In my last post I outlined the five primary forces that I think are fundamentally changing the way corporations approach back office finance functions and their banking partners.  However, one of the dynamics I did not explore is the dependency of the business model changes on technology.  Changes to accounting systems and bank connectivity will be critical factors in the success of corporate transformation efforts.  To realize cost efficiencies, A/P organizations must be able to efficiently route payment instructions to their key banking partners using highly reliable, secure and cost-effective communications channels.  To benefit from a centralized treasury, cash managers must be able to obtain detailed, up-to-date account statements from their financial institutions in order to perform end-of-day investment and borrowing activities. 

I have compiled a list of the top five forces I think are transforming the technical interfaces banks and corporate customers use to communicate electronically.  These five forces are the technology changes complementary to the business model changes outlined in my last post:

1.       ERP Consolidation – More multi-national corporations have a project underway to standardize and consolidate the various ERP applications being utilized within their enterprise.  Standardization enables consistent business practices across divisions and the creation of shared service centers.

2.       SWIFT Connectivity – Several hundred large corporations have registered to participate in SWIFT’s corporate access programs (SCORE).  SWIFT connectivity can reduce the costs and complexity associated with corporate banking communications by replacing the mix of web, fax and host-to-host transmissions with a single connection to banks worldwide.

3.       ISO 20022 XML – Otherwise known as the Universal Financial Industry (UNIFI) standard, ISO 20022 XML is designed to replace the myriad of local file formats (e.g. EDI, NACHA) used for payment processing around the world with a single, global message scheme.  See my blog entry on ISO 20022 for more details.

4.       Multi-Bank Cash Reporting – Multi-bank reporting applications aggregate end-of-day and intra-day balances for all accounts onto a single web portal.  Treasury personnel with visibility to all cash positions at bank accounts worldwide are better equipped to perform cash forecasting, borrowing and investment activities.

5.       Bank Relationship Management Software – Bank connectivity has become such a complex issue for corporations that several ERP vendors have introduced specialized software modules to simplify integration.  For example, SAP recently introduced its “Bank Relationship Management” application.  See my blog entry on SAP BRM for more information.

For those interested, I published a more detailed view of the 10 Forces Transforming Corporate Banking Connectivity on the www.gxs.com web site.

More bad news for the banking sector this week as five of the largest US financial institutions (Wachovia, SunTrust, Fifth Third, Regions Financial and Washington Mutual) announced a total of $11 billion in quarterly losses.  Just when you think the worst is over, the financial services industry finds a way to deliver more surprises.  But believe it or not, there are other interesting things happening in the banking industry in addition to the subprime mortgage crisis.  In my last post I talked about the Single European Payments Area (SEPA) launched earlier this year, which I believe will have as big of an impact on banking going forward as the subprime fallout.  One of the other trends that I find interesting is the changing dynamics between corporations and their banking partners. 

During the past 18 months I have spent a lot of time visiting with both corporates and financial institutions throughout North America, Europe and Asia.  In total I have probably met with 75 companies during the past year and half.  One of the conclusions that I have reached is that almost every major multi-national corporation of $5 billion or larger has a major transformation project occurring in their back office.  What are they changing?  A better question is what is not changing?  Multi-national corporations are reorganizing their treasury and accounting functions; re-evaluating their approach to payment processing; renegotiating agreements with key banking partners and re-architecting their financial information systems. 

I have spent some time in recent months analyzing the underlying forces driving these dramatic changes with a goal of understanding the market dynamics better.  Some forces are obvious such as the desire to reduce costs and operate more efficiently.   The other forces are more specific to financial processes including changing regulations, disruptive technologies and increasing globalization.  I compiled a list of the top 5 forces that I think are driving the transformation projects at multi-national corporations.  The first five are business oriented forces:

1.       Conversion from Checks to EFT – The past 10 years has seen a migration away from paper based check instruments to electronic funds transfer.  The most significant transition is occurring in the US, which historically utilized checks as the primary B2B and B2C payment instrument.

2.       Payment Factories – Multi-national corporations are rethinking the organizational structures for their Accounts Payable (A/P) groups.  Corporations are moving from country-centric A/P organizations towards shared service centers operating on a regional or global basis.

3.       Centralized Treasury – In addition to creating shared service centers for A/P, corporations are centralizing treasury functions as well.  Centralization enables a number of efficiencies in the areas of cash forecasting, foreign exchange and cross-border payments.

