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How Supply Chain Vigilance Impacts Credit Risk

“I’ll have the usual”

As a frequent visitor of South Street Diner, Boston’s historic 24 hour greasy spoon, I had the pleasure of calling for “the usual” and diving into an omelette just minutes later.

Breakfast after breakfast, “the usual” was ordered and happily consumed. It became my default behavior. I was hooked.

After an apartment change and a six month South Street hiatus, I returned to the diner to find a new chef and tweaked menu behind the same friendly waitstaff. The usual order (she remembered!) was met with runny eggs, a bigger bill, and a search for a new breakfast spot. 

Quality changes, prices move and customers update.

A Boston staple or default option?

“Same as last week?”

Small businesses today rarely have enough time to measure the quality and cost of their many product inputs. Even more rarely do they find time for a nice breakfast. Yet, without keeping a keen watch over their vendors, and how the market is responding, businesses run a real risk of losing clients. Responsible management of the supply chain has a major impact on future happy customers.

What is the supply chain? Though Websters defines it as an utterance used to signal relevance, we know it as a network of human-made transactions. We have discovered, much to our delight, that emotion beats out rationality in most of these decisions.

Retailer interviews confirmed our sneaking suspicion that ordering the “same as last week” is a great substitute for inventory optimization. The sales and delivery team have families, bring donuts, and offer banter on last night’s game. Why adjust one’s ordering pattern and risk losing insight on the MLB lockout?

Laziness means risk

As it turns out, customers’ tastes change. In fact, it is highly unlikely that the best selling product is still the fan favorite just three months later (83% chance of change in top performing product). Same-as-last-weekers run a serious risk of tying up cash flow in slow inventory, missing out on future winners, and turning to the discount crutch.

At Lendica, we sort on smart operators. Our Vigilance Score, one of several behavioral indicators, uses vendor purchase invoices to sniff out the same-as-last-weekers. We compare historical purchase behavior relative to future sales, on a per product basis. The underwriting model, trained on millions of transactions, penalizes lazy ordering and rewards vigilant decision-makers. 

Future free cash flow, or cash generated net of goods and expenses, is directly impacted by laziness in the supply chain. Less vigilance and slower inventory turn negatively affects cash flow and makes it harder for borrowers to pay back their debt on time. 

When we can separate lazy and vigilant operators, we can optimally price the risk of each financing – especially every invoice financed using Lendica’s PayLater. 

And, of course, better risk pricing means better rates for our customers!

For a more detailed explanation on the Vigilance Score and some other behavioral indicators  (Helter Skelter Score, Generosity Score, Diligence Score, etc.), click here to schedule a call.

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How savvy suppliers can turn any buyer into their “McDonalds”

Perfect World

A supplier and its buyer have the same goal: get the best possible product to the end customer. So why don’t all buyers and sellers simply get along?

In a perfect world, a supplier should seek to maximize value to its buyers. Its customers’ success invariably leads to more orders, larger SKU counts, and, if supplier executives are lucky, a bigger paycheck come Christmas. Buyers ought to feel the same way. A fair deal to a vendor can lead to a stronger supply chain with less disruptions. Afterall, if a supplier runs out of cash and stops supplying, their buyer runs that same risk.

At Lendica, we don’t always witness such a smooth supply-chain scenario. We have found the breakdown typically begins with net seller terms.

Setting net seller terms, a topic we discuss ad nauseum, is often a function more of art than science. The option to pay after delivery requires a complex calculus that weighs the perceived credit risk of the buyer, one’s current financial stability, and the potential for future business. The heuristics involved in this decision-making process likely warrants a separate post.

We instead explore a separate, critical issue in supplier relations. Once a customer is offered NetX, how do you assure it doesn’t become NetY? Said differently, how do you get your customers to pay you on the agreed upon date?

McDonald’s Case-let

First, a brief divergence to dissect a supply chain maven, Ray Kroc. For those turned off by Kroc’s portrayal in the movie The Founder, it’s worth noting the McDonald’s entrepreneur employed impressive diplomacy and effectiveness in managing his supply chain.

