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If you hesitate to pilot new contracting technologies and hope to stick to tradition, you’re not alone. But ready or not, many automations are upon us, including block chain, process automation, Artificial Intelligence (AI), and digitization.

We all will need to change how we do business especially as it relates to the supply chain. While some finance organizations are ducking the challenges, others are cruising ahead with new methods that save them time and money.

The core question arises: exactly how are technologies impacting the future landscape of financial flows in the supply chain?

Our authors, Robert Handfield and Joseph Martinez, respond to that question and review not only the technology tools and methods that work well in finance, but what contract managers (CMs) should know before they commit too quickly to specific applications in automation. It’s a time of transitioning with so many moving parts. It’s complex, but the benefits outweigh the learning curve, especially for the finance sector practitioners! 

Dynamic discounting cuts costs 

A large global financial services organization interviewed during this study is piloting a new tool – a dynamic discounting algorithm -- that provides suppliers better opportunities for cost savings plus early payment discounts that require access to working capital.  For example, typical payment terms may be 10 days with a 2% discount, or 0% discount in 30 days.  But what if the suppliers need cash immediately?  What would they be willing to pay to get the payment within 2 days?  Some organizations are even borrowing against their payables to get letters of credit and pay higher interest rates on commercial paper (CP).2 

The algorithm enables banks to set an internal hurdle rate,3 and put current payables out on an auction4 that allows suppliers to bid and request early payment on their payables. The tool can yield significant cost and time savings for banks and help suppliers with their cash flow positions.

One caution: Using “smart” algorithms to link external events and internal contracts requires knowledgeable, experienced finance practitioners and contract management, supply chain business experts who can visualize how the technology supports the contract outcome.

So, the challenge for contract managers (CMs) is to understand clearly the technologies that will make them more efficient in using better search algorithms through better databases that allow them to compare contracts. CMs also need to become more efficient in aligning external events or factors5 correctly with contract statements of work (SOWs), service-level agreements, and KPIs.

Contract managers need to know how to ensure that the verification of services performed accurately responds to the contracted requirements and statement of work. For instance, using an Agile software development perspective, you could build a two-week deliverable checkpoint into the process that would allow the customer to send a signal back into the blockchain confirming that the code had been completed, tested, and verified. This would in turn drive the payment cycle. It’s one of many potential future applications that would transform procurement, and potentially eliminate the need for software such as Ariba, etc. that normally requires processing of POs, invoices, requisitions, etc.

Working with blockchain and Bitcoin in smart contracts

This same institution is developing a pilot with IBM involving the use of smart contracts to enforce Service Level Agreement (SLA) management of their server contracts within their outsourced data center.  This saves banks expenses for their professional services. 

IBM manages 400 prepositioned servers for the company.  Each subserver has an Internet of Things (IoT) sensor prepositioned and tied to a condition in the contract for those storage services.  When the server is provisioned,6 the IoT trigger automatically releases a purchase order and invoice for that server and once an SLA is activated, it states that the server must operate at an uptime of 98.6%. 

If there is a faulty chipset and the server fails to hit the SLA, the server first sends a signal into the blockchain (a digital ledger where transactions made in bitcoin are recorded chronologically and publically) and generates a service credit.  Then, the blockchain immediately creates a settlement for the credit, using a specific bitcoin, an internally-generated cryptocurrency with a defined value of a common currency.7 

Potential future scenarios for blockchain applications are enormous for the financial services sector.  One of the biggest expenses for banks is professional services, and one of the biggest challenges is how to monitor services delivered in a Master Services Agreement (MSA).8

Assigning a logical level of risk within much regulation

Companies are re-examining their external relationships in a highly regulated environment.  One executive observed, “The regulations will be different in each of the 47 countries in which they operate and will cause many to rethink how they plan to standardize the gaps (risks) in the organization, and whether the company remains compliant with the regulatory environment.  Tracking the flow of activities in the value chain9 has been an on-going challenge within our end-to-end sourcing process.  It helps us identify hundreds of different steps in our process.  But the real benefit of driving a better process is to help the company forecast, plan and budget more accurately for their future supply chain activities. So, we need to start at the beginning -- examine the path a new business might follow…”

