The Win-Win of Buyer Intermediated Finance

For a company that make goods, landing a top retailer as a client is often the goal. But for these small suppliers, the win comes with the big challenge of figuring out how to finance their operations to actually deliver the goods, defect-free, to get paid. When they can’t line up traditional bank loans — because of lack of credit history or because they aren’t as available in developing economies — small suppliers often resort to payday-like loans with very high interest rates, increasing overall costs in the supply chain and reducing efficiency. To make it work, large buyers have started stepping in to make sure their suppliers are getting the financing they need.

In new research, Tunay Tunca, professor of management science and operations management at University of Maryland’s Robert H. Smith School of Business, explores whether this risky method is a good move.

Called buyer intermediated financing (different versions of which are also called “Reverse Factoring”), the practice involves a large retail buyer often underwriting loans their suppliers get from financial institutions. This means the buyer assumes the risk from the loan, so if their supplier defaults, they are on the hook to repay the bank. The process works because buyers often have more information about their suppliers than the bank would, thanks to their established history of working together. They can essentially vouch for the supplier with the bank to secure the loan and bring down the risk, so the bank will lend money to the supplier at a better rate. In analyzing the practice, Tunca, with co-author Weiming Zhu of IESE Business School in Spain, found that it can significantly improve channel performance, and can simultaneously have big benefits for both buyers and suppliers.

JD.com, one of China’s largest online retailers with more than 1 million products from thousands of brands — many from small suppliers who routinely need financing to operate — is a large retailer that employs this innovative practice. To ease supplier financing costs, JD launched a supplier finance intermediation service in 2012, where JD acts as a go-between for their suppliers and third-party banks, guaranteeing the payment of the full amount of a bank loan at the due date, along with payment to the supplier for the remaining amount, provided that the product was not defective.

Using transactional data from JD, Tunca and Zhu study the effects of the practice. They demonstrate that buyer intermediation lowers interest rates and wholesale prices, increases order fill rates, and boosts supplier borrowing. They predict that implementing buyer intermediated financing improved channel profits by 13.05 percent, increased supplier and retailer profits by more than 10 percent each, and yielded approximately $44 million in projected savings for the retailer.

They say the practice has big implications to improve outcomes for suppliers and buyers around the world.

“This innovative approach to ease suppliers’ budget constraints not only can improve supply chain efficiency but also may help many small suppliers gain their footing in the industry and grow their business, ultimately helping development of economies, trade growth, and value generation around the globe,” write the researchers.

Read more: Buyer Intermediation in Supplier Finance is featured in Management Science.