View from the Frontier: what is deep-tier financing and why does it matter?

November 1, 2019 Mads Stolberg-Larsen

Tradeshift Frontiers has broken new ground over the last few months. We started off by processing the world’s first “smart invoice” on a public blockchain and followed that up by partnering with Monerium to settle the world’s first invoice on the blockchain using smart contracts and licensed digital cash

These are important milestones and prove the viability of these cutting edge technologies in a B2B environment. But that’s not why we’re experimenting with these technologies. We’re experimenting to find new ways to solve real business problems. In this case, we’re doing it to find innovative ways to push financing through supply chain ecosystems by unlocking the power of deep-tier financing.

In this post, we’ll take a detailed look at what deep-tier financing is and why it may be transformative for supply chains. 

What is deep tier finance? 

At its heart, deep-tier financing is a simple concept. It’s about leveraging business relationships to unlock access to cheap finance for every supplier, not just the first tier. That means taking those first tier supplier financing options and making them available to tier two, three and four sellers. 

But isn’t that just supply chain finance? Yes, but with one key difference: supply chain finance at the moment only benefits the Global 2000 and a fraction of their tier-one suppliers. In contrast, deep-tier financing seeks to make financing available to the whole ecosystem of suppliers. 

Financing the ecosystem

The companies that fall out of the tier one bracket don’t have access to the same financial opportunities because lenders are unwilling to enroll these sellers onto financing programs. Why? Because they lack visibility into the companies, which leads to increased financial risk that makes financing just not worth it. 

But sellers deep in supply chains are often desperate for access to cash. To get it, they have limited options: they’re either forced to wait for 60, 90, or 120 days for payment or they have to turn to expensive forms of financing to plug their working capital gaps, which can often come at a cost of 10% APR or more. They’re stuck between a rock and a hard place. 

This is where distributed ledger technology and smart contracts have the power to change the game. They’re allowing us to remove the structural inefficiencies that blight ‘traditional’ supplier financing to unlock the potential for offering deep tier finance. 

They do so by allowing us to tokenize the receivables of sellers with large creditworthy buyers as counterparties. These tokens act as collateral that gives funders the ability to finance companies right through the supply chain. This means sellers can access financing at the large buyer’s cost of funds. And this will cost a lot less than 10%. 

Our recent pilot transaction with IKEA Iceland and Nordic Store provides an example of how tokenization of invoices work in practice. 

It’s a win-win-win

The benefits for sellers through the supply chain are clear. But deep-tier financing isn’t just a one-way street: large buyers at the top of a supply chain benefit as well. 

For one, it gives them the opportunity to optimize working capital in exactly the same way that supplier finance does today. But the impact will be even greater given that all suppliers in the supply chain can potentially enroll in the program.  

And with more suppliers able to access cheap finance buyers can build more resilient supply chains. As we explored earlier, supply chains are complex ecosystems. They’re comprised of companies of all shapes and sizes, each with their own unique financial position. And they’re constantly evolving, especially in these unstable times. So while a company’s supplier ecosystem may be healthy today it doesn’t mean it will be tomorrow. Giving all suppliers access to finance is the best way to mitigate any risk if its suppliers are struggling for cash and causing issues in your supply chain. 

Deep-tier financing can also help companies meet their CSR objectives. Companies can link their finance rates directly to a supplier’s sustainability and ethical practices. That way they can reward those that meet certain standards and use finance as a way to promote sustainability through their supply chain.  

Finally, don’t forget the funders. Deep-tier financing represents an opportunity for them to tap into the SME market by removing many of the structural hurdles they face today. This allows them to extend their reach deeper into supply chains, creating new opportunities to service a new tranche of companies and open up a brand new revenue stream.

Watch this space

While deep-tier financing isn’t the only way we can work to close to the $1.5 trillion trade finance gap it is an approach that certainly holds a lot of promise. If you’d like to know more or take part in one of our pilots, please contact the team here at Frontiers

 
 

About the Author

Mads Stolberg-Larsen

Mads is an economist specialized in business models around blockchain. When working for Deloitte Denmark he delivered their first blockchain project. He's excited about the decentralized version of the ongoing digital revolution.

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