4.       In-House Bank – Corporations are establishing their own in-house banks to complement centralized treasury functions.  The in-house entities operate much like a commercial bank by offering payment processing, cash management and collections functions to the various subsidiaries.

5.       Consolidation of Banking Relationships – Along with centralization of internal functions, multi-national corporations are also rationalizing the number of banking relationships they maintain.  In many cases, corporates are reducing banking providers from over 100 to 2-3 global relationships.

Some multi-national corprorations are in the early phases of these transformation projects while others have nearly completed them.  It will take another five years for the transformation to fully occur.  However, once complete the dynamics of corporate banking will have changed forever…

IndyMac, Fannie Mae, Freddie Mae…government seizures, government bailouts, government regulations…can the banking crisis get any worse?  And this was just the last two weeks!   Earlier this year, we witnessed the collapse of Bear Stearns in the US and the nationalization of Northern Rock in the UK.   For each bank who has failed there are five more who have escaped immediate peril but continue to suffer distress from rapidly falling stock prices - Wachovia, Washington Mutual and Lehman just to name a few.

It is difficult to tell whether we are near the end of the subprime mortgage fallout or still in the beginning.   However, one absolute certainty is that 2008 will be recorded in the history books as a period of unprecedented loss and radical transformation the banking industry.  Experts predict that the final tally of losses will reach $1 Trillion.  The banking sector will become even further consolidated as institutions collapse or seek buyouts from healthier firms to survive.  Access to capital will be more challenging to obtain as lending practices become more stringent and tighter regulation emerges. 

Bear Stearns on e-Bay - Found on a Reuters Blog site

The subprime mortgage crisis is not the only source of radical change in the banking industry this year.  A less publicized, but perhaps equally significant transformation is occurring across Europe this year as part of the Single European Payments Area (SEPA).  Much like the credit crisis, SEPA will result in significant losses to banks.  Payment fees collected could decline between 30 to 60%, the equivalent of €13-29B of foregone revenues.  But unlike the credit crisis, SEPA losses will not be the result of a series of unplanned events leading to catastrophe.  Instead SEPA is a deliberate, methodical attempt to evolve the banking system that will provide substantial long term benefits to both consumers and businesses.   SEPA is not a new phenomenon.   Planning for the changes has been occurring within the European banking sector for over a decade now.  However, since the SEPA initiative’s progress has not been well communicated outside of Europe, I thought I would take a few minutes its goals and benefits.

Background to SEPA 

Historically, Europe has been host to a complex set of country-specific pricing, regulation and systems for payment processing.  For example, consumers pay different prices for the same banking services depending upon their country of residence.  Italians and Germans might pay ten times what a Dutch or French citizen is charged for basic retail banking services.  Geographic limitations constrain today’s service offerings.  Many of the banking services consumers purchase are limited to the home country in which the financial institution is based.  For example, when a Belgian citizen travels to another country such as Austria, his debit card from the Belgian bank will most likely not allow him to withdraw funds from a local ATM. 

Corporations suffer many similar challenges to consumers.  The fees assessed by banks for payables and receivables services vary widely based upon country.  A multi-national corporation making a €1000 payment to a supplier might pay €0.75 in Italy; €0.25 in Spain and €0.05 in France.   There is one consistency in payments across all European nations and that is cross-border transactions are expensive regardless of the country of initiation.  For example, before SEPA the €1000 payment explained above would have cost €20 if it were to be made from a payer using a German account to a payee using a foreign bank. 

Single European Payments Area 

Starting in the 1990s, the European Union began the SEPA initiative to harmonize and simplify payments across the 15 countries which have embraced the Euro as the national currency.  Consumers and corporations will enjoy consistent pricing and service levels irrespective of their country of citizenship and the location of their bank account.  Surcharges for cross-border transactions within the Eurozone will effectively be eliminated.  As a result, citizens and corporations will be able to make payments in any Eurozone country as easily and cost-effectively as they could in their home nation. 

