the Orbian IT platform. Agreements with the large suppliers from the emerging markets are under considerations, because they are influential to attract more banks to join the program. This conventional strategic approach is about to achieve a mutual development between large corporate and financial institutions. It takes time to negotiate and exploit, but eventually Orbian is able to help Siemens expand the supply chain financing services to small-medium sized suppliers in the emerging markets. It is complicated to make decisions satisfying different organizations in supply chains. Strategic marketing plans and financial management should be allied, and the advanced IT solutions are also inevitable. If Siemens chooses the conventional approach, then further communication and coordination with partner banks are superior. Prior to that, Siemens should prepare sophisticated negotiation strategies to emphasize the benefits for banks. If Siemens chooses the ambitious approach, then upgraded IT solutions in the company and training programs for suppliers in the emerging markets are significant.

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Chapter 6 Conclusions
In this chapter, critical arguments of the research process are stated first. Followed possible explorations to other aspects are outlined in the section of suggestions for future research of interests. The critical arguments are based on the same framework of the research in this study but breaking into more details. Overall conclusions are at the end.

6.1 Criticism The selection of indicators is limited and self-reported. Seen in section 3.3, only numerated indicators have been discussed based on the EVA model. Recall the statement of research design in section 1.3.1; we can see that both qualitative and quantitative research methods are applied. The study concentrates more on the quantitative research methods, because the impact of SCF on corporate performance is expected to be seen by the improvement of accounting figures. The implied methodology to determine FSCM performance indicators is step by step from supply chain value drivers to operational drivers. For instance, if the supply chain value drives are not possible to be calculated, then the author moves further to supply chain related operational value drives. The selected financial ratios for profitability rely on the empirical literatures; however the cause-effect relationships between operational and financial performances are not only limited by the configurations in this research. If the research starts with qualitative method, then the selection of indicators and ratios will be more precise and adequate. For example, DPO could be used for empirical analysis instead of CCC. More FSCM performance indicators might be derived from practical supply chain business processes in the company and used in cross-sectional estimation. The performance indicators related to supply chain solutions might not always be recorded by figures but language interpretations sometimes. Discussions and arguments based on the qualitative research experience are also important, even though it is hard to put them in figures for statistical analysis. If the research focuses only on the case study at the company, then practical applications of SCF will be the main content. Additionally, detailed supply-side cooperation on the program and practical supply-side
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risk management will be highlighted as fundamental knowledge to explore the improvement of corporate performance. The use of CCC to explain the working capital condition might not be convincing. A pretest on the relationships between CCC and working capital could be necessary, even though there are certain literatures that have suggested their solid interrelations. If we do use working capital as an indicator, then we need to discuss the transform of working capital into the indicator that present the features of the SCF program such as duration and volume. The improvement of paying liabilities on time could be an option to start the investigation.

6.2 Suggestions for future research of interests The formulation of research problems determines research methods and resolute consequences. The structure of this study is outlined from financial points of view, and the empirical analysis on the financial accounting data has become the foundation to cope with theories and practices. To continue with this research design, further statistical analysis on an expanded sample is optional. For instance, other large organizations without SCF can be compared with the large organizations with SCF in the sample. The distinction can be settled by adding an additional dummy variable, where the large organizations with SCF are indicated by 1 and others by 0. The extended sample is about to provide supplementary evidences highlighting the significance of applying the SCF program. Certainly, we would like to see the positive impact of SCF is true and the large organizations with SCF can generate more profits than the large organizations without SCF. This phenomenon could be applied to specify that competitors in industries are able to use the SCF program to enhance organizational capabilities. A company based case study of SCF has the possibility to continue exploring thoroughly, and additional FSCM performance indicators are expected to be derived. The design of performance control by a consideration of SCF is a tendency; it is useful to clarify target values for corporate sustainability management. On the performance control panel, both numerated and non-numerated components should be involved. The predicted growth on the key figures influenced by SCF and the optimization of the related supply chain business processes are the targets. Balance scorecard (BSC) model
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is able to provide more elements for operational and financial performances as well as supply chain KPIs. The EVA model is able to build the comprehensible relations between operations and corporate finance. Combined BSC model and EVA model is able to add more FSCM performance indicators on the panel. Moreover, it helps both supply chain and financial managers to control efficiencies and effectiveness in business processes from suppliers to customers.

