Supply Chains - Partnership Development -Innovative Finance

How to Avoid 5 Development Finance Pitfalls

Article | April 17, 2020

Levi Strauss & Co. had a dilemma. In 1991, it became the first multinational apparel company to establish a comprehensive workplace code of conduct that set standards for worker’s rights, a healthy work environment, and an ethical engagement with the planet for its manufacturing suppliers in developing countries.

By 2014, the company continued its trailblazing ways by setting more ambitious corporate environmental and social goals. It had also created a program to assess how its suppliers met its workplaces standards, identifying problems areas to improve.

To realize its targets, thousands of Levi Strauss & Co.’s garment suppliers would have to upgrade their environmental, health, safety, and labor standards. Except the company had little to no direct control over its garment suppliers, but they needed to find a way to reward and incentivize the suppliers.

The solution was found by forming a cross-sector partnership with the International Finance Corporation, which is a Development Finance Institution (DFI). The entities created a program that offered working capital loans to garment suppliers who met Levi Strauss & Co.’s sustainability standards.

As suppliers improved against the company’s standards, they could access more competitive loan rates and remove collateral requirements. Since many suppliers faced gaps in working capital, this model gave them a strong financial incentive to invest in their operations and to improve against Levi Strauss & Co.’s standards.

Promising Partnerships

For companies operating in developing markets, securing their supply chains while meeting sustainability goals has never been more important. It’s also never been more challenging, which is why forming cross-sector partnerships is critical.

For many companies, DFIs hold tremendous promise. DFIs are specialized development banks or subsidiaries set up to support private sector development in developing countries. These organizations are usually majority-owned by national governments or benefit from government guarantees. This ensures their creditworthiness, enabling them to raise large amounts of money in international capital markets and provide financing on very competitive terms.

A DFI can bring multiple benefits to a company including:

  • More flexible capital, including longer-term loans
  • A higher risk tolerance than most traditional, private-sector investors, since DFIs are designed to go into countries or markets that other private investors won’t

How to Avoid 5 Common Pitfalls

Partnering with a DFI and finding the right project or program can take time, patience, a bit of homework, and a lot of persistence. While the reward is big, far too many companies come up short because of common pitfalls.

To help teams succeed where others have gotten derailed, Resonance has identified five traps and how to avoid them. These include:

1. Understand the problem on the ground first.

Before a DFI will sign onto a deal, they want to know a company has done some initial research, mapping, or feasibility reports to understand what’s happening locally, on the ground, that’s affecting their supply chain.

Sustainability managers need to answer questions like: why does your company need financing? What problem or issue in the supply chain (or elsewhere) will this financing help you solve? What’s the program or solution you’re putting forward? Who are your local partners? What behavior on the ground are you trying to incentivize?

For example, does the company want its local suppliers to adopt more energy-efficient manufacturing equipment? Are manufacturing plants experiencing frequent electrical outages, so they need a more reliable, clean, and affordable energy source? Is a company concerned suppliers may be engaged in child labor practices? Is a company concerned about the health and well-being of their suppliers or farmers or producers? Are there specific climate change issues like droughts, access to clean and fresh water, or sea level rise? Is the company trying to reduce the gender pay gap or income inequality?

2. Think of financing as the tool, not the solution.

Financing is a powerful mechanism to change the behaviors of farmers, producers, vendors, and other critical players in the supply chain. Use it appropriately and strategically. For example, one sustainability manager we worked with didn’t understand why their farmers refused to invest in better irrigation equipment. It took some digging and talking with locals on the ground, but the company learned that while the farmers supported better irrigation, it was more important to them that they spend their limited money on sending their children to a private school for better education.

The company eventually worked with a DFI to create a program that offered grants to famers so they could send their children to school, but a pre-requisite was that a farmer must buy and install better irrigation equipment.

The company is improving irrigation and water issues but in an indirect way. By supporting education, though the company also strengthens their relationship with their farmers.

3. Choose the right DFI.

Before reaching out to a DFI, spend time researching and understanding their needs and requirements. Not all DFIs are the same. DFIs are absolutely hunting for deals, but each has its own priorities and mandates that will drive its investment decisions.

As political organizations, each have specific priorities and constraints they must operate within. For example, the U.S. Development Finance Corporation (formerly OPIC) offers debt financing in the form of direct loans and loan guarantees to support medium- to long-term investment projects in emerging markets. Loans are typically 3-15 years. All investment projects must support respect for the environment, workers’ rights, human rights, and local communities. Whereas the IFC requires multinationals to be investment grade (or close) and use an environmental management system to monitor suppliers.

4. Take a long-term view.

If a company needs cheap and fast capital, they may be better off partnering with local market actors and traditional financing providers. But if a company is looking for a partner who will work with them in risky, volatile climates, where the private sector can come and go or there are high macro risks, then a DFI is worth considering.

If the country has a recession, a DFI is more likely to help a company navigate the downturns and unforeseen events. A DFI has broader goals than just extracting a return on investment, so they may be more willing—and able—to alter payment terms and repayment periods.

For example, unlike traditional banks, which often pull back financing in tough times, the IFC recently raised $8 billion to target efforts to prevent, detect, and respond to the rapid spread of COVID-19. However, the bulk of this capital will go to existing clients in industries that are directly affected by the pandemic—such as tourism and manufacturing—to help offset their reduced cash flow. The package will also benefit those involved in the pandemic response, such as the healthcare industry.

5. Be patient.

Deals can take a long time to close and have multiple steps. Before a company can talk about financing and structuring a deal, they have to have a planned project and concept that has been validated. They have to know their local partners and have all their “ducks in a row” including knowing how much financing they need from the DFI. The internal process at a company may take 6-12 months, and talking and structuring a deal with a DFI can take another 3-6 months—and that’s in a best case scenario, assuming the company has provided all the required information to the DFI. More complex deals can take even longer, up to a year or longer. DFI deals aren’t rapid response, however they can pay dividends to everyone once the program or project is kick-started.

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