Why Does Factoring Get Such a Bad Rap?

Supplier organizations submitting invoices to customers have at their disposal several methods in which to receive payment earlier than the initial or negotiated term. A prompt payment discount opportunity is, perhaps, the oldest and most straightforward way for suppliers to receive early payment from customers.  Supply chain financing (or reverse factoring) is another method used by suppliers, once initiated by their customers, in order to expedite payment.  Dynamic discounting, a newer solution leveraging technology and a sliding scale by which suppliers can choose which approved invoices to take early payment on, is yet another method suppliers have at their disposal.  While supply chain financing and dynamic discounting solutions are receiving a lot of press as of late, factoring appears to be getting a bad rap in some circles.

Factoring has been around for quite some time, dating back to ancient Mesopotamian trading and European Middle Ages when clothing merchants used factoring to help finance their businesses.  The modern practice we see today derives from the 1940s when American banks began offering the service.  For the last several decades, we’ve seen factoring companies of various sizes emerge in the marketplace, but more recently, their reputation has taken quite a hit among supplier organizations who now see that there are other early payment solutions available to them.

Technology and Dynamic Discounting

The advent of technology-based early payment providers has propelled venture capitalists to invest in payment-based fin-tech companies.  These companies offer the promise of significant revenue and return on investment from billions of supplier-customer transactions.  Dynamic discounting has positioned itself as an alternative to other forms of early payment due to the ease-of-use and self-service it offers, the ability of suppliers to pick and choose which invoices they want paid early and removal of the “who does the customer pay?” issue.  Providers of dynamic discounting solutions often differentiate themselves to factoring companies by highlighting these specific benefits.

The challenge with dynamic discounting is the limited coverage it offers.  While it does present a streamlined, pre-approved, online solution, it’s only available to those invoices submitted to those customers featuring that solution.  In addition, most dynamic discounting solutions work with invoices that are submitted electronically, such as through a third-party network or EDI.  Paper-based invoices, which 78 percent of suppliers still use in one form or another, are usually not eligible to be paid early via dynamic discounting.

Supply Chain Financing or Reverse Factoring

Supply chain financing, or reverse factoring, allows the supplier to take early payment while the customer settles with their own funding source. Because the payment mechanism is usually set up by the customer, that customer will determine when and under what circumstances a supply chain finance solution will be available to the supplier.

Similar to dynamic discounting, supply chain financing is driven by the customer and offers a form of incremental revenue to the customer.  The supplier gets paid early, but the customer benefits as well by receiving “free” money or revenue not associated with specific costs of goods.

Factoring Positioned by Competitors

Although factoring has been around for quite some time and has proven to be a trusted source of immediate capital for many organizations, competitors have –  somewhat successfully – painted factoring as prehistoric.  It’s important to know that a key marketing strategy used by many organizations across multiple industries is the positioning of competitors as older and more obsolete.  This strategy highlights the shortcomings of the competitor or alternative, whether or not the shortcomings are true, while promoting the strengths of the challenger.

It appears fin-tech companies have been more fleet of foot when telling their story and positioning factoring as outdated.  In turn, factoring companies find themselves on the defensive.

Partially as a result of how they’ve been positioned by competitors, factoring companies are often viewed as less innovative and cumbersome when it comes to maintaining good supplier-customer relationships.  But it’s not all a result of marketing.  Factoring can be implemented as either recourse (the supplier is responsible if the customer does not pay the outstanding invoice) or non-recourse (the supplier is not liable for the outstanding invoice).   To many suppliers, the recourse option may seem prohibitive, especially since neither dynamic discounting or supply chain financing puts the responsibility for payment on the supplier.

What Can Factoring Companies Do?

Although fin-tech companies continue to make headway in the marketplace and the future may appear somewhat uncertain for all others, there are some options factoring companies have at their disposal.

First, factoring companies can do a better job of telling their story.  As we mentioned above, fin-tech companies are well-versed in helping to position their competitors.  Factoring companies can better illustrate how their solution is not limited to only those customers that have an early payment solution in place, does not require submission of invoices electronically or dependent on which approved invoices the customer wants to pay early.

Second, factoring companies can work directly with customer groups featuring large supply chains and tailor specific solutions just for them.  In this regard, factoring companies are no longer competing with customers who potentially want their own revenue-generating mechanism; they can partner and provide one for them.

Third, factoring companies can better understand the appetite supplier organizations have for early payment based on invoice submission methodology and how refined their invoice-to-cash process is on the front end.  In our 2017 Perceptions study, we found that 54 percent of suppliers are open to receiving early payment but that no solution has dominated the market.  Respondents indicated that they use supply chain finance, dynamic discounting and factoring at relatively the same rate (about 25 percent).  In conjunction, only 19% of respondents indicated that they were very familiar with early payment solutions available to them.  This presents an opportunity for factoring companies to better educate their target market about the virtues of factoring.

The so-called ‘bad rap’ that factoring companies appear to be getting can be overcome.  The bigger question is whether they understand the advantages they have at their disposal, can better tell their story and can understand the changing marketplace and position themselves accordingly.

Ernie Martin is Founder and Managing Director of Receivable Savvy. He brings over 25 years of experience in financial supply chain management, marketing and communications and draws upon his extensive experience to share knowledge and best practices with AR professionals. His resume also boasts time at several well-known brands and companies such as Tungsten Network, Delta Airlines, CIGNA Healthcare and Georgia Pacific as well as a number of years as an independent consultant.