Dear all,
Capital Optimization requires synchronizing the activities of the agents participating in the value chain, reducing the Capital consumption of the system.
This process has been the basis for the development of technology and processes that have transformed the non-financial economy in the last 50 years and which has been driven by SAP's strategic vision.
When Dietmar Hopp, Hasso Platter, Claus Wellenreuther, Klaus Tschira and Hans-Werner Hector founded what is today SAP AG, they were beginning a long path of standardization and integration of business processes in the real economy. By integrating, for example, production planning with supply and demand, they established a common language that allowed the three dimensions to be synchronized, improving service levels while reducing inventory obsolescence costs.
Since then, and especially after the arrival of SAP R3 in 1992, the standardization and integration of processes has accelerated, covering 70% of the non-financial economy.
I started my career as a SAP consultant 30 years ago, at that time our goal was to integrate the processes of the companies' departments.
10 years later we were integrating processes of the subsidiaries of the groups of companies with other subsidiaries of the group.
And in the last 15 years we have massively integrated the business processes of clients, suppliers, logistics operators in a standardized language (SAP). And with this synchronizing the activities of all agents, reducing Capital consumption (transportation costs, inventory obsolescence, supply, etc.), while maintaining a high level of service.
This standardization and integration process has not been carried over to Financial Services. Banking and insurance companies, with very limited exceptions, present silo-style architectures with very limited integration that represent a brake that makes Capital Optimization difficult, if not impossible.
Following the example of the transformation experienced in the non-financial economy, the Optimization of financial capital (solvency and liquidity) requires:
1) Integrate the processes of the agents involved in the acquisition, generation and delivery of financial services.
2) The integration of the agents involved in the acquisition, generation and delivery of financial services with the processes of the real economy.
Point 1 can be covered with SAP Banking technology, rated by many experts as the most visionary in Financial Services. But while 70% of the real economy is expressed in terms of SAP processes, point 2 can only be covered with SAP technology. And this simple argument makes SAP Banking the only alternative to Optimize Capital.
If in addition, as is the case, the cost of capital is rising due to the energy crisis and excess debt, the transformation of financial services towards Capital Optimization has become a strategic urgency.
Our team detected this opportunity 12 years ago, and since then we have worked to integrate the processes of the real economy in terms of generation and consumption of Solvency and Liquidity, integrating the processes of SAP Banking, with the standardized business processes of SAP in the real economy, which as I said before, represent 70% of the non-financial World GDP.
By doing so, we change the paradigm of Financial Services, establishing financial and non-financial collaboration models. The objective is to detect capital and liquidity deficits and surpluses in business processes and cover them with debt and investment financial instruments, optimizing the system's capital consumption.
Making an analogy, it is like the Vendor Managed Inventory collaboration processes of Supply Chain Management, but in financial services. Delivering financial instruments of debt and investment instead of replenishing sales and production materials.
But in the same way that has happened in the real economy with the strategic vision of the founders of SAP, when you change the paradigm in financial services, you open a universe of capital optimization opportunities based on the synchronization of economic agents. In the next lines, I will briefly describe one of them.
One of the greatest advantages that pricing in SAP and its integration with Analytical Accounting brought was its ability to analyze the margin of purchase-sale operations. By integrating the cost of sales and transportation costs through statistical conditions in the Sales Order and the Invoice, we could analyze the margin of these operations in unimaginable detail until then.
But the buying and selling processes are also affected by capital costs that are not visible without integrating financial services with the real economy, but have a real impact on the margin. And they will have more as Capital costs increase.
For example, when we sell (or buy) a merchandise in foreign currency, we are exposing ourselves to a future loss depending on the exchange rate at the time of payment.
To eliminate this risk, companies implement hedging strategies with financial instruments (Forex Forwards and Options). These financial derivatives have a cost that is not visible at the time of confirming the purchase and sale order, limiting the ability to optimize capital in this process.
We all know that price policies are determining factors in the generation of income and the globalization process has generalized buying and selling in foreign currency.
When we negotiate a price in foreign currency, the sale price is not the conversion of that amount according to the spot rate.
A buy-sell order is a future operation, subject to foreign exchange risk, so the hedging cost must be included in the analysis. At the time of the order confirmation we know the exchange rate of the day and we can only estimate, assuming a risk, the future exchange rate. And that risk represents a cost of capital that our income statement is bearing.
Visualizing this cost in each order item, analogously to what we did with the Cost of Sales more than 30 years ago, we provide the company's managers with tools to optimize this Cost of Capital.
Determining the forex risk Cost of Capital depends on three components.
1) Current and future exchange rates and their volatilities.
2) The amount of exposure to forex risk.
3) The duration of the exposure.
The first component is information available in the capital markets (Bloomberg, Reuters, etc.)
The second component is the order amount in foreign currency that our SAP system knows perfectly.
The third is the duration of the exhibition, from the payment date to the estimated payment date of the order, easily estimable at the time of confirming the order.
With this information, and the capabilities of SAP's Pricing Determination tools, it is not difficult to define a Condition Type in the Pricing Procedure that includes the Cost of Capital per Forex risk and with this, using the standard integration with Analytical Accounting, make visible this Cost of Capital. In this way we improve the decision-making capacity of managers to determine price policies, optimizing capital.
But at the time of confirming the order, we can only estimate the capital cost for forex risk, it is a standard cost that will manifest itself at the end of the business process. Visualizing this cost in each operation, analogously to what we did with the cost of sales more than 30 years ago, we provide the company's managers with tools to optimize this Cost of Capital.
The actual foreign exchange risk Capital Costs will depend on the efficiency with which the exchange risk coverage processes are executed by the managers of the Treasury department.
By integrating actual Forex Risk Capital Costs into Analytical Accounting, with the Sales Order-Invoice granularity offered by SAP, company executives will be able to measure the deviation between actual and standard Forex Risk Capital costs. And in this way make the necessary decisions to improve the efficiency of the integrated process.
This is just one of the many examples of the opportunities to Optimize Capital by integrating the value flows of the real economy and financial services.
There are alternatives to the above proposal which provide even better estimations of the Cost of Capital, including the Market and Credit risk analyzer of SAP Banking. I will give you more details in a future blog.
In general, the SAP Banking architecture provides a data and process model that shares the integration principles of SAP systems that have transformed the real economy in the last 30 years. Transferring these principles to Financial Services is the only effective way to Optimize Solvency and Liquidity.
We are working on presenting our proposals to the market, and looking for business partners and investors, if you are interested do not hesitate in contacting me with a private message in linkedin.
Looking forward to reading your opinions.
Kindest Regards,
Ferran Frances.
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