In McDonald’s early days, the burger (read: real estate) tycoon struggled to maintain positive cashflow during an aggressive expansion period. Despite a relatively simple menu of burgers, milk shakes and fries, Kroc and team had to corral an extensive vendor network to meet strict quality control. The fast-food chain sourced buns, for example, from several bakeries across the country – each of which were scrutinized over size, taste, and even sesame seed count.

The french fry was McDonalds secret weapon during early-days expansion.

Many pressured Kroc to bring manufacturing in-house. Even your average MBA could calculate the potential cost savings from a “simple” vertical integration. Kroc wouldn’t listen. He knew that his business’s core competency was retail and felt that the minute you begin “selling the product to yourself” is when you start flaking on quality.

Instead, he put trust in his vendors to create the best product at a fair price and, when he found a vendor that was to his liking, sought ways to grow the relationship instead of threatening it. (Kroc famously pulled a baker out of early retirement and moved him to California to support west coast expansion – a deal that paid off for both companies). Supplier goodwill was one of the key drivers to McDonald’s successful scale in the 60s and 70s – a considerable loan from several suppliers even saved the business in the early days. The goodwill, of course, was repaid by McDonalds’ with massive contracts and timely payments.

In short, Kroc’s long-term trust in his suppliers, and vice versa, was primarily a fair exchange which greatly benefited all parties involved.

Ability vs. Willingness

Today’s suppliers are not typically enamored by the idea of extending a loan to a struggling buyer. Yet, a poorly managed net-seller program is effectively a zero-interest loan! When a buyer receives goods ahead of their payment, the seller has limited recourse – aside from holding future orders and pleading pretty-pleases. The buyer is taught to conserve cashflow at all costs – each with their own set of tricks and tales to push back sending funds. Each day that passes represents a higher chance of default and an implied discount on the sale.

Lendica Lens 🔎

Interestingly, the buyer often has the ability to pay for the goods but lacks the willingness to do so.

Our analysis of tens of thousands of invoices suggest that buyers oftentimes are able to make a payment but still delay several days past due. We attribute lack of buyer willingness to a variety of behavioral traits including the Pain of Paying (Zellermeyer) and the Availability Bias (Kahneman/Tversky) – buyers are constantly introduced to new manufacturers and undervalue the high switching costs associated with changing a supplier or bringing operations in-house.

As a result, buyers may apply implicit discounts to their supplier relationships and, perhaps without realizing, justify the delayed payments beyond the agreed upon terms (e.g pay a Net7 invoice in fourteen days). Advances in digital marketing may increase the occurrence of the Availability Bias and, in parallel, decrease a buyers’ willingness to pay.

The Savvy Supplier

It would appear that, short of sorting on Ray Kroc enthusiasts, good buyer management protocol is a major challenge. Finding buyers is hard enough, let alone those willing and able to pay according to schedule. Lending money to struggling customers is not always feasible (or wise) but taking risk to support their growth can prove to be a profitable endeavor. How does a savvy supplier manage the process?

Using a supply chain management partner, such as Lendica, is oftentimes the best approach. Here are a few key benefits:

  • Dynamic Seller Terms. It is important to remember that each invoice is a unique transaction which requires a detailed analysis. This includes consideration of buyer credit risk, your current cash position, and the likelihood of future orders. Supply chain management tools offered by Lendica allow sellers to treat each invoice as a unique transaction and helps price the risk accordingly.
  • Leverage the Pain of Paying. The cost of a 5c bag at many grocery stores is by no means a ploy to grow revenue. Instead, it is a clever, state-mandated initiative to incent shoppers to reduce plastic bag consumption. Five cents is not a financial hurdle that deters most customers, but the sheer act of introducing another cost has proven to be a successful measure to changing behavior. Your supply chain management tools should include nominal late fees and a variety of nudges to alter buyer behavior. Lendica has seen several cases where the pain of paying even a $25 late fee can speed up collection time on invoices, regardless of order size.
  • Focus on Customer Success. The availability bias should work to your advantage. Most suppliers are in constant communication with their customers to share updates on their products and promote new ideas. Challenges may arise when those updates are dominated by collecting overdue invoices. This shifts the tone of the discussion and can lead buyers to negatively update. Outsourcing your accounts receivable ensures prickly conversations are handled outside the organization and dramatically reduces the chance of negative buyer sentiment.

