Demanding supply

There has been much talk in both British and US business of late about stakeholders. A couple of years ago UK politicians and commentators appeared to rediscover section 172 of the Companies Act 2006, which codified the pre-existing law on directors’ duties. Section 172 makes clear that prosperity in business can only be delivered by taking into account the interests of stakeholders (including, specifically, employees, suppliers, customers, local communities and the environment). Companies are now responding to a new call in the Corporate Governance Code to report on how they have done this in practice. More recently, the US’s Business Roundtable (BRT) in August purported to redefine the purpose of the corporation by asserting the need to consider the interests of customers, employees, suppliers and communities as well as shareholders. 

I’ve explained elsewhere that the modern US assumption that shareholder interests always come first is a misreading of the legal precedents, so this restatement seems unnecessary. It’s also worth noting that the negative response to the BRT statement from the major US investors was based more on a disbelief that any of the 181 corporate signatories actually meant it than on a belief that stakeholder interests are unimportant. The actions since its publication of many of the companies whose leaders signed the statement have not demonstrated any shift in their approach to the treatment of stakeholders: none has demonstrated greater fairness of late.

For these key stakeholder relationships all need to be mediated by fairness — indeed the BRT statement specifically mentions fairness, at least in relation to employees and suppliers. Yet, all of these stakeholders are at various times mistreated and not dealt with fairly — if this were not the case there would be no need for the US corporate elite to restate something that amounts to no more than motherhood and apple pie. 

Of all the unfairnesses, perhaps the most consistently unfair is the way that large companies treat their suppliers. The power imbalances in most supply chain relationships were brought home very clearly to a friend of mine early in his business career when his triumph over a successful negotiation, knocking down a supplier’s prices significantly, turned to rather different emotions a few months later when the supplier went bust. This, and the challenge and cost of replacing that supplier, apparently amounted to a highly chastening experience. 

Most choose to sweep it under the carpet, but the unfairness of these differential power relationships is made plain by those handful of companies that are transparent about their economic treatment of suppliers. The result is economic madness as well as supplier unfairness. A typically excellent recent report from the Financial Reporting Lab highlighting best practice disclosures on the sources and uses of cash includes a small section on supply chain financing. It is mostly obliged to lean on invented examples as there is precious little best practice in reporting on such financing. The report does, however, include some disclosures from AstraZeneca which allow us to have some insight into the economic irrationality that underlies how big companies treat their suppliers.

AstraZeneca reveals in its Annual Report (p34 and p177) a relatively recently established supply chain financing programme, whereby suppliers are able to be paid earlier than their contracted due date through payments from financiers Taulia and Greensill Capital. AstraZeneca then pays Greensill on the contractual date. The suppliers in effect pay an interest rate for the privilege of being paid earlier than they might be. As at the year-end December 2018, 2548 suppliers were enrolled and the trade payables associated with the programme amounted to $166 million (the newness of this programme is clear from the fact that this balance has risen from $64 million in the prior year, and $0 previously).

A more mature such programme is operated by Vodafone. It has 3500 suppliers enrolled, and the balance of supplier invoices in the programme at year end March 2019 was £2.5 billion (this seems to be near steady-state as the prior year balance was £2.3 billion). The company explains this as follows: “Our suppliers have the opportunity to take up early invoice payments on a completely voluntary basis, where payment can be taken in advance of agreed terms at much lower rates than they are likely to receive under traditional factoring or borrowing arrangements” (quote from p63 of the latest Annual Report, other information p161). 

It is that ‘at much lower rates than under traditional borrowing arrangements’ that reveals the unfairness of this approach for our economy as well as for the individual suppliers. Having had discussions with the financial institution that provides this financing, the model is clear: it is an arbitrage between the cost of debt of Vodafone (very low) and that of its suppliers (higher, by a lesser or greater margin). In effect, suppliers are allowed to piggy back on Vodafone’s credit rating and so borrow money more cheaply than they might otherwise be able to.

For many finance teams, this reflects a way they seek to demonstrate their effectiveness: they try to manage down the company’s working capital, minimising the amount of money tied up in the business. Among other actions, they work to extend supplier terms, and measure success by paying as close to the final deadline as possible. Nirvana in this mindset is negative working capital — being paid by consumers or customers for goods before having to pay suppliers for the inputs. Some finance teams wear this like a badge of honour.

It’s economic nonsense though. As the Vodafone case shows (and note that I have no reason to believe that Vodafone or AstraZeneca are any worse than other companies, it’s just that we have some visibility on what they do), this is a deliberate shifting of the borrowing burden onto those with a higher cost of capital. Before anyone suggests that money is essentially free for consumers, do remember that at least 4% of consumer spending is on (expensive) credit. Even on relatively modest assumptions, the economic drag from just this visible portion of Vodafone’s approach to paying its suppliers runs into the tens of millions of pounds.

Companies act as though this money that they use to run their business, the money that is in effect borrowed from customers and from suppliers, is free. But the cost drag is clear: a higher cost of debt is built in to the prices companies pay their suppliers. So not only is the differential power relationship between companies and suppliers leading to unfairness, it also represents a drag on the economy. If the larger companies provided the financing, and did not seek to minimise their working capital, the overall cost of debt in the system would be reduced, leading to greater economic efficiency and greater fairness to all participants.

We need to find a fairer approach.

Accountable Capitalism, Governance, October 2018

Statement on the purpose of a corporation, Business Roundtable, August 2019

CII Responds to Business Roundtable Statement on Corporate Purpose, Council of Institutional Investors, August 2019

Disclosures on the sources and uses of cash, Financial Reporting Lab, September 2019