Planning for future supply chain process – the pathway

  1. Set up business strategy and budgeting. A startup business has a need they must fulfill, and they usually do it through a business strategy, which leads to a budgeting activity and a budgeting application. For instance, companies may use a tool such as Hyperion, used by a Finance Planning and Applications group. 
  1. Assign level of risk. The next process involves introducing a third-party risk management assessment.  This third party will look at the contracting engagement -- whether the process is done internally or through a third party -- and assess the engagement through a risk lens.  (One example is the Archer application.  But the tools are very immature and comply with just very general guidelines provided by the OCC (US Department of Treasury’s Office of Comptroller of Currency) and FRB (US Board of Governors of the Federal Reserve System) policies, which are written in a very general manner.) 
  1. Once the project has been assigned a level of risk, it goes through a source to pay process, which includes various systems such as Coupa, Ariba or others.
  1. The sourcing request can generate a customer proposal, solution e-auction, supplier selection process, contract negotiation, and master agreement.
  1. Eventually this leads to a purchasing transaction, then on to fulfillment, through a catalog, order release, then an invoice and accounts payable. 
  1. The last stage in the process involves entering the elements of these transactions into the Enterprise Resource Planning (ERP) system where the General Ledger (GL) resides, and the transaction is then entered into one of the GL accounts determined by the company comptroller.

But several problems result from this end-to-end process. It consists of several hundred individual process steps (or elements in the process). These steps spawn a lack of visibility that grows as a project proceeds through these steps. Almost no visibility exists to discern where the “work in process” occurs. So, today, most of these processes are connected through manual transactions (emails, phone calls, etc.).

Worse, not only do so many steps complicate the process, but it can take up to 22 months.  So the company is developing strategic performance indicators that can monitor the rate and flow of projects through these steps.  Also, a further complication arises because of the inability to correctly classify the project, the supplier and the procurement transaction.  Comptrollers determine and set the GL codes, which do not always make sense. For instance, in one company, all travel expenses fall under the GL code Business Development.

New sourcing codes help eliminate problems

Because of these challenges, the supply chain team at this bank established a new set of sourcing codes that could be mapped back to the GL.  This method would open the door to a more detailed category-based analysis that would align with a category structure for internal sourcing decision-making -- which the GL structure does not do particularly well. 

The team divided the sourcing codes into to four primary categories. Within each category are subcategories.  The risk associated with a specific engagement is then assigned to a subcategory level of risk associated with the required level of due diligence.   The subcategory risk is assessed for each class of supply, which then allows the team to develop six primary buying channels (methods of buying the product or service) to use for each subcategory.  This approach will provide some level of continuity among the different stages of the flow across the four categories of the process. 

The sourcing process thus becomes a bridge between the systems.  The subcategory code ties together the project budget, the risk assessment, the sourcing process, and the mapping to the GL codes.  And for the first time, this “overlay” technology – as it monitors the process workflow – will be fundamental to driving efficiency by laying the foundation for other technologies to follow.  Overlay monitoring will drive value and eliminate people to manage the workflow across the several hundred process steps. 

Bridging the gap 

Another important outcome of tying back to a subcategory code is the potential ability to prioritize work coming from different businesses at the portfolio level.10 Today there is no way to prioritize work for the retail bank, for information security, or for the transaction bank, etc.  In the past, prioritization of work inevitably caused problems as to assignment of priorities.  So, what would be considered fair?  The known tendency to not understand why procurement was delayed has been related to a lack of understanding that hundreds of steps had to occur across the system and the time consumption required was huge.  We must remember that the system was designed by the bank, not by procurement.  Today, with visibility to the pipeline of work, and the ability to map workflow, reports can be provided that can clarify the process, which is being launched as a new project.  

Selecting the right technology, know the challenges 

Here are a few tips to keep in mind.

Select technology tools incrementally, not all at once. Banks and other financial organizations are smart to seek opportunities to explore the technology relating to asset and contract management innovation. But selecting all the technologies at once can lead to problems. If one is faulty, it may become timely and costly to find and replace it.