Finding a long-term, consistent buyer is the goal of any supplier. Realizing this goal requires a deep understanding of risk pricing and buyer behavior. The McDonalds’ team benefitted from their visionary leader Ray Kroc and his unique perspective on vendor management. Most suppliers don’t have the fortune of securing contracts with an icon.

For suppliers that want to help buyers manage their cashflow and support growth – like the early-days McDonalds’ vendors – while still effectively managing their own business, a supply management tool like Lendica is often the answer. Providing net terms, sending small nudges, and outsourcing collection calls can help improve buyer relationships and, most importantly, allow the supply chain to focus on creating a winning product.

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The Future of Embedded Finance

“What the [heck] is a bank branch?”

Each year, my highschool and college students are presented with a slide from the CFA Financial Literacy curriculum entitled: Big Banks vs. Small Banks. The material, developed no more than five years ago, argues one should consider the number of bank branches when deciding which bank to use. “A major benefit of bigger banks is they have more branches! More branches leads to better customer experience and added convenience…” It’s as if Bank of America sponsored the course. 

Each year, without fail, hands shoot up from across the classroom. It’s always the same question, “What the [heck] is a bank branch?”

It is possible, someday in the not so distant future, we too may no longer know.

The information age, with an assist from a nationwide lockdown, has catalyzed the digitization of banking services like payments, cash management, and lending. Lendica is likely not alone in thinking we are just at the beginning.

“Lollipop on the way out.”

Today, the average person spends roughly 10 hours per day staring at a screen. That number surpasses 12 when you filter by the regularly employed. It’s only natural that banks are going digital to reposition themselves in front of the next generation of customers. 

The challenge is, be it brick and mortar or online, we still don’t like going to a bank. It’s no coincidence that banks place a bowl of candy in the line. You are offered a lollipop on the way out to help justify the painful experience. 

Dealing with finances, personal or as a small business operator, is often stressful stuff. We don’t check our credit score because we’re worried it’s low. We don’t look at our bank balances because we fear the same. When you add unnecessary hurdles such as a confusing process, excessive wait times or required travel, it’ll take more than a few suckers to get someone to engage. 

The digital banking renaissance is supposed to solve for this. What we have found, even with endless automation and mobile convenience, is the industry is far from a satisfying solution (dare we say: several licks away from the center). 

“Simple, fast, and here.”

Ask Kabbage 10 years ago and they would tell you they are changing the world. Ask BFS Capital (now Nuula) 20 years and they would argue the same. In fairness to these two disruptors, they certainly did. 

Access to small business funding transitioned from hopelessly pleading with your bank to warding off MCA brokers “selling you cash” in under a decade. We won’t comment on whether these MCA options are any good (hint: they are not) but we will commend the creation of a roughly $100bn credit market. 

These two businesses have dramatically changed. Yet, even with their new owners or facelift, we’d argue that they still miss on the three most important dimensions – simplicity, speed, and location. We can run them and others through the Embedded Checklist: is it simple, is it fast, and is it here?

Kabbage, FundBox, Pipe, […. insert your favorite internet lender] are moving in the right direction. The web applications are designed to be simple – often allowing one to “connect apps” with a few clicks. The speed has improved – usually you’re funded within 24 hours. The location is creeping closer – online just like their customers! 

That said, we examine these companies’ exorbitant cost of customer acquisition to suggest they are far from perfect options. Why is it so expensive to get and keep customers?

“Embedded sounds good.”

Technology companies have been making waves in the lending space for some time. Perhaps you’ve read our piece on the Big A.S.S lenders (Amazon, Shopify, and Square) and their success in small business financing.

The business case for technology vendors as lenders (“tech lenders”) is simple. Tech lenders generate real-time data that their customers rely on to make decisions on business operations. That same data can be used to assess credit quality. The beauty of this data, also known as Truth Files, is its immutability. Lenders and customers can put aside Akerlof’s lemon problem and trust the data is reliable and symmetric. 

Technology companies are increasingly seeking tech lender solutions. The build, rent, buy discussion usually lands on “embedded sounds good.” Embedded finance companies are designed to easily consume the Truth Files, perform an underwrite, and then return the customer an offer. This can be any form of lending, insurance, banking, or payments solutions. 

