Background
A few years ago, a small, medical technology firm (“Back Co”) sought to issue a Bank Guarantee or Standby Letter of Credit to help them negotiate a tense situation with their supplier.
Back Co sells a single product: A kit consisting of implants for spinal fusion surgery. Like its competitors, Back Co’s kits consisted of several dozen parts that the doctor could choose from during the operation. The parts were necessary due to the sensitive nature of the surgery because slight differences in spinal segments from person to person would require different implants. Back Co’s kits where costly, but allowed doctors to perform successful spinal fusions on virtually all patients. Usually, hospitals ordered these kits in large batches schedule for earliest possible delivery. Upon receiving an order, Back Co would obtain all necessary components from its various suppliers and, upon receiving the components, would package and send the kits to their customers.
In order to become more competitive, Back Co decided cut down on lead time. The lead-time on this process was usually at least several weeks although the customers preferred immediate delivery. Back Co’s management team realized that if they had the kits available on hand (i.e. in inventory), they could ship to their clients within days of receiving a purchase order. Back Co used its available cash reserves and credit lines to procure storage space, and ordered enough supplies to cover their projected sales for the next quarter.
The Problem
Back Co soon realized that they were falling significantly short of their projected earnings that season. Cash flow was tight and some vendor payments had to be delayed. Usually, Back Co settled transactions with their largest supplier, a producer of medical screws (“Screw Co”), on an open account basis – Screw Co. was extending credit to Back Co.
by giving them payment terms on the cost of goods rather than requiring payment upfront or prior to shipment However, after failing to pay Screw Co on time, the supplier stopped extending credit to Back Co. and withdrew their payment terms until Back Co. could sell the inventory they previously purchased on open terms and pay down their balance with Screw Co.. In the absence of immediate payment, Screw Co wanted an instrument to help them secure their finances, even if Back Co did not sell its inventory.
The Solution
Back Co’s management team considered using a Bank Guarantee or a Standby Letter of Credit. After Back Co explained their dilemma to us, we deliberated and decided that a Standby Letter of Credit was the instrument best suited for this situation. By providing Screw Co a Letter of Credit from a top global bank, Back Co was able to continue operating without further straining their relationship with their supplier.
During the term of the Standby Letter of Credit, Back Co’s sales grew, revenue increased, and they were able to pay Screw Co. in full by the time the instrument expired. By giving Back Co. time to sell their inventory without hassle from their supplier, the Standby Letter of Credit helped to ensure that Back Co. was able to repair its tense relations with Screw Co and to obtain credit from them in the future. Thus, Back Co’s supply chain was not only maintained but strengthened because their supplier now had proof that Back Co. would work with them to handle tough situations in the future. This gave Screw Co. sufficient confidence to restore their faith in Back Co. and to reinstate their favorable credit terms.