Know the challenges so that you are not caught off guard by things like differing tax liabilities and regulations regarding data that exist in different regions of the world. Many challenges exist in a global economy because of country-specific laws restricting data movements. Be aware of the following:

  • Cryptocurrency will allow improved transfer pricing across regions, and create tax advantages as well, by ensuring that the vendor management is occurring in the jurisdiction with the best tax structure. For instance, JP Morgan has a captive center in India which writes contracts but cannot approve or sign them. They can only be done in the US, so the tax liability doesn’t occur in India, and 75% of the budget hits the US budget.  
  • Similarly, in Singapore and Indonesia, data has to reside in the Asia Pacific region (APAC), and cannot leave APAC. So, data must be maintained in data centers, and chain sourcing (exchange of data) is illegal in certain countries. If minute data crosses borders (considered “cross-border”) it is in violation.
  • Many countries are still resisting the Cloud, and data security and regulated data requirements can also limit data transfers. Although this is a challenge for midsized regional banks, blockchain holds the promise of providing many solutions in this space.

We’re still transitioning, change is slow

Blockchain is just one small dimension of the contract (the payment part). Eliminating the ledger and the middle man is a start, but it may take time for change to happen. Remember that 18 years ago banks moved from paper to check imaging and clearing/posting of paper checks is largely gone today. We will likely continue to see technologies that worked somewhere else begin to be used in financial services.

Financial services are in the early stages of adopting many of these new technologies, but some finance organizations are also leading the piloting of these approaches. IACCM has a real advantage if it can use the technology on a global basis, by industry and subclass, to develop a procedure to protect participants, create anonymous contracts, but always have the visibility to pull them back and reconnect them to actual risk elements of each position. This remains an important opportunity for the future to think about.

To conclude, these developments will be emerging in the next five to ten years and in some cases, they will be arriving sooner.   Blockchain technologies will also emerge to eliminate elements of the procure-to-pay cycle, and fund transfers between entities will occur in a very different manner. 

Finally, contract managers will always remain alive and well in the loop, and the importance of human relationships will never be completely subsumed by automation.  In particular, the human element in creating relational contracts will remain as a fundamental component of inter-organizational relationships.

END NOTES

  1. Commercial Paper Rates and Outstanding Summary (reference: Board of Governors of the Federal Reserve system)
  2. Definition of hurdle rate
  3. Emerging technologies impacting contract management in the Financial sector by Robert Handfield, PhD (reference: article in NC State University, Supply Chain Resource Cooperative, January 26, 2018
  4. External events (factors) in business article commentary
  5. Definition of provisioning - PC Encyclopedia and reference also Article titled Fundamentals of IoT device management, from IoT Design online
  6. Currency Converter - reference to convert yen to other currency (OANDA)
  7. Definition of MSA
  8. Difference between value chain and supply chain
  9. Definition of portfolio level


ABOUT THE AUTHORS
 

Robert Handfield is the Bank of America University Distinguished Professor of Supply Chain Management at North Carolina State University, and director of the Supply Chain Resource Cooperative (SCRC). He also serves as an Adjunct Professor with the Supply Chain Management Research Group at the Manchester Business School. He is the Consulting Editor of the Journal of Operations Management, one of the leading supply chain management journals in the field and is the author of several books on supply chain management, the most recent being Supply Market Intelligence, Supply Chain Re-Design and Introduction to Supply Chain Management (Prentice Hall, 1999, 25,000 copies sold, and translated into Chinese, Japanese, and Korean). He has co-authored many textbooks.

Joseph Martinez is the Chief Procurement & Financial Operations Officer - MUFG where he is responsible for sourcing, travel, procurement to pay operations, corporate real estate, corporate insurance, corporate security and 1st line third party risk management for MUFG.  Prior to joining MUFG he was the Head of Global Sourcing – APAC at Deutsche Bank in Singapore. He brings more than 30 years of experience in Supply Chain Management where he has held various senior positions in financial institutions such as Bank of America, American Express and was Chief Procurement Officer at Wachovia Bank. He also served as a Managing Director in the Strategic Sourcing Group at JPMorgan Chase, successfully leading the Professional Services Procurement Operations on a global scale.  His prior experience also includes consulting for PricewaterhouseCoopers, as well as spending over ten years living and working internationally in Asia (Japan, China and Singapore) and two years in the Latin America markets earlier in his career.  

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Robert Handfield, PhD & Joseph Martinez.


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