6.3 Conclusions The thesis studies the application of the SCF program in supply-side value chain management, containing the cost saving financial strategy and cash flow optimization. The combination of theoretical, empirical and practical research methods gives a general framework to explore the use of the SCF program in organizations. The EVA model in connection to the features of the SCF program provides the theoretical foundation of selecting FSCM performance indicators and profitability ratios. CR, SR, IT and CCC are selected to conduct the cross-sectional estimation. The FSCM performance indicators combine the KPIs from both supply chain and financial flows. Except for CCC other selected indicators do show the significant effects of the development on profitability. The structured linear models of ROIC, ROE and ROA are significant in dependence on the selected indicators. CR and SR are negatively related to profitability; IT is positively related to profitability. Unfortunately, the impact of SCF on short-term corporate performance is not possible to be observed around the financial crisis. However more companies have adapted to the program after the financial crisis and the companies can be better-off obviously, seen by the significance of year dummy. The result implies the increasing popularity of the SCF program and the imminent beneficial consequences. Further case study of SCF at Siemens modifies that the improvement of CCC around the financial crisis might be observed in mid-term. Additionally, controlling CCC is not considered in practices to improve economic value added in the company. Instead, controlling DPO can generate the economic value added directly. The financial crisis result the profitability ratios at Siemens in diminishing trends, however ROIC is still increasing sustainably. It signifies the use of the SCF program is able to improve ROIC
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is important, because it solely focuses on the companys operational drivers. So an efficient operational process with coherent financial solutions is significant and competitive, and it provides the company opportunities to grow even in economic recession. The success of supply-side value chain management on the SCF program is mainly visible in lowered cost of capital financing and speed-up cash flows from suppliers points of view. Buyers can exploit the features of the program to generate cost savings for the suppliers and then leverage the savings for further negotiations on COGS in order to lower purchasing prices. Furthermore, the buyers can manage payment term extension (DPO) to control the economic value added remaining competitive in the marketplace. The impact of SCF on the corporate performance can improve supply chain efficiency in terms of cost saving payable processes and profit maximizing payment terms. The financial solution with SCF can result in an upgraded operating cycle in supply chains; the improved supply chain efficiency can benefit the company through better financial performance; the increased corporate economic power in the marketplace is accomplished by an increase of the overall corporate performance.

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Internet: http://www.cpoagenda.com/previous-articles/summer-08/heads-up-w07/tactics-supplychain-finance-101/ http://www.ehow.com/info_8080378_differences-account-documentary-lettercredit.html http://www.scmdirectory.com/index.php?option=com_content&view=article&id=279:a riba-teams-with-orbian-to-provide-third-party-supply-chain-financing&catid=22:scmpartnerships&Itemid=74 http://www.imd.org/research/publications/upload/PFM178_LR_Ralf_Daniel_Seifert.pdf Supply Chain Finance - Whats It Worth? , www.imd.org, no. 178 October 2009. http://www.investopedia.com/articles/06/cashconversioncycle.asp Understanding the Cash Conversion Cycle, Jim Mueller, Investopedia May 16, 2010. http://www.ifc.org/ifcext/globalfm.nsf/Content/GTSF2 Global Trade Supplier Finance https://www.ordoro.com/blog/2009/12/15/cost-of-money-calculation/ 4 simple steps to calculate the Cost of Money for your small Business http://cran.r-project.org/web/packages/np/index.html R tutotial for non-parametric kernel smoothing methods

Appendix
A1: Abbreviations SCF - Supply Chain Finance FSCM - Financial Supply Chain Finance EVA - Economic Value Added BSC - Balance Scorecard SCM - Supply Chain Management KPI - Key Performance Indicators LC - Letter of Credit CCC - Cash Conversion Cycle DIO - Days of Inventory Outstanding DSO - Days of Sales Outstanding
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DPO - Days of Payable Outstanding AR - Account Receivable AP - Account Payable IV - Inventory Value IT - Inventory Turnover COGS - Cost of Goods Sold SG&A - Selling, General and Administration CR - COGS as % of Revenue SR - SG&A as % of Revenue GM - General Margin ROIC - Return on Invested Capital ROE - Return on Equity ROA - Return on Assets ROS - Return on Sales WACC - Weighted Average Cost of Capital

