In the modern world of international trade, firms do not always need to be paid in cash. Counter-trade can be equally, if not more beneficial, to the seller.
Essentially a counter-trade is whereby payment is made with goods or services of an equal value which are then sold to a third-party. Such an agreement can range from the basic barter contract whereby one set of goods or services are exchange for another to more elaborate agreements involving multiple parties.
The most common type is a counter-purchase whereby there is at least a minimum of two contracts for the first supply of goods or services and then a second that allows the original supplier to covert the goods or services into cash. Counter-trade is not restricted to simply the private sector; governments also use it quite extensively.
Recently, the Malaysian government purchased 20 locomotives from General Electric with the payment made through palm oil supplied by a plantation company. Large companies such as GE have a long history of using commodities in return for payment and also a special department for it.
In today's trading environment countertrade is not only limited to large companies but can be strategic tool that small and medium enterprises (SMEs) can use to enter new markets. This is more so the case where the new market has certain trade impediments such as the restrictions on the transfer of capital, availability of reserves, and so on.
As a result, counter-trade is an important manner of doing business in the lucrative markets with no money actually changing hands. It can also be an effective manner in which SMEs can procure reliable sources of raw materials.
In most cases, counter-trade agreements tend to be confidential and reliable statistics difficult to obtain. Nevertheless various estimates show that it is a rapidly increasing form of trade finance with more than 100 countries using it.
Studies show that the volume varies between 15 to 30 per cent of global trade. In some regions, it can be as high as 50 per cent of the total trade value. The rise has been greatly assisted by the internet, which has allowed firms to match needs with availability. In the past firms may have avoided counter-trade due to the difficulty in identifying a counter-party.
In other words, success rested on the fact that as the economist Paul Samuelson noted "a hungry tailor happens to find an undraped farmer, who has both food and a desire for a pair of pants, otherwise neither can make a trade."
Historically, counter-trade was an inefficient system of trade finance because the initial seller also had to look for the parties who wanted the commodity or service that was received in exchange. For large companies such as GE, it was less of a problem because of their specialised trading departments, which facilitated the identification of counter parties.
For the typical SME, counter-trade used to be difficult. However, the internet has changed this so that any SME can participate using widely accessible platforms such as Alibaba.com. These platforms allow even the smallest of SMEs to post the products available to potential customers all over the world.
Anecdotal evidence shows that some SMEs have been able to improve their collections cycle as a result of counter-trade. Cash payments are typically dependent on a number of related factors such as liquidity, seniority of accounts payables, etc.
However, with counter-trade the buyer simply exchanges a commodity which they have ownership over in return for the one that they are acquiring. Therefore, payments are not related to the liquidity position of the buyer.
Avoiding official links
More importantly, in countries where transfers are difficult or subject to restrictions, counter-trade avoids the official payment mechanisms. Another important factor that is persuading more firms, and particularly SMEs, to be actively engaged in counter-trade is a more difficult business environment. When firms are transacting in stable business environments or those that have few hurdles, traditional payment mechanisms and trade finance tools are sufficient.
However, when firms are transacting with buyers located in countries with difficult economic and commercial conditions, then sellers need to be innovative in the manner in which they do business. The interesting aspect of dealing with buyers in countries with difficult economic and business conditions is that there is usually a strong demand for goods and services.
However, more often than not the strong demand is not necessarily matched by the immediate ability to pay with cash. Therefore, counter-trade offers buyers an immediate ability to finance imports without the use of cash. Of course, it does require the SME to be innovative in that it needs to identify what the buyer has readily available as a form of payment and to seek out potential counter parties.
The writer is the head of export market intelligence at Dubai Exports