By: Harry Gandhi (CEO)
Oil & Gas: Service industry payment woes
It is not news that buying on credit (open-account) dominates global trade. The International Chamber of Commerce (ICC) generally acknowledged that at least 80-85% of all global trade in 2010 was settled on open-account (OA) terms.
When buying on credit the buyer takes on the supply risk and is obliged to “match” a purchase order, shipping or warehouse data to the supplier invoice. This is seen as low-risk for the buyer as goods can be rejected on inspection for various reasons, and payment will only be made if a full match occurs and at conclusion of payment terms.
When selling on credit the supplier assumes all the credit risk. For small and medium enterprises (SMEs) cash flow is always a priority but they are often challenged with a lengthy cash conversion cycle due to 45/60/90-day payment terms, late payment or even non-payment. This risk is now being highlighted that 73% of businesses were paid late in 2010/11 with the average SME being owed £27,000 at any one time.
A recent discussion with most of my industry colleagues showed that nearly 50% of large oil & gas companies, EPC Contractors & Government organisations were more likely to extend supplier payment terms now than they would in 2011, thereby increasing buyer-supplier tensions and increasing supplier credit risk.
Based on these dynamics, which don’t appear to be changing soon, why would I suggest that large buyers should want to pay suppliers on time, or even early..?
Supply Chain Disruption
The implications of supply chains failing are well known, and the recent high profile geographic incidents in Asia have only established it further. Large buyers have in many ways compounded their supply chain risk by employing lean just-in-time practices to be more efficient, continually reducing costs by sourcing overseas, centralising distribution and manufacturing for economies of scale and by consolidating suppliers in the chain.
To reduce the impact of disruption and ensure business continuity, many large corporates are re-examining their supply chains and implementing proactive strategies to mitigate risk such as dispersing their portfolio of suppliers and facilities. When examining risk, there are some common drivers that fall under ‘disruption’ such as natural disasters, war, terrorism and single-supplier dependence but perhaps one driver that buyers do have the most control over is supplier bankruptcy.
Paying on Time – Or early
Late payments, either through bad process or extension of payment terms is compounding credit risk for suppliers who are faced with the double-whammy of lack of access to credit and a longer cash conversion cycle.
SME’s lack of access to credit is well publicised and this was highlighted in 2011 when company insolvencies in the oil & gas sector rose. One of the reasons for this cited by analysts was tight credit conditions. Getting paid on time is such a widespread challenge that the European Union updated its late payments directive in 2013 to ensure private companies settle their bills within 60 days (The UK Forum for Private Business has been regularly naming and shaming poor payers since 2003). A similar approach needs to be undertaken by OGP and IMCA to help SMEs in the industry. Paying on time offers buyers a simple method of injecting liquidity into the supply chain. It reduces the need for suppliers to take high-cost financing options such as factoring receivables and asset-based lending and indirectly avoids supply chain disruptions through insolvency. Alternatively, some large buyers are optimising their own working capital by offering discounted early payments or by engaging in Supply Chain Finance (SCF) programs where banks offer alternative funding to suppliers by financing approved invoices (payables).
By helping key suppliers reduce working capital concerns, their businesses will run more efficiently thereby providing more value to you by investing in areas such as research and development. Isn’t it also logical that if your cost of goods is based on the supplier’s current cost of borrowing, then by reducing the supplier’s need to borrow or enabling lower-cost financing options your cost of goods will reduce over time?
Even at a situation wherein most of our manufacturers supply credit of less than 60 days whilst we are getting paid between a period of 75 to 150 days, we are determined to find alternatives other than truncating the business volume. There is minimal working capital finance available from traditional banking channels and our business is resorting to a mezzanine debt at 14% per annum interest. It is not ideal to pass this on to our customers or increase our own margins. The scenario is not a one-off and I am sure that my industry colleagues and competitors are also engaging in discussions to address the same woes.
What is our solution to this issue? As a reputed member of the SME community, I feel it is imperative for industry organisations such as IMCA and OGP to help the industry understand the advantage of paying on time and form a committee to help companies recover their pending dues. This will greatly assist smaller and medium sized companies to operate and will support growth in the industry.
In order to continue to be an attractive industry, a working plan needs to be put into effect before it becomes almost impossible to attract a new set of suppliers to this field and investment becomes challenged for the oil and gas market sector.
**All views and opinions expressed in the article are those of the author.