This article originally appeared in Credit Today.
A payment trend affecting credit teams across all industries is customers disregarding supplier-set trade terms, and extending these terms. Private U.S. companies reported a 14.3 day increase in their average accounts-receivable days (37.5 days–51.8 days) from 2012 to 20132. This is despite that customers are sitting on record cash holdings.3 I have discussed the ways in which the supplier can either accept a customer’s terms pushback strategy (TPS) and attempt to mitigate the associated credit risk, or use principled responses (i.e. contract controls, loan covenants and the Robinson-Patman Act) to rebuff the pushback.4 However, given the increasing use of formal TPS rollouts (as opposed to TPS requests) from what the supplier’s management would deem an indispensable customer, as well as the recent reports of possible inflation, this article discusses the immediate and long-term impact of a customer’s TPS on the supplier’s profitability, with emphasis on the supplier’s cost of capital and the impact of TPS in an inflationary economy.
I. The TPS Trend
A. Why Are Customers Pushing Back on Supplier-Set Credit Terms?
One of the primary factors contributing to the recent spike in customer TPS is the expense of bank financing. Unwilling to pay the high interest fees of non-bank lenders, more customers are instead extending their supplier-set trade terms to better suit their working capital and cash flow needs. While a TPS presents the customer with a less-expensive financing option, the TPS negatively affects the supplier’s DSO and cash flow. And, given the lack of affordable sources of financing, it is difficult for suppliers to borrow from either bank or non-bank lenders to bridge the gaps in their cash flow.
B. TPS: Not a Temporary Request
Another worrisome trend for suppliers is the increasingly formal nature of customers’ TPS rollouts. With a formal TPS, the customer does not request extended terms from its suppliers, but rather dictates extended terms to its entire supplier base.
Where the supplier is selling the customer on a P.O. – or invoice-based relationship, there are no contract controls to keep the customer within terms on future invoices. Therefore, the supplier must anticipate that any customer TPS request will apply to all future invoices –not just the next P.O. While the credit team is willing to carry the receivable for one, or even several invoices, in the interest of preserving the trade relationship, it is far less likely to support carrying extended receivables for the duration of the trade relationship. This places the credit team in a difficult position, especially where management has classed the customer a key account due to its volume and product mix.
C. TPS and Terms Creep
The supplier must also appreciate that when it concedes to a TPS, the agreed-to extended terms are still able to be pushed further out, absent a long term supply contrast locking in the customer to fixed terms. A TPS in this invoice-based relationship opens the door for “terms creep,” whereby the customer continues to push out the already extended terms with each new invoice.
II. The Shifting Nature of Customer TPS
A. More Customers Rolling Out Formal TPS
Another worrisome trend for suppliers is the increasingly formal nature of customers’ TPS rollouts. With a formal TPS, the customer does not request extended terms from its suppliers, but rather dictates extended terms to its entire supplier base. In addition to the negative effect on the supplier’s DSO and cash flow, a formal TPS presents another problem for suppliers: where a TPS request may be a negotiation, in a formal TPS, the customer holds the trade relationship leverage and is less likely to negotiate the terms.
B. TPS, the Robinson-Patman Act (RPA) and Discriminatory Pricing
The RPA prohibits suppliers from extending more favorable pricing to one customer without extending comparable pricing to all similarly-situated customers. The price of the supplier’s product also includes credit terms as well as supplier concessions, such as credits, rebates, promotional allowances and early pay discounts. The RPA is limited to the sale of tangible goods and does not cover services.
The RPA is a civil statute. Both individual and class action lawsuits can be brought against violators for actual damages as well as pecuniary damages. Violators are also subject to injunction, from either the Antitrust Division of the USDOJ or any state’s Attorney General.
Where the supplier does not qualify for a Robinson Patman Act exception and management mandates acceptance of the indispensable customer’s TPS, the credit team must consider offering comparable pricing to all competing customers…
i. If the Supplier Accepts One TPS, Must It Offer Extended Terms to All Customers within that Class?
Where the supplier does not qualify for an RPA exception and management mandates acceptance of the indispensable customer’s TPS, the credit team must consider offering comparable pricing to all competing customers (whether in the form of extended terms, discounts or promotional allowances). For those suppliers selling to multiple competing customers, RPA compliance in the face of TPS rollouts can be an expensive for suppliers.
