After many years of low interest rates following the financial crisis, rates are finally on the way up. The U.S. saw three hikes in 2017; the Fed increased rates again in March and two more increases are expected this year. In the UK, meanwhile, the Bank of England increased rates to 0.5% in November - the first increase in a decade.
Higher interest rates may come as a welcome development where investments are concerned – but how could your supply chain be affected by further hikes? The short answer: it depends. For large, cash-rich companies, higher interest rates may reflect a more supportive economic environment and the opportunity to grow their businesses. But for smaller suppliers, the combination of increased customer demand and a higher cost of funding could spell trouble. Let’s explore this in more detail.
What do higher rates mean?
As we have seen with the recent hikes, higher rates can be a sign of robust economic activity and solid forecasts for the year ahead. In this environment, larger companies are more likely to be focusing on growing their businesses and tapping into increased customer demand.
Meanwhile, other developments in the U.S. – like the tax reform and the new rules around repatriating cash from overseas – mean that many companies could have more cash on their balance sheets going forward. And they’re not the only ones with cash to spare: companies in EMEA had a cash surplus of almost €1 trillion as of the end of 2016, according to research published by Moody’s. The question is whether companies will use this cash for programs such as share buybacks and dividends, or whether they will use it to grow their businesses.
Implications for suppliers
If large buyers opt for the latter approach, this may turn out to be something of a mixed blessing for their smaller suppliers. On the one hand, suppliers are likely to welcome the additional business. But a sudden increase in orders can also pile the pressure on, particularly for SME suppliers which may struggle to keep pace with a rapid surge in demand. After all, more orders mean more revenue – but they also mean that costs will rise, and that inventory levels may need to be ramped up. To fund all this, it’s likely that suppliers will need access to additional liquidity.
This brings us back to interest rates. For smaller suppliers, securing the necessary finance can be more problematic in a higher rate environment. It’s therefore important to consider how your suppliers could be affected by rising interest rates, and what the knock-on effect could be for your business:
1. Access to capital
As rates increase, smaller suppliers are likely to experience a higher cost of capital. They may also find that traditional lenders have less finance available in a rising interest rate market.
2. Cost of goods
This may have implications when it comes to planning ahead on the procurement side. Your suppliers will probably pass on the impact of higher costs to you in the form of price increases – so how would your business be affected if your own costs rise?
3. Supply chain disruption
Alternatively, if a supplier attempts to absorb costs within their process – for example by paring back inventory levels – what is the risk that you could see a supply chain disruption further down the line?
Weighing up the impact
In practice, of course, not all buyers are large corporates, and not all suppliers are SMEs. The impact felt by individual companies will depend on a number of variables, including the size of the company, its position within the supply chain and the industry sector it operates in, as well as its access to short and long-term borrowing and the associated costs. While larger firms tend to have more funding options available, they can still experience challenges when rates rise, depending on the length and intensity of interest rate pressures and the additional costs incurred.
That said, it’s important to ask how robust your supply chain is today, whether there are any risks that could be caused or exacerbated by higher interest rates - and how these risks could affect different players up and down the supply chain. In other words, a rising rate environment can provide a good opportunity to review your supply chain health and explore how you can protect your business from possible disruption.
It’s also worth considering that non-traditional sources of capital may become more important in a higher rate environment. With the cost of funding from traditional lenders likely to rise, companies may have more to gain from looking at alternative providers - for example, by adopting a supply chain finance solution.
Supply chain finance can help companies address the pressures of a rising rate environment in different ways. First and foremost, it can reduce the cost of capital for smaller suppliers. This means that the funding constraints brought about by higher interest rates can be mitigated – reducing both the risk of disruption for parties up and down the chain, and the likelihood that suppliers will ramp up their prices.
This approach can also bring direct working capital benefits. By enabling you to pay invoices later than you would otherwise, supply chain finance means you can free up your own working capital and achieve greater stability, without adversely affecting your suppliers. Conversely, cash-rich companies may be able to put their excess cash to work by taking advantage of opportunities such as early payment discounts.
To summarize, the current increasing rate environment may bring opportunities for companies of all sizes to grow their businesses. But it can also bring certain risks for both buyers and suppliers. Solutions like supply chain finance can play an important part in mitigating these risks, from avoiding possible disruption to reducing the risk that suppliers will be forced to increase their prices.