How does the average “embedded fintech” perform on the Checklist?

Simplicity and speed. These all depend on execution. The best embedded finance products must include a beyond simple application process and instant decisioning. This is typically born from management teams with years of small business funding experience – both underwriting and platform research. 

Here. The execution on location is subtle but arguably most important. The customer should never have to leave their current webpage. Anything else is just a referral link. 

“The most valuable real estate.”

Back to our Financial Literacy students. Where will the future small business leaders be spending their time if not walking past bank branches? We begin by defining a small business. In its simplest form, it is an organization made up of a product, data to fine tune it, and capital to execute on it. We recall countless stories of small business operators up at night staring at the computer screen. The decisions made to guide their business are driven by the data consumed from their technology vendors.

It should come as no surprise that technology vendors – POS, ERP, Payments, Ad-tech, Talent Management, etc. – will continue to see the most digital foot traffic and likely become the most valuable real estate for a financial institution. 

Therefore, technology vendors should be ultra-selective – embedded finance platforms that do not check all three of the boxes (simple, speed, and here) run the risk of lost rent. If a customer cannot silently share data, instantly access an offer, or navigate the tools from their current webview it is not an embedded finance solution. 

“So what’s the future?”

Building a fully embedded solution takes time and resources. The technology lift is an ongoing challenge, the underwriting efforts require a growing team, and the balance sheet management is not trivial. It is no surprise that many technology vendors are outsourcing these operations. 

There are additional considerations including portfolio diversification, use of equity dollars, types of funding products, evolution of services, and cost of capital. We’ll drill in on the last one. 

Banks do serve a few good uses beyond the occasional hard candy. Namely, their bank charter allows the institution to draw funds from the federal government at the lowest possible rates. Small or mid sized technology vendors rarely qualify for a bank line of credit. Their customer concentration, limited compliance, and platform equity risk scares off most banks and leaves alternative credit funds to fill the gap at higher rates!

So what’s the future?

Our vision is simple. Imagine one embedded finance platform that any technology vendor can easily install. The platform is designed with user simplicity in mind, offers instant decisions, and can be quickly launched or hidden without leaving the current webpage. It’s equipped with simple funding products designed for several use-cases (revenue-based finance, supply chain, etc). Customers can manage all of their finance products across several technology vendors or all directly from their mobile phone. And finally, since the borrower-base is sufficiently diversified, customers can access the most affordable financing options on the market. We believe this model exhibits the perfect embedded finance solution. 

The banking world is quickly changing and today’s industry leaders will undoubtedly be disrupted. We eagerly await more innovation in embedded finance and invite you to join this discussion.

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Are you offering your SMB customers lending? Here’s why you should.

The Big A.S.S lenders, Amazon, Shopify, and Square, are three of the largest small business (“SMB”) financiers in the country. If you offer eCommerce, Supply Chain, Payments or Point of Sale solutions to SMB customers and do not also have a lending arm, you are at risk of losing clients.

Small business struggles

Access to capital is one of the major challenges for small businesses across the country.

Did you know that only 2.7% of loans to small businesses are funded by the SBA?

As a result, small businesses seek capital from banks and alternative lenders. These two solutions have been historically unreliable, slow, and at times very expensive. Worse, community banks and thrifts have been consolidating or folding during a low yield environment reducing the already limited credit options for SMBs.

SMBs need better solutions to finance their growing businesses.

Tech fills the gap

The challenger banking model, a b-school buzz word that loosely translates to “technology companies now lend,” has been a largely successful alternative to traditional banking.

One of the keys to success is, of course, the data.

Technology companies, perhaps even like the one you work for, hold some valuable data about the performance of their business customers. Point of Sale companies can track, in real-time, revenue of a business. ERP/Inventory management companies can see the evolution of order sizes and SKUs sold. These are great barometers for the success (read: credit risk) of a small business.

Data becomes the ultimate form of collateral.

The Big A.S.S lenders, and many of their smaller competitors, have invested heavily to build sophisticated systems that, securely and simply, allow their customers to leverage their business data to get quickly qualified for funding. The platform gets an additional revenue stream and the customer receives instant capital to plow back into the business. Laymen refer to this as a win-win.

