In my March 21 post, “The Diet of 900 lb Gorillas”, I referred to the recently-published Morgan Stanley report on B2B Finance. That report raises a number of issues, only one of which was really addressed in that prior post, so I want to return to it again.
This time I want to point out a couple of statistics that are key to assessing the long-term potential of The Receivables Exchange.
The first of those statistics is the gross size of the SME (small to mid-sized enterprises) market. Morgan Stanley reports that the SME market accounts for about 45% of all business revenues in the US. Morgan defines the SME category as all businesses with annual revenues of less than $500 million.
Now for the purposes of discussing TRE’s near-to-intermediate term potential it’s unrealistic to assume that its addressable market includes businesses with $500 million in sales. So we have to adjust Morgan's 45% figure.
The smallest category Morgan uses comprises businesses with revenues of less than $25 million. That category accounts for 25% of total corporate revenues.
TRE requires Sellers to have annual revenues of about $1.5 million and, at present, a $25 million Seller would be at the upper end of the TRE size spectrum. So this is really the near-term target market-segment for TRE marketing efforts.
To eliminate those businesses that are too small to qualify for TRE Seller membership we have to reduce the 25% total. This is completely guesswork on my part but I suspect we wouldn’t be far off if we reduced the 25% figure to maybe 15-20% to eliminate the smallest businesses.
If we apply the 15-20% range to the estimate (based on the Fed’s flow-of-funds report) of the overall volume of annual B2B accounts receivable generation (about $18 Trillion), that suggests a potentially-addressable, near-term market size in the range of $2.7 to $3.6 Trillion.
That ignores the fact that some of those businesses, especially the smaller ones, probably do not extend trade credit, but it’s also the case that some large businesses extend very little trade credit. It’s hard to know how to adjust those volume figures with any confidence, so I’ll just let them stand with the caveat that there are potentials for error from a number of sources.
If we use the mid-point of that indicated range, or $3.15 Trillion, and we assume an average AR duration (days-to-pay) of 45; that suggests that the average outstanding AR balance on the books of that segment of the business community would be about $390 Billion.
That’s a big number!
The Morgan Stanley estimate of the total US factoring market is given at $136 Billion, suggesting that our estimate of the near-term, potential TRE-addressable market is three times the size of the entire current industry. But that's not really the appropriate comparison.
It is clear that the smallest businesses will account for no more than their relative percentage of the total factoring market and probably quite a bit less. How much less is a guess, but let’s just say for conversation that it’s overstated by 100%, or that the actual factoring activity in this smallest segment of the economy is half its representation in the total economy.
That would suggest that $10-$13 Billion is employed by the factoring community in the smallest segment of US business.
If that’s anywhere close to the mark, it implies a current market penetration of only 3% or so of indicated near-term potential.
If a realistic maximum penetration were, for argument's sake, to be measured at 25% of the currently-addressable market, the implied potential would be $390 Billion x .25 = $97.5 Billion, less (about) $12.5 billion (already served), or something in the range of $85 Billion in potential for capital employment.
That’s clearly a market worthwhile pursuing.
And that is without considering the potential ultimately afforded by businesses with revenues above $25 million, some of which, over time, should be attracted to the flexibility of an auction environment.
On the other hand, it has to be recognized that many smaller businesses are in no condition to be brought to TRE at this point.
TRE’s marketing effort has to include a long-range education program to bring potential Sellers to the realization that “clean” and accurate financial records and disciplined management of their billing and other AR functions are critical to positioning themselves for access to a market like TRE.
It’s easy to make the case that the market potential for TRE is substantial in the near-term and extremely substantial in the longer-term.
It’s not a stretch to view the TRE growth curve as exponential for some time to come.
But that doesn’t mean achieving that potential is a certainty.
There are difficult problems to be solved, not least of which is maintaining the discipline required to adequately vet potential Sellers and to strictly implement the safeguards in place to protect against abuses.
But it seems clear that the size of the opportunity makes tackling the problems well worth the effort.
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It's About Time!
13 years ago
Your analysis of the small business receivables marketplace certainly provides encouragement for those of us rooting for TRE. However, I beleive you overlook much of the potential mid-sized businesses afford. I spent 17 years in finance with four different firms that would today fit that category (lets say $25-$250M). All had easy access to asset-backed financing that included pledging their receivables.
ReplyDeleteThe problem with AR and asset backed loans is there are a lot of exclusions, and that is why I believe TRE offers a tremendous opportunity to mid-sized businesses as a supplement to their bank borrowing. All the companies I worked for had large customers with 90 day or more terms, which were excluded from the borrowing base. All had international sales (also excluded) on letters of credit payable at either a US bank or a foreign bank branch in the US. Other sizable accounts were excluded because they always had some unresolved invoice deductions sitting open beyond 90 days. Financing any or all of these receivables on TRE would seem to be a viable option for accelerating cash flow. Mid-sized firms selling seasonal products should also be likely candidates for TRE's services, and undoubtedly there are other circumstances where TRE will provide the best alternative to the traditional financing products available to mid-sized firms.
As the late Senator Everett Dirksen is reported to have said, "A billion here and a billion there, and pretty soon you are talking about real money." That may not apply to politics any more, but in terms of TRE, the impact of mid-market firms finding their way to the exchange could transform their treasury management options. But, as you rightly observe with the small businesses, there is a lot of education that is going to be necessary in order to pave the way.
Thanks very much, Dave.
ReplyDeleteI'm hopefully not actually overlooking the potential of the mid-size business segment.
My point is that the CURRENT Seller community is dominated by the under-$25 million firms and that the smaller firms probably represent the bulk of the near-term opportunity.
In the intermediate-term, as the "mid-sized" companies come to better understand the auction model, and TRE proves itself to be a permanent part of the finance landscape, I agree completely that many should be attracted to it.
Even without that market segment, though, the opportunity is very significant.
Thanks, as always, for your thoughtful reply!
Chuck