Blockchain technologies could change your supply chains

Roger OakdenGlobal Logistics, Logistics Management, Logistics Planning, Procurement, Supply Chains & Supply Networks

Blockchain word cloud

Blockchains as a disruptor.

Start-up businesses become disruptors when entrepreneurs can see a business opportunity caused by failings in the current business model or complexity that can be reduced; but it requires availability of suitable technologies . This could happen to financing within supply chains, through the adoption of Blockchain technology.

A recent report by Bloomberg describes a trial that is testing the viability of using Blockchain technology and ‘smart contracts’ to deliver commercial benefits through a supply chain. The trial involves a shipment of 88 bales of cotton travelling between the USA and China. As part of the trial, when the cargo is unloaded an update to the electronic records will trigger the transfer of ownership and release of payment; all without the current document overload and cost of the Letter of Credit (LC) process.

The article also notes that more than 50 financial institutions are working in a consortium to ‘design and deliver advanced distributed ledger technologies to the global financial markets’. This is a valued investment, because financial institutions can obviously see the potential pot of gold awaiting them.

However, the world of trade finance is not about to change overnight. The challenges on a global scale are regulatory and legal, with counties needing to update trade laws and regulations to accommodate changes from paper based to electronic systems. Also the trials by consortium members must test how scaleable is the Blockchain concept and how inter-operable are multiple Blockchains.

The Blockchain structure

The technology was initially developed to handle the shared accounting ledger of ‘Bitcoin’, but is now a standalone technology that can be applied within any network of users. The technology requires three key components:

  1. a transaction
  2. a transaction record of the transaction and when each transaction happened in chronological order and
  3. an application to verify and store the transactions

The result is a chain of information, stored as a ‘block’, with each block ‘attached’ to the block before it, identifying any data conflicts. Small programs, called ‘smart contracts’ are attached to transaction records as calls to action; for example, changes to an ownership title or inventory of physical goods.

Records are logged across users’ computers that operate in tandem and once entered, information cannot be erased. Data storage is therefore decentralised and visible for all parties involved; the shared (distributed) ledger structure ensuring authenticity of the viewed information. Network users are able to access a Blockchain via a web interface and use a digital ‘wallet’ to communicate with other parties.

Decreasing trust in supply chains

The effectiveness of supply chains increases with improvement in two factors – trust and transparency. However, as technologies are introduced to improve transparency concerning the movement and storage of items, trust in supply chains is reducing.

This is illustrated by a report for the Australian competition authority which stated that the largest 100 publically listed companies in 2015 controlled 47 percent of the economy. In 1990, that figure was only 15 percent. One outcome of increased power in the market and the desire by large buyers for suppliers to provide the working capital, is longer time to pay suppliers. This situation is mirrored in Europe and possibly other parts of the world. Increasing the time to pay breaks the perceived trust between buyer and seller, which is that the seller will ‘deliver in full, on time, with accuracy (DIFOTA) and the buyer will pay in full, on time, with accuracy (PIFOTA).

Because suppliers rely on timely payments from customers to stay in business, the situation has enabled the growth of invoice financing intermediaries. The earliest financial product was factoring, which has been followed by a number of products to meet different business finance needs. So, as capability of financial intermederies is increasing, levels of trust between parties in supply chains is decreasing.

The ultimate situation is when a buyer and seller agree on the specifications, delivery details and price of the product or service being sold, but the financing aspects of the contract for both parties are managed by third party financial institutions.

The value of Blockchain for supply chains

Into this situation steps Blockchain technology. As a shared record of information distributed over a network of users, it is applicable where there is little or no trust. This is a technical solution for a business problem, which could deliver a different kind of trust. There are three main scenarios for blockchain technology when financing supply chains:

  1. Domestic tier 1 suppliers that currently use purchase orders
  2. International tier 1 suppliers that currently use letters of credit (LC)
  3. Multiple tiers of suppliers attached to the main contracts between the brand company and tier 1 suppliers. This is called ‘deep tier’ financing

For scenarios 1 and 2, the process becomes:

  • Buyer and seller agree to trade goods
  • Confirmation received by the selling party (via their digital ‘wallet’) of payment (by the buyer or financial institution), conditional on the negotiated contract
  • Container with the goods contains a barcode or QR code linked to a ‘smart contract’. Goods are received and contract terms comply
  • ‘Smart contract’ is executed to trigger the transfer of ownership to the buyer and payment to the supplier

Unlike the cost of LCs, once the Blockchain structure is established, the cost per transaction is negligible; so transaction costs for the parties decrease; but the process enables the financial institution to be a party in the Blockchain. This allows the financier to automatically pay the supplier an early settlement (discounted) and finance the buyer for extended payment. In this case, Supply Chain Financing (SCF) uses the brand company’s higher credit rating to support the purchase agreement, allowing the buyer to maintain long payment terms but ensuring that suppliers are paid when they require the cash.

Extending this thinking, the money paid to tier 1 suppliers by the brand company flows back through each item’s supply chain; therefore, the brand company’s credit rating can support financing as far up the chain as required. This is ‘deep tier’ financing (scenario 3), supported by Blockchain technology. It includes:

  • All suppliers that the brand company and tier 1 supplier wish to be included can be attached, but suppliers retain control of their own data. So, financiers can check that a total PO or invoice is authentic, but not view unit pricing and discounts
  • Tier 1 suppliers can allocate a percentage of their receivables from the brand company to tier 2 supplier(s), which in turn can allocate a percentage to the tier 3 supplier(s) and so on.
  • The bank can view the original contract(s), orders placed and the allocation of money at each tier, plus manufacturing and transport events associated with fulfilling the contract. Therefore, the bank has transparency, which supports authentication and audit.

These first steps of using Blockchain technology in SCF are being trialled and developments are occurring in other aspects of supply chains, such as provenance (where the materials actually come from ) and sustainability. This will take time, but could become common within the next decade. For this reason alone, Blockchain principles and implementation should be part of the curriculum in higher education Supply Chain and Logistics programs..

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About the Author

Roger Oakden

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With my background as a practitioner, consultant and educator, I am uniquely qualified to provide practical learning in supply chains and logistics. I have co-authored a book on these subjects, published by McGraw-Hill. As the program Manager at RMIT University in Melbourne, Australia, I developed and presented the largest supply chain post-graduate program in the Asia Pacific region, with centres in Melbourne, Singapore and Hong Kong. Read More...