III. Threat of Inflation
A. Inflation on the Horizon?
For years, the inflation rate has remained low, averaging 2.3% over the past decade, and at 2.1% from May 2013 to May 2014.5 Given this low inflation rate and the need to spur economic growth through the recession, the Federal Reserve has taken an easy-money approach in recent years, keeping the short-term interest rate near 0% since 2008.6 An upward trend in the consumer price index (0.2% in March 2014, 0.3% in April 2014, and 0.4% in May 2014) and low rate of short-term unemployment (4.1% in May 2014) have many experts fearing inflation and much higher interest rates.7
B. How Would Rising Inflation Affect the Rate of TPS Rollout and the Supplier’s Cost of Capital?
If the economy is headed towards inflation, it could have a significant impact on a supplier’s cash flow:
- more expensive financing will drive more finance-needy customers to push back on their supplier-set credit terms, while
- higher interest rates will make it more difficult for suppliers to carry their customers’ receivables on an extended basis.
Consider the following formula for calculating the cost of carrying receivables:
Cost of Carrying Past Due AR = (Amount Outstanding on Invoice x Interest Rate) /
(365 Days in a Year x Number of Days Debt is Outstanding)
C. Is the Threat of Inflation Real?
Despite the uptick in the consumer price index and the appearance of impending inflation, the Federal Reserve has not yet taken action. Diane Swonk, chief economist at Mesirow Financial notes that the Fed uses a different metric than the consumer price index to calculate its inflation rate. According to the latest available data, the Fed’s inflation metric, which is based on personal consumption expenditures, measured inflation at 1.6% between Aril 2013 and April 2014; this figure falls below the Fed’s targeted annual rate of 2%, and well below the Fed’s tolerable annual rate of 2.5%.8 Despite the Fed’s unwillingness to take immediate action, suppliers should ready themselves for higher interest rates and an increase in customer TPS rollouts.
The takeaway for the credit team facing a formal TPS is to educate the sales team and management that extended terms will have a much greater impact on eroding the profitability of the trade relationship in an inflationary environment, given the supplier’s increased cost of capitol. The supplier needs to also consider the financial impact if it must offer comparable extended terms to all within the customer’s class of competitors per the RPA.
Scott Blakeley, Esq., is a founder of Blakeley & Blakeley LLP, where he advises companies around the United States and Canada regarding creditors’ rights, commercial law, e-commerce and bankruptcy law. He can be reached at [email protected]
Check out these other great resources:
Download: Discount evaluation spreadsheet – A spreadsheet that allows you to plug in any combination of price changes as well as changes in your discount rate and/or the length of time to pay.
Download: Meet the Competition Form – Here’s a great form to hold customers’ feet to the fire when they claim that competitors are offering longer terms.
Download: Request For Extended Terms Process – This is the process used by a major manufacturer when they receive a request for extended terms.
Download: Letter to Counter a Request For Longer Terms – This letter should be used when a customer declares that they will be paying you in “their” terms, which are longer than, and not consistent with, your selling terms.
1. Scott is a principal at Blakeley & Blakeley LLP, where he practices bankruptcy and creditors’ rights.]
2. Sageworks. “The Private Company Report.” Sageworks.com (January 2014).
3. Burne, Katy. “Companies Hold on to Their Cash: Survey Finds Increase in Share of Firms Raising Funds, Holding Short-Term Instruments.” The Wall Street Journal (July 29, 2013).
4. Blakeley, Scott. “What’s Your Team’s DNA, Accommodative or Punitive? How to Rebuff the Terms Pushback Strategy.” NACM Business Credit Magazine (February 2014). See also Scott Blakeley, “The Antitrust Laws as a Vendor’s Response to a Customer’s Terms Pushback Strategy,” CRF News-3rd Quarter (October 2013).
5. Browning, E.S. “Inflation Signs Touch off a Debate: Some Investors Say Weaker Growth Will Rein in Price Pressures; Others See a Complacent Fed.” Wall Street Journal (June 23, 2014).
7. Short-term unemployment refers to the number of unemployed who have been out of work for under 6 months.