Increased complexity has become the norm
Following a turbulent two years marked by the global pandemic, the second half of 2022 added further complexity to many organizations that were just beginning to normalize. Inflation drove costs up across most categories, followed by a steady increase in borrowing costs, putting pressure on both margin and the balance sheet.
According to recent EY research and analysis1, as of Q4 2022, net working capital increased 22% in the prior year, driving up the cash conversion cycle by over four days. Net debt is at record levels, necessary in part to fund the inflationary-driven increases in working capital requirements. Average interest costs increased by 20% by the end of Q4 2022 and are expected to increase significantly in early 2023, as the impact of escalating interest rates on short-term borrowing and refinancing impacts company financials.
Now more than ever, organizations are faced with greater complexities and added pressure to deliver healthier margins and deliver on financial and operational objectives.
Managing the increased challenge of competing priorities
The new economic reality for companies is one of high inflation, increased interest rates and rising cost of capital – all of which are causing a range of impact across companies within a sector. This is due to multiple factors, including the amount of leverage and size of company.
Companies that find themselves with higher leverage may look to obtain more favorable payment terms or lower minimum order quantities to reduce cash tied up in working capital. In contrast, companies that have lower debt leverage may decide to deploy more capital towards trading partners who need it to generate further incremental returns in margin.
The difference in cash conversion cycle between large (>$10b annual revenue) and small companies (<$1b annual revenue) has continued to grow. At Q4 2022, small companies had an average 33 days’ higher cash conversion cycle (+82%).1 Smaller companies typically have less and more expensive financing options. Therefore, for many of these smaller companies, faster payment may become an increasingly valued negotiation lever, which larger companies can offer for a relatively lower cost and in return for other favorable terms.
For many companies, there remains an opportunity to reduce overall working capital, balanced against other priorities. According to our analysis, there remains a wide range in performance between the best and lowest performers; in terms of sector days payable outstanding (DPOs), there is a range of between 20 to 60 days difference in each sector between lower-quartile and upper-quartile performers. 1 Most likely, as stressors continue, one of the first actions companies will take will be to delay payments or push terms.
What does this mean?
One of the areas that is typically the first lever for action when trying to improve financial performance is procurement. Procurement will typically evaluate price, working capital, as well as other factors, such as total landed cost and lead-times, into a negotiation strategy. The current economic environment is creating opportunity for procurement to reduce cost, including negotiating cost reductions from lower commodity prices (from peak prices) and reducing working capital costs with appropriate trade-offs. For example, historically, leading organizations were able to generate significant working capital benefits through extending payment terms or improve profit margin by offering early payment discounts. However, given the wide range of impacts on companies in the current economic environment, binary negotiation strategies are no longer optimal. Organizations need to gear-up to approach procurement negotiations in a more deliberate way and at greater scale.
Taking on complex negotiations at scale
Companies are looking to procurement to help realize cost savings more quickly while optimizing other areas of value, including reducing supply chain risk, which was a major lesson learned from the pandemic. However, given capacity constraints, most companies’ central procurement organizations cannot conduct thorough negotiations with all suppliers. Rightly so, organizations focus their procurement efforts on high spend and strategic suppliers. “Tail end,” or non-strategic, suppliers typically sign agreements with cookie-cutter terms, or have historical contracts with sub-standard terms. Although it doesn’t make sense to hire more people to negotiate these smaller deals, the result is that many companies leave significant savings unrealized.
This is where AI comes in. Pactum AI, a startup that focuses solely on automating negotiations, can help solve this problem by combining data and behavioral economics to negotiate better deals at scale. Pactum AI has demonstrated with Maersk, Wesco, and other large enterprises how using chatbots for supplier negotiation at a massive scale helps improve working capital and save costs across the board. This AI solution allows organizations to optimize for multiple areas of value that are customized for the organization.
AI chatbot is cutting costs
One very powerful feature of an AI-based negotiation is the use of a total value function to automatically find the best negotiation outcome.
A total value function includes key areas of value for both the company and the supplier that are relevant to the negotiation. As with the concept of total cost of ownership, a monetary value is assigned to each element of the function, allowing the AI algorithm to find an optimal outcome with a supplier. It’s important to understand all areas of value, including non-price elements, to increase the potential for value creation in the negotiation. An example is a better payment term, or discount, from the supplier in exchange for a “preferred supplier” status that may enable the supplier to grow their business. Customizing this for the organization facilitates a win-win negotiation.
A Harvard Business Review article recently discussed a major retailer’s journey to automate their supplier negotiations using AI-based negotiations at scale.
This case study shows that during the initial pilot with Pactum AI, the retailer gained 1.5% in savings on negotiated spend and an extension of payment terms by an average of 35 days. How was this achieved? Pactum AI’s intelligent chatbot successfully improved the terms of 68% of the business agreements, generating an average savings of 3%.
In addition to cost savings, an AI-based approach to negotiations, when used properly, can improve supplier relationships in the following ways:
- Provide an opportunity for a broader set of suppliers to engage with the buying organization
- Enable an unbiased and objective approach to negotiate value for both the supplier and the buyer, providing a transparent and trusted approach to negotiations
- Collect and update supplier data
- Allow suppliers to negotiate at their own pace, with key outcomes known at the end of the process
Pactum’s AI has dispelled various myths around the use of AI technology in negotiations. Some of the surprising benefits of successful implementations include:
- High conversion rate of supplier negotiations to a final deal
- Simpler approach than negotiating with a person
- Implementation can be fully value based with ROI typically achieved within a company’s fiscal year, providing a powerful tool to realize cost savings and working capital quickly
To realize these benefits, it’s important to use an implementation approach that combines the buying organization’s negotiation expertise with leading practices in procurement and AI negotiations. Prioritizing this as part of a procurement transformation program often provides both new capability and value creation within a short timeframe.
In conclusion, as companies face increased pressure on margins and balance sheets, there is a growing need to optimize working capital and reduce costs while balancing other priorities. AI + chat negotiations can be a valuable tool for achieving these goals. AI-based negotiations, such as those offered by Pactum AI, can help organizations optimize for multiple areas of value and automate negotiations with suppliers at scale, resulting in significant cost savings and improved working capital. This often results in 3% to 5% savings, which for most enterprise clients equates to hundreds of millions of dollars in savings per year. As the business landscape continues to evolve, leveraging innovative technologies like AI chatbots can give companies a competitive advantage and help them be recession ready.
Recently, companies saw increased pressure on margin and balance sheet caused by inflation and interest rate hikes. Increased complexity in the needs of buyers and sellers is creating an opportunity for value creation through procurement negotiations, and AI + chat negotiations can create value at scale in this complex economic environment within a potentially short timeframe.