SEPA offers numerous benefits to consumers, corporations and financial institutions.  The efficiencies to be gained through SEPA will lead to a 1% increase in GDP for the EU making it more competitive on the world market.  However, the productivity improvements will not come for free.  The gains will be achieved at the expense of the banks.  And they will be substantial.  As I mentioned above, SEPA’s impacts could reduce bank’s payment revenues by 30-60% or €13-29 Billion below 2010 expected results.  One of the greatest areas of impact will be cross-border payment fees which will be reduced from between €16 to €24 per transaction to under €0.50 per transaction.  Another contributor to revenue declines will be the normalization of fees across the EuroZone.  As the region is transformed into a single, common marketplace for retail and corporate payment services, competition will drive prices to their lowest common denominator.

Why are banks willing to participate if they lose so much money? 

While SEPA requires banks to sacrifice short-term payment fee revenue, it offers a promise of much larger long-term revenue and profitability gains.  In today’s model, regulations and requirements for operating a bank vary by country.  As a result, only the largest financial institutions can afford the start up costs to establish operations in multiple countries.  With SEPA the barriers for financial institutions to expand into new markets will be reduced considerably.  As a result, banks can expand their geographic footprint to capture a larger share of the larger EuroZone market and its 300 million citizens.  Furthermore, banks can offer a unified product set across the various countries gaining significant economies of scale in back office operations.

SEPA is, of course, just one part of a broader plan to harmonize the financial systems throughout the European Union.  The EU has similar initiatives completed or underway for invoicing, currency, taxation, securities and financial reporting.  Europe’s success has not gone unnoticed.  The Middle Eastern nations of Saudi Arabia, Bahrain, Kuwait, Oman, Qatar and the UAE have already started efforts to unify their economies through the establishment of a common currency by 2010.  2010 is only 18 months away.  And we can only hope that confidence in the banking sector will have been restored by then…

In my last post I discussed the issues surrounding labor negotiations at the US West Coast ports.  This potential work stoppage at critical California ports could not come at a worse time.  Suppose, for example, that a work stoppage occurred August 1^st.   

Record Energy Prices 

What are the alternative means of importing goods from Asia to the US?  Re-routing goods to East Coast of Gulf State ports is one option.  Shipping goods via air freight is another option.  However, record high energy prices make these options more expensive than ever.  $150/barrel oil has led to skyrocketing increases in jet fuel and gasoline.  Higher energy prices have not only affected air and ground transportation.   Oil prices have increased the costs of marine freight as well.  The diagram below illustrates the dramatic cost increases for shipping a 40 foot container from Shanghai to the US at various oil prices.

As a result, no matter what contingency plans are followed, importers will pay an unusually high premium to divert shipments around the work stoppage.

Olympics 

The clock in Tiananmen Square is counting down the minutes remaining to the opening of the 2008 Olympics in Beijing on August 8th.  The Olympics present a critical milestone in China’s development.  Government officials want to ensure that while country is showcased to the world during the Olympic Games that outsiders will gain a favorable opinion of China’s progress in recent years.  Among the government’s largest concerns is pollution.  There have been several unconfirmed reports of government actions to curb pollution.  Examples include closing factories, halting construction and limiting automobile use.   For more information see the post on Bryan Larkin’s blog  or the recent articles from AMR Research  or Business Week (An Olympic Loss for Industry).   

The Olympic disruption to transportation and manufacturing is significant in that it could interrupt the flow of exports to the US for several weeks.

Back To School 

Challenged by a recessionary economy throughout the duration of 2008, US retailers are hoping to stage a comeback in the second largest sales period of the year – back to school season.  Overcoming recessionary pressures in consumer spending will not be easy.  US retail sales for June increased by only 0.1%.  Much of the gains are attributed to rising gasoline prices which are included in the sales figures.  Consumers are demonstrating a reluctance to spend even though the US Federal Government has injected over $90B in liquidity into consumer’s bank accounts through its tax stimulus programs this spring. 

The Perfect Storm? 

So back to the original question at the beginning of the post - what would happen if a port strike occurred on August 1^st?  High volume imports of apparel, footwear, electronics, toys, furniture and other consumer products would come to a halt as steamships anchored idly off the California coast.  This comes at a period in which the US is already anticipating decreased flow of exports from China.  Government actions to temporarily reduce Chinese manufacturing and transportation capacity to offset pollution will be occurring throughout July.   Alternative transportation methods such as shipping cargo via air freight and re-routing to East Coast ports with subsequent ground transportation are possibilities, but may be prohibitively expensive due to rising oil prices.  