The business case

The reasons to offer lending extend beyond just additional revenue and happier customers. Adding a financing solution to your technology service has become more than just a trend — it is approaching default behavior.

Small business customers may now expect their technology vendor to offer some form of financing product.

Importantly, software companies that offer these lending solutions are winning business over competitors. Even customers that do not currently have borrowing needs are sorting based on this added service assuming they eventually will need it!

Getting started

Creating a small business lending division requires a serious investment. Specialists are required to build the application and underwriting processes, price the credit, manage the balance sheet and handle collection.

If you are considering bringing this process in-house, be prepared for a 24 month rollout and a minimum $2,500,000 investment (not to mention credit losses in your first 12 months of operations).

Alternatives exist to get operational in just a few minutes. Lendica, a truly embedded financing platform, offers an industry leading, full-service lending application that is installed in seconds. Lendica provides the underwriting software and capital to fund the deal which means your customers can get funded instantly. Technology vendors can now generate incremental revenue while providing a value-add service that their customers will soon expect — all with just a few lines of code!

As small businesses continue to seek alternative sources of financing, they will increasingly turn to their technology vendors to help with bite-sized funding solutions. Now is the time to fight back against the big A.S.S lenders and offer them yourself!

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Lendica Partners with Top ERP Software Companies to Launch FundNow and PayLater

BOSTON, Aug. 31, 2021 /PRNewswire/ — Lendica, a fintech startup providing embedded financing solutions, recently announced a partnership with industry leading supply chain management platforms Flourish Software and Apex Trading. 

These partnerships mark a new era in supply chain financing. Flourish and Apex customers will soon be able to instantly get funded for their open invoices and extend better payment options to customers – all done with a few clicks directly from their ERP dashboard.

“Smart operators know the importance of optimizing their cash flow throughout the supply chain,” says Jared Shulman, CEO of Lendica. “The challenge is the process is often confusing and drawn out. Our software provides transparent funding options from right where and when the customer needs it – right at their ‘point of decision.’ No more wasting time with dead-end financial institutions and more time focused on scaling the business.” 

“We are fortunate to partner with Flourish and Apex who demonstrate the importance of great user experience and customer success,” adds Lendica’s CTO Jerry Shu. “Both of these companies have a growing base of customers that can soon use Lendica’s software to get smarter about their cash flow.”

Operators can activate FundNow, a tool used to get paid instantly on outstanding invoices, or PayLater, a way for their customers to pay invoices over time, within a few minutes through Lendica’s iTab – an integrated application that sits on top of Flourish/Apex’s order dashboard. Once activated, operators can immediately select individual or bulk invoices to FundNow or PayLater. Lendica provides the capital and uses its secure payment platform to easily collect and distribute the funds.

“The whole process is seamless,” says Colton Griffin, CEO of Flourish Software. “We have seen customers at times struggle with funding their supply chain and operations. This partnership immediately addresses these issues. We are thrilled to integrate Lendica directly onto the Flourish platform to help our customers instantly access funding.”

“Our customers have been searching for better options for invoice financing,” adds John Manlove, Apex Trading CEO. “We were approached by a Lendica customer to help them with better customer payment options. We are delighted to very soon be able to provide these two innovative products across our entire customer base. The partnership is a win for all!” 

Customers interested in learning more about Lendica’s FundNow or PayLater options can visit Lendica’s website or ask their Flourish/Apex representative about early access.

About Lendica
Lendica is a truly embedded finance company focused on smart lending. We provide simple and transparent funding solutions for businesses at the point of decision. Businesses today rely on many technology vendors to make and execute decisions – process payment, make deliveries, purchase inventory, manage invoice, etc. Lendica creates integrated technology which enables tech vendors to provide their clients instant access to capital and help them finance these decisions and grow their business.

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How to provide supplier terms to your customers?

Your competitors are offering terms. Are you?

What are supplier terms? In many industries, it is common for suppliers to provide net 45 day terms. Simply put, the customer is allowed up to 45 days to pay the invoice even after the product has been ordered or delivered.

Why do suppliers offer terms? Cash is king! A common adage passed around business school classrooms (zoom chatrooms), the concept of preserving cash at the expense of financing fees or supplier relations is a focal point of CFOs everywhere. The longer your customers can wait to pay for your goods, the more money they can sink into growing their business.