A2: R coding and outputs data <-read.table("E:/Dan/master thesis/FSCM/data/R-Kernel regression.txt",header=T) 1) Model test on ROIC: model <- lm (ROIC~CR+SR+IT+CCC+Dummy,y=TRUE,x=TRUE,data=data) X<-data.frame(data$CR,data$SR,data$IT,data$CCC,data$Dummy) output<-npcmstest(model=model,xdat=X,ydat=data$ROIC,tol=0.1,ftol=0.1) summary (output) 2) Model test on ROE: model <- lm (ROE~CR+SR+IT+CCC+Dummy,y=TRUE,x=TRUE,data=data) X<-data.frame(data$CR,data$SR,data$IT,data$CCC,data$Dummy) output<-npcmstest(model=model,xdat=X,ydat=data$ROIC,tol=0.1,ftol=0.1) summary (output) 3) Model test on ROA:

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model <- lm (ROA~CR+SR+IT+CCC+Dummy,y=TRUE,x=TRUE,data=data) X<-data.frame(data$CR,data$SR,data$IT,data$CCC,data$Dummy) output<-npcmstest(model=model,xdat=X,ydat=data$ROIC,tol=0.1,ftol=0.1) summary (output) 4) Model test on ROS: model <- lm (ROS~CR+SR+IT+CCC+Dummy,y=TRUE,x=TRUE,data=data) X<-data.frame(data$CR,data$SR,data$IT,data$CCC,data$Dummy) output<-npcmstest(model=model,xdat=X,ydat=data$ROIC,tol=0.1,ftol=0.1) summary (output)

********************Output********************** Consistent Model Specification Test Parametric null model: lm(formula = ROIC ~ CR + SR + IT + CCC + Dummy, data = data, x = TRUE, y = TRUE) Number of regressors: 5 IID Bootstrap (399 replications) Test Statistic Jn: -0.550776 P Value: 0.36591 --Signif. codes: 0 '***' 0.001 '**' 0.01 '*' 0.05 '.' 0.1 ' ' 1 Fail to reject the null of correct specification at the 10% level

Consistent Model Specification Test Parametric null model: lm(formula = ROE ~ CR + SR + IT + CCC + Dummy, data = data, x = TRUE, y = TRUE) Number of regressors: 5 IID Bootstrap (399 replications) Test Statistic Jn: -0.6679528 P Value: 0.64411 --Signif. codes: 0 '***' 0.001 '**' 0.01 '*' 0.05 '.' 0.1 ' ' 1 Fail to reject the null of correct specification at the 10% level
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Consistent Model Specification Test Parametric null model: lm(formula = ROA ~ CR + SR + IT + CCC + Dummy, data = data, x = TRUE, y = TRUE) Number of regressors: 5 IID Bootstrap (399 replications) Test Statistic Jn: 1.041218 P Value: 0.14536 --Signif. codes: 0 '***' 0.001 '**' 0.01 '*' 0.05 '.' 0.1 ' ' 1 Fail to reject the null of correct specification at the 10% level

Consistent Model Specification Test Parametric null model: lm(formula = ROS ~ CR + SR + IT + CCC + Dummy, data = data, x = TRUE, y = TRUE) Number of regressors: 5 IID Bootstrap (399 replications) Test Statistic Jn: 0.5987174 P Value: 0.49123 --Signif. codes: 0 '***' 0.001 '**' 0.01 '*' 0.05 '.' 0.1 ' ' 1 Fail to reject the null of correct specification at the 10% level

******The statistical results provide evidences of linear models******

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A3: Letters of credit and open account supplier finance

Sources: Dyckman, Bob (2009), Integrating supply chain finance into the payables process, Journal of Payments Strategy & System, Vol. 5 Issue1, p311-319.