The combined effect could be a perfect storm of logistical challenges that result in an unprecedented volume of out-of-stocks during the mid-August to late August peak shopping season.  Let’s hope the longshoreman and port operators can reach a consensus on the critical issues soon.  Otherwise a depressed retail sector may be stealing headlines from the automotive and banking industries come September…

Bank failures, record oil prices, potential automotive bankruptcies…what next?  How about a major port strike in the West Coast of the United States?  Believe it or not, a strike could happen at any minute now.  The dockworkers who manage the California, Oregon and Washington state ports have been operating without a contract for two weeks as of today.  A series of six months of negotiations between management and unions to resolve terms about working conditions, benefits and compensation failed to culminate on July 1^st when the contract expired.  Since then dockworkers have been continuing to perform their daily responsibilities with a few exceptions.  In the past few days, workers have begun to take coordinated breaks designed to disrupt productivity.  The result has been a 10-15% productivity decrease in port operations, but this is just the beginning…

What are the impacts? 

Imagine if the negotiations reach a stalemate resulting in a temporary work stoppage!  What would be the impacts of a port strike to US retailers such as Wal-Mart, Home Depot, Target, Lowes, Best Buy and JC Penney who are critically dependent upon Asian imports to fill their shelves?

West Coast ports are the critical entry point for inbound ocean containers arriving from China, India, Malaysia, Vietnam and other Asian exporters.  Together the 29 ports in the states of California, Oregon and Washington represent $1.3 Trillion in annual domestic business impacts.  $1.3 Trillion is roughly equivalent to the Gross Domestic Product of the entire country of Canada or Mexico. 

Dockworkers failed to reach a consensus with management during the last round of contract negotiations in 2002.  As a result there was a 10-day shutdown of critical West Coast ports that cost the US economy over $1 Billion per day.   Since 2002, port volume has increased by over 45%, raising the stakes of a potential shutdown even higher.

Who are the players? 

• Pacific Maritime Association – effectively acts as the management entity for the 71 different companies who operate the ports.  Owners include cargo carriers, terminal operators and stevedores.   What is a stevedore?  A stevedore is a company who manages the process of loading and unloading container ships.  Stevedores typically own the equipment used to manage the freight and manage the longshoreman who facilitate the process.
• International Longshoreman and Warehouse Union (ILWU) – is an AFL-CIO organization that is one of two major labor unions in the US for dockworkers.  The other is International Longshoreman’s Association which represents the East Coast, Gulf States and Great Lakes ports.  The ILWU represents over 40,000 members in over 60 unions from Oregon, Washington, California, Alaska and Hawaii.

What are the issues? 

• Compensation and Benefits – Health care benefits and salaries are listed amongst the key issues by the union.  However, statistics provided by Pacific Maritime about dock worker compensation might lead one to side with management.  The average full time employee earns $136,000.  Union members with the title of “Clerk” receive $145,000 and Foreman gross over $200,000.  Members enjoy a benefits package that costs over $50,000 per employee including full health insurance with no deductibles.
• Safety – Compensation and benefits are better understood if you consider the dangerous environment that dock workers operate in.  Over 17 employees have died in the past six years since the contract was renewed.  Many workers claim that pressure from port operators to improve productivity leads longshoreman to take shortcuts that compromise safety.
• Environment – The port facilities are filled with transportation and loading equipment that collectively generates a significant amount of pollution.  A longshoreman’s work is performed amongst trucks, ships, locomotives, tug boats, tankers, barges, yard hostlers, cranes and forklifts.  Pollution not only affects the dock workers during business hours, but it affects friends and family throughout the West Coast region who are subjected to smog and poor air quality.

What can importers do to avoid being impacted by a potential strike?  One strategy is called “port diversification”, which I introduced in a post earlier this year.  Instead of all Asian routing shipments through the US West Coast Ports of Long Beach and Los Angeles, retailers are being to explore alternative options such as:

• Routing of shipments from India through the Suez Canal and into US East Coast hubs such as Baltimore, Savannah or Charleston.
• Routing of shipments south of the US to Mexico.  Intermodal links enable transfers of containers to rail cars for travel to the Midwestern US states of Texas, Oklahoma and Kansas.

