Fun fact of the day! How many gallons of fresh water does a good-sized iceberg (3,000 x 1,500 x 600 feet) comprise? Approximately 20 billion gallons. If 1 million people each used 10 gallons of water daily, then 20 billion gallons would meet the needs of 1 million people for more than five years. Now, imagine if you could easily transport an iceberg. That’s a lot of supply to help people who struggle to access fresh water!
Within a supply chain, liquidity gets trapped over time and concentrated with key players. Like icebergs, these liquidity pools drift around, but what if there was a way to release this frozen liquidity by getting it out of the hands of powerful buyers into the hands of suppliers that need it?
The construction and infrastructure sector is a great example. There are several dominant names in the market that have a strong credit profile and want to keep their key sub-contractors locked in to service their growing projects. But pressure is mounting on smaller sub-contractors crying out for alternative finance solutions to support their growth.
The working capital challenge – growing pains
Australian construction; both public and private has seen strong growth. However, the availability of credit, particularly to smaller players, has contracted and remains expensive. Subcontractors need to expend money before getting paid. Working capital, the lifeblood of any business, remains frozen and coupled with high finance costs puts financial strain on the entire supply chain. Payment times for the sector (Dunn & Bradstreet, Feb 2017) are estimated at 14.5 days late on average, making it one of the more problematic industries for late payments. It is a labyrinth of stakeholders, documents, certifications and approvals which tends to result in uncertain payment times and unpredictable cash ﬂow. The culture tends to be “I will pay you when I get paid”.
Supply Chain Finance (SCF) has proven to be an effective solution to offer a win-win for both buyers and suppliers. The Australian construction sector has lagged other industries like retail, industrials and technology in this space. Our view at Timelio is that SCF can melt the construction iceberg and deliver unparalleled benefits to principal contractors, subcontractors and investors.
The solution – how can SCF help?
Benefits to the Builder (Principal Contractor)
- Better pricing – By leveraging the principal’s credit rating to offer cost-effective finance to suppliers, it creates an opportunity to negotiate better contract pricing and drive down project costs.
- Improve return on surplus cash – Cashed-up players are sitting on surplus cash and this presents an opportunity to create an alternative revenue stream by funding their own SCF program.
- Preferred supplier relationship – Attract a strong network of subcontractors who want to do more work and support your growth.
- Reduce project risk - Fewer subcontractor defaults means more on-time projects and happy developers/clients.
Benefits to Subcontractors/Suppliers
- Faster payments- Suppliers can choose when they want to get paid giving them control e.g. day 5 instead of day 30.
- Reduced financing costs – Rates on SCF range from 4% to 10% per annum, compared to an overdraft of 15% per annum or expensive early payment discounts. It also avoids the hassle of bank financing paperwork and frees up debt.
- Fund growth – Cheaper cash coming in means suppliers can pay bills and execute more projects.
Is Australia ready?
If SCF sounds so great for construction, then why haven’t we seen more uptake? Historically, there have been challenges around banks who have shied away from offering SCF solutions to this sector, limited visibility across the invoicing and certification process and weak risk mitigants. But the landscape has evolved significantly and now is a great time for large contractors to consider SCF. Firstly, a new class of investors (institutional, hedge funds, superannuation etc.) come with strong balance sheets and a different risk appetite bringing funding diversification. Specialist “fintech” firms are proliferating, offering innovative online platforms driving up automation and efficiency. In Australia, The Building and Construction Industry Security of Payment Act (SOPA) certification regime and maximum payment times along with Personal Property Security Register (PPSR) provides strong mitigants to deal with underlying risks. Finally, an unstoppable appetite for residential, commercial real estate and infrastructure will put further pressure on the finance gap. New financing techniques like SCF can offer competitive advantage to ensure that the wheels keep moving on new projects.
Call to action - who will break the ice?
The Australian construction and infrastructure sector is missing out on the benefits of SCF. By shifting liquidity from key anchors to downstream suppliers, the industry has a fantastic opportunity to secure Australia’s future to support growth, create jobs and help build sustainable communities. Internationally, several large players like Balfour Beatty (UK) and Turner Construction (USA) have stepped up to implement these programs.
SCF can bring benefits to the entire supply chain and still provide the liquidity to support growth. The Australian Bureau of Statistics estimates that there is $2.86 of additional economic benefit for every $1 of construction GDP. A healthy construction supply chain has a multiplier economic effect.
The bigger question remains: who will be the first to break the ice and jump at the opportunity, differentiate and shape the market?
To find out more check out our blog on how SCF can work for your business and your suppliers, or get in touch today!