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A 4: Examples of the SCF announcements The Toro Company Partners with PrimeRevenue and Well Fargo to Improve Working Capital, the news of PrimeRevenue, 11 August 2009. The news indicated that PrimeRevenues technology and services with financing provided by Wells Fargo HSBC Trade Bank (NYSE: WFC) powered Toros Supply Chain Finance (SCF) program. Toro suppliers would gain online visibility to their Toro-generated receivables in advance of their due date, and the option to sell receivables for cash in advance of the original due date with financing provided by Wells Fargo. Doing the right thing, Financial-I, October 2010. In the article Markus Schiffers, head of Supply Chain Finance, Siemens Financial Services (SFS) talked about that Siemens had applied SCF since 2008 and its direct benefits for Siemens Financial Services. Siemens suppliers could sell their receivables to Orbian and got early discount payment. Casio goes live for e-trade on Bolero, Press Release Bolero, 11 March 2007. Casio started Japans first LC based exporting e-trade services on Bolero. As a result, Casio enabled improvement of customer service and the early stage collection of accounts receivable for suppliers.

A5: Links of the SCF announcements on the internet http://www.marcusevans.com/marcusevans-conferences-eventdetails.asp?EventID=13368&SectorID=7 (Nokia 2008) www2.orbian.com/documents/news_items/39.i2i_siemens_m.schiffers.pdf (Siemens 2008) http://www.slideshare.net/Bobtb/financial-supply-chain (Novo Nordisk 2007) http://www.ariba.com/news/press_release.cfm?press_id=2832 (Carlsberg 2009) http://www.primerevenue.com/about/press_releases/09_12_07.html (Volvo Group 2007) http://www.primerevenue.com/about/press_releases/05_18_06.html (Aberdeen Group 2006) http://www.primerevenue.com/about/press_releases/12_05_06.html (Big Lots 2006) http://www.primerevenue.com/about/press_releases/02_24_09.html (General Motors 2009) http://www.primerevenue.com/about/press_releases/02_24_09.htm (Chrysler 2009) http://www.primerevenue.com/about/press_releases/08_11_09.html (Toro Company 2009)
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http://www.ariba.com/news/press_release.cfm?press_id=2801 (British Airways 2009) http://www.primerevenue.com/about/press_releases/11_28_06.html (Sainsburys 2006) http://www.bolero.net/en/Newsdownloads/news-details/09-1019/Noble_Group_launches_Bolero_global_multi-bank.aspx (Noble Group 2009) http://www.bolero.net/en/Newsdownloads/news-details/07-03-23/Casio_goes_live_for_etrade_on_Bolero.aspx (Casio 2007) http://www.bolero.net/en/Newsdownloads/news-details/05-03 14/Glencore_goes_live_with_Bolero.aspx (Glencore 2005) http://www.labinnovator.com/events/events-fsc2006.htm (Novozymes 2007) https://www.miag.com/uploads/pics/MIAG_MVD_Brochure_2810D1B_FINAL.pdf (Metro Group 2007) http://www.gfmag.com/archives/22-february-2008/108-features.html#axzz1Yaz8Thfy (Coca Cola 2004) http://www.ariba.com/news/press_release.cfm?press_id=2828 (Dtwyler Cables 2009) http://www.ariba.com/news/press_release.cfm?press_id=2835 (Aviva 2009) http://www.ariba.com/news/press_release.cfm?press_id=2837 (SGS 2009) http://www.ariba.com/news/press_release.cfm?press_id=2847 (Carphone Warehouse 2009) http://www.ariba.com/news/press_release.cfm?press_id=2849 (Swisslog Healthcare Solutions 2009) http://www.ariba.com/news/press_release.cfm?press_id=2861 (Atlas Air Fuels 2009) http://www.ariba.com/news/press_release.cfm?press_id=2867 (CVS Caremark 2009) http://onlinelibrary.wiley.com.ez.statsbiblioteket.dk:2048/doi/10.1002/tie.20373/pdf (Zara 2008) http://onlinelibrary.wiley.com.ez.statsbiblioteket.dk:2048/doi/10.1002/tie.20373/pdf (Toyota 2008) http://www.euromoney.com/Article/1425461/BackIssue/51468/Financial-supply-chaindebate-Linking-the-supply-chain.html?single=true (Philips 2007)
Last time accessed: November 2011

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