But even with re-routing, a port strike would have a massive impact on the US economy adding further turmoil to an already financially disastrous year…

I was not able to post any blog entries in June as it was an unusually busy month for me.  In some respects I expected to be busy as I had planned some vacation time.  However, I also had a few unexpected events that kept me out of the office.  In the early part of the month, I had the pleasure of contracting a fairly nasty stomach illness, which kept me confined to my bedroom (and bathroom) for about 48 hours.  I had just suffered from a stomach virus in late March so my initial assumption that I had caught another strain.  Although the illness was not pleasant, my bigger concern was that I was going to pass on the stomach virus to my 18 month old son and my wife who was six months pregnant.  However, my illness proved not to be contagious as my son and wife never became sick.  As I read the newspapers over the following week it occurred to me that perhaps my illness was not a stomach virus, but salmonella poisoning instead. 

The US has been the victim of a fairly serious outbreak of salmonella in raw tomatoes throughout the past two months.  The latest reports from the Centers for Disease Control have identified 810 salmonella cases in 36 states linked to raw materials.   The tomato salmonella outbreak is the largest fresh produce contamination issue in US history.  In early June, many of the top food service establishments such as McDonalds, Burger King and Chipotle all stopped serving tomatoes for a short period of time.  Grocery retailers suspended sales of tomatoes as well.  One of the unfortunate consequences of food safety issues is that an entire product category is often penalized for problems that may be isolated to a particular SKU.  Regulators, retailers, distributors and manufacturers have learned to be overly cautious in the case of public food safety matters.  No retailer or manufacturer wants their brand name tarnished by a series of public health issues.  Such was the case with tomatoes in the US throughout the early part of June.  For example, Roma tomatoes were identified to be the source of the poisoning.  Cherry, grape and other variants of tomatoes were not affected.  Public health officials were able to isolate the geographic source of the outbreak as well.  Tomatoes harvested in California, Texas, Georgia and many other states were deemed to be safe for consumption.  Nonetheless, grocery and food service retailers were not discriminatory in efforts to remove tomatoes from their product lines.  The National Restaurant Association claims the salmonella outbreak has cost the industry $100 Million to date.

The source of the contamination has still yet to be identified.  Experts state that the root cause may never be determined.  Given the advanced technology and extensive resources in the US, I find it fascinating that after 60 days public health officials have not been able to pinpoint the source of the outbreak.  The Centers for Disease Control (CDC) seems to have the primary responsibility for researching the root causes of food safety issues.  The Wall Street Journal published an article titled “Anger Rises over Salmonella Probe” on the front page of yesterday’s newspaper.  Also on the front page was a story about how the US government is forcing UBS to divulge account holder information for several of its customers.  I thought the point of having a Swiss bank account was to keep the ownership information private!  In any event, I am pleased to see that the government has plenty resources to violate privacy rights and prosecute tax evaders even if they cannot resolve long-standing public health issues…

But let us suppose that the CDC had been able to quickly identify the source of the outbreak amongst the various tomato growers.  How quickly would the agricultural and retail community have been able to respond?  The easy part would be to contact the affected tomato farmers to request suspension of all future shipments.  The more challenging exercise would have been to pinpoint the location of all the contaminated tomatoes already stocked in various warehouses, grocery stores and food service establishments throughout the country.  Which types of supply chain applications and e-commerce technologies could be leveraged to rapidly identify and recall contaminated food products?

The retail industry has developed a set of standards for the traceability of food products.  The efforts have been led by the GS1 organization based in Brussels and its various member organizations throughout the world.  Specific traceability models have been developed for fresh produce products as well as beef, fish, wine and bananas.  More information can be found at www.gs1.org/traceability.  The food traceability processes depend upon a few key e-commerce technologies such as EDI, data synchronization, barcode labels and RFID.  Unfortunately, many of the underlying e-commerce technologies, particularly data synchronization, suffer from a lack of critical adoption by major retailers and agricultural product manufacturers.  As a result, the GS1 traceability models would be relatively ineffective in efforts to accelerate the recall of unsafe food products from the supply chain.

I find the lack of a technology infrastructure to rapidly isolate and recall unsafe food products somewhat disturbing.  What if the tomato salmonella outbreak was much broader in scope, affecting 8,000, 80,000 or perhaps even 800,000 people?   What if there was an intentional effort to sabotage the food supply (i.e. bioterrorism)?  How many lives would be impacted?  What economic impact would occur?  Should the retail industry and government regulators be more aggressive in efforts to promote food traceability technology?  More in a future post…