Avoiding bad debt backlash in the channel

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This article appeared in the June 2014 issue of CRN magazine.

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Avoiding bad debt backlash in the channel

A buy-now, pay-later system of credit underpins the business of resellers, distributors and vendors. With margins shrinking, credit control has become even more critical for resellers and distributors alike. But since the global financial crisis, and a series of channel companies going belly up, credit is harder to come by. Credit relationships these days are now stretched.

Hugh Evans, managing director of reseller financing outfit MoneyTech, says that since the GFC, distributors have been working to instructions from credit insurers.

He says that whereas a reseller may require a hefty credit line for a project, insurance restrictions mean distributors may only be able to insure, say, half as much. “If a reseller needs a million dollars’ worth of credit limits, they can only get half-a-million dollars of insurance these days after the financial crisis. The distributors are turning down the limits so that the maximum that a reseller will get will be half-a-million.”

Evans says this has been true for many years, but became more pronounced in the crisis and continues today as the economy struggles still to shake off the impact of the crash, which sent many resellers and IT companies to the wall.

“It’s always been the same but having said that, it’s probably tighter at the moment because more companies have gone into liquidation and administration over the past few years since the financial crisis so that’s why the appetite is a bit tighter,” Evans says.

Fast-growing or acquisitive companies can be hamstrung in a credit-shy market. Anittel, which topped the CRN Fast50 twice in a row, knows the issues only too well. The publicly-listed reseller has posted a series of less-than-stellar results, which has not won it fans among credit insurers or suppliers.

Anittel managing director Peter Kazacos says: “One of the issues I have found with Anittel – where we have been growing by acquisition and have gone through a number of years where we haven’t made profits and where we have written down goodwill – we have been in situations where suppliers said they couldn’t give us credit because our numbers weren’t good.”

They were working to instructions from their credit insurer. Kazacos says: “What we have found over the years is that because a number of companies have gone belly up, distributors have insured against their risk. What they do is they will only give you credit if their insurance companies say they can give you credit.”

In Anittel’s case, its M&A spree had seen a number of goodwill write-downs, which, while not ‘real money’, had subsequently hurt its bottom line. Kazacos may also argue that the credit insurer’s recommendations ignored his solid credit history after many successful years in the channel. “What I have done in the past should be enough, but that isn’t the way they work. They use other mechanisms.”

Ultimately, Kazacos secured credit from a distributor that ignored the recommendations from its credit insurer. “With one supplier, the insurance company said no but the managing director of the company said, ‘I believe you are good and I will give you the credit’, so we got a fair amount of credit from that distributor. They understood where the business was, where it was going and they understood me.”

He concedes that while the outcome was “all right for me”, other resellers may not be so fortunate.

Trying times

System integrators also face other risks, particularly due to the fact that many projects require multiple technology solutions that may not arrive at the promised time. Kazacos says credit relationships can be strained when a distributor gets an order for a solution that might have three components – A, B and C – and only delivers A and B, with C on back order. “My customer says I won’t pay until I get a working solution,” Kazacos says. “Therefore, we are exposed to having to pay for A and B when we haven’t been paid by the customer.”

The trend towards cloud services is redefining credit relationships, with more services now being paid for on an annuity or monthly subscription. Kazacos is certain this will eventually be extended to hardware and other products, simply because it takes the stress out of the credit relationship and ensures everyone gets paid on time. “It makes it even more encouraging to do that because you get your money straight away,” he says. “You do it now with phones and Chromebooks; it’s just a natural transition.”

Another past Fast50 winner, MBits, understands the pressures on new or fast-growing business. Eugene Nolan, founder of the Fyshwick, ACT-based business, says today’s credit environment is particularly difficult for new resellers and start-ups. The same goes for starting relationships with new suppliers.

“If it’s an existing relationship, it’s usually fine. If we have a relationship with Ingram or Express Data, they will normally honour their line of credit we have had in place,” he says. “But if it’s a new distributor, it can be difficult. They normally ask for trade references, and in some cases it can be really difficult because companies don’t act as trade references any more. That makes life difficult. It depends on how old your company is, the cash flow, and the reputation the company has in the market.”

As securing credit has become a trial for some resellers, it has become a bartering card for disties to secure business. Stephen Knights, managing director of Balgowlah NSW-based Commulynx, says he has noticed over the past 18 months that many distributors are now offering extended credit terms to resellers as a way of enticing them across. Such is the competition in the sector where technology has become increasingly commoditised and where differentiation is harder to come by.

“The end of quarters is a classic for particular vendors,” Knights says. “That particular vendor and that particular distributor will have a package of extended terms. I’ve seen it quite frequently as a way of attracting people to get sales. It’s definitely used as a tool to entice people to focus on a particular product set.”

Peter Agamalis, founder of distributor Impact Systems, agrees that it is something his company does, as do other disties.

“We just have no choice really,” Agamalis says. “It’s just the way it is. It’s a vicious cycle that they’re falling in that space and state of play. A lot of these guys are long-term customers of ours that have been buying from us for many years so we give them extended terms. And sometimes our vendors support them as well.

“For us, it’s always been like that. I wouldn’t put it down to current conditions. I find a lot of the distributors have a lot of customers who have long-term relationships with them, and there is a level of support. It comes down to the level of risk and you have to mitigate that risk,” he adds.

The way that risk is mitigated, of course, is through credit insurance and due diligence on resellers.

Agamalis says credit relationships – whether between vendors and distributors, between distributors and resellers or between resellers and their clients – have to be carefully managed these days.