What do I need to provide supplier terms? A balance sheet (cash is king, remember?)! We would all love to be generous and hand out terms like it’s Halloween, but sadly it is quite expensive and requires significant cash balances. Remember, customers don’t always pay and your business still needs cash to run its operation. A simple rule of thumb when considering offering terms: you should have access to enough cash on your balance sheet to continue operations if 20% of your customers don’t pay!

How else can I provide supplier terms? If you are running tight margins or do not have a full-time A/R department, it might be better to outsource this function to experts. Third-party finance companies, like Lendica, are designed to help businesses of all sizes tap external balance sheets to make it easier to offer terms. Lendica was built specifically to handle the underwriting, funding and collection of payments/invoices in all high growth industries.

Sounds great… so how does it work? Your customers who ask for supplier terms can instantly qualify with Lendica. When you share the invoice along with basic customer details with Lendica, your customer receives a simple link to share a bit more information on their business. After completing the two minute application, Lendica’s system processes the data and presents them with an offer. Once accepted, Lendica pays you for the invoice on day one, you fulfill the order, and your customer pays Lendica over simple installments. That’s it!

How do I get started? Lendica’s embedded finance technology may already be available with your inventory management system, point of sales provider, or bank. Check our list of partners, here. If not, you can contact us directly to set up your own, dedicated supplier term portal.

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The Lemon Problem of Lending

The Lemon Problem of Lending

Why premium borrowers get squeezed.

The Lemon Problem, famously presented by George A. Akerlof in The Market for “Lemons”: Quality Uncertainty and the Market Mechanism, discusses how asymmetric information leads to an ineffective market.

Now [on to lamens terms], this research shows how both buyers and sellers can arrive at a suboptimal price simply because they do not share the same information.

Here’s why:

A buyer, knowing they’re out of the know, cannot tell whether their desired item is a premium good or a lemon. Using simple heuristics (fancy way of saying “no clue”), the buyer offers an average price — somewhere between the premium item and lemon item.

Asymmetric information leads to suboptimal pricing.

When the product is in fact a clunker, the seller wins! The price transacts above the “Item Value” and the difference is their profit. Sadly, and all you quality borrowers best listen up, the seller of the premium item is penalized. The buyer cannot know for certain it’s a premium good and purchases at the average price — below the Item Value (in the chart above, the Item Value is the top of the green box). Again, a profit is pocketed — this time going to the buyer.

On to lending…

If we replace “Seller” with “Borrower” and “Buyer” with “Lender” we have a similar landscape with slightly different outcomes.

Once again, in almost any case, the Borrower knows more about the business than a Lender. [If not, you may have yourself a lemon :)]. The Lender will not be able to offer the “Item Value,” or true price for your loan, because they do not have enough information to tell Borrowers apart.

What’s worse, the average price is likely not the mid-way point between good and bad. When a loan defaults, the lender can lose up to 100% of its principal. This means they’ll need to make many more good loans to make up for their losses. The result is a much bigger gap between the Item Value and Average Price.

The lender profits on good borrowers at the expense of bad borrowers.

As you can see, the Premium Loan — the quality borrowers running strong operations— are getting poor pricing to make up for the Lemon Loans. The Lender does not have enough information to tell them apart and, like Akerlof’s famous Lemon Problem, are pricing them accordingly. As pleasing as the colors are above, if you are a premium borrower it is not a pretty picture.

Enter Lendica

Lendica has had enough with Akerlof and his lemons.

In today’s information era, there is no excuse for lenders mispricing loans, working capital, factoring or lines of credit. Your business is already teeming with data — POS systems, card processors, inventory tracking, banking, wholesalers, security footage — the list goes on.

So what happens when life gives you data? [Punchline has been removed for obvious reasons]

Lendica helps you take the data that exists throughout your business and add it to your credit profile. We make it simple to export, share, or simply SSO your vendor data into our system. We then use your entire credit picture to offer you the best possible rate.

Remember, it is your data, so make it work for you!

So the next time you get a loan quote and think to yourself, “am I really a lemon,” just remember — only the highest quality borrowers get squeezed. And when you’d like a chilled, refreshing change, come check out Lendica.