“The reseller has a specific relationship with their customers, so they don’t want to rock the boat in terms of pushing for payment because perhaps, sometimes, they might feel it would complicate things. Adding too much pressure might look like they’re desperate and they don’t want to come across that way, and so it can be a sensitive topic at times.”

Distributors can offer resellers special arrangements to ensure the payments go through and thus preserve the relationship.

“Sometimes they can offer a discount on top of the invoice,” he says. “For example, for the customer to expedite a payment within less than 30 days, they might take two percent off, or if they expedite the payment within seven days, they might give them five percent off.”

He says more resellers are now paying by credit card. “Credit cards are a great form of payment these days. There is no such thing as a free lunch and you have to pay for money somewhere but if you’re going to pay extra interest, why not get some points out of it.”

Agamalis says Impact will provide credit to start-ups, but it’s limited. “We’re always happy to give them terms, but the terms are always limited in terms of what their exposure is like. There are also personal guarantees of whatever assets they have that they need to account. If they’re not prepared to do that, the credit then is pretty small.”

Stuck in the middle

Munsoor Khan, a director and co-founder of Digital Networks Australia (DNA), says distributors are probably the most exposed in the credit food chain.

“We’re always in a tricky position because we have to pay our vendors on time,” Khan says. “Our partners have varying terms and varying payment cycles as well. We’re always juggling working capital. I don’t think there are many businesses out there that wouldn’t be. Obviously, you cover yourselves with external financing to make sure you can meet all your commitments but, at the end of the day, it’s a fine art in balancing what’s coming in and what’s going out.”

Credit insurance, he says, is now a critical part of the equation.

“If you look at the vendors, one of the things they look for in a distie is the bank. Where the credit goes into the channel, that’s where the risk comes, and that’s why distributors have debtor insurance and rigorous credit checks to make sure we are minimising the risk,” he says.

“We also use credit checking agencies to make sure the amount of credit is in line with what they would be comfortable with, and that gives us a layer of security that people want to see.”

Working out the credit arrangements with the reseller is part of that balancing act. Like Agamalis, Khan says it’s so competitive these days and the margins are so compressed that they can’t afford to push the reseller too hard. Where there is a relationship, it becomes a negotiation.

“It helps if the reseller is your partner and you are aware of their business needs as well as your own, and you work out what’s appropriate for both parties. If it only goes one way for either party, there’s a problem. We have standard terms and resellers will say, ‘These are our terms’ and we will look at it and see if it’s a solid business, and if it is we’ll do it and if it’s not, we’ll try and work out something that works for both parties. It’s so competitive these days that if you’re laying down the law to resellers, you’re going to find yourself with a problem.”

Working with start-ups requires special treatment. “A complete start-up has no credit history. You can either set them a nominal limit, which they can trade to but if the trade is going to go higher than that, then unless you can get a guarantee from the director – which isn’t easy to get – you’ll have to do it on gut feel; how comfortable you are with that organisation and what you can find out in terms of what they were doing before. It’s a risk assessment and you go accordingly.

“Perhaps it’s cash on delivery or a percentage of the price upfront, and you help them with some payments up to what would have been the normal credit terms, so they can build up a bit of a history. So there are ways to design something for both parties. Both parties have to be motivated,” says Khan.

“We’ve been doing this for 21 years now and we’ve gotten pretty good at it; a lot of times we’ve had to be creative. We’re motivated to do it because we want to help them grow their business, the theory being if they grow their business, they will help us grow ours.”

Cloud effects

Khan says the growth of cloud computing models like AWS will see more people moving to an annuity payment system.

“Some of our suppliers have started to move into that space because of the popularity now of AWS vendors. They have to find solutions that fit into that AWS environment and that’s dragging us into this world.

“Maybe that will take some of the credit pressure off because invoices go out every month, so you need less credit. That means money is coming through the business more regularly; it comes through every month and that has to be good for everybody.

“The cloud is not going to go away. How successful has it been to date? I’m not sure, probably not as much as the hype would suggest, but it’s going to happen in a fairly significant fashion. But it’s not going to replace goods and services that it can’t supply. Organisations will always need IT products in their own environment or to support cloud initiatives,” says Khan.

“But a lot of distributors now offer a monthly leasing arrangement. You can buy laptops and IT equipment and work out a three-year arrangement. The challenge that the cloud throws up is it’s not going to be the same cost every month. With the cloud, you pay for what you use.”

Khan says that the big trend now is where resellers are repaying their accounts one month after the 30-day period. This works when the reseller makes the order at the beginning of the month. He sees more resellers adopting this method of repayment, which, in turn, will put pressure on the relationship between the distributor and vendor. Loryan Strant, founder of cloud integrator Paradyne, told CRN back in March about the company’s trials in securing credit early on – and how this framed its early relationships with disties.

“We went to Express Data, we went to Ingram, we went to Synnex when we started Paradyne, and no one wanted to give us credit because we were brand new. But it was a bit different with Express Data. We had a personal relationship there; we filled out a credit form and the account manager vouched for us. We got a decent line of credit and we haven’t reneged on it at all.”

It’s a bet that looks likely to have paid off for the distributor: this year, Paradyne joined the CRN Fast50 with 99.65 percent growth.

Jodi Seah, commercial director of credit insurer Coface Australia, says businesses trading on credit terms are always susceptible to non-payment and insolvency risks.

“In our opinion and from a broad perspective, it is fair to say that the ICT sector is not flagged as a high-risk industry per se, but we observe that the credit risks tend to snowball down the supply chain, whether value adding services or distributors, increasing in magnitude as the sale moves closer towards end users or consumers.

“This is not surprising, as each stage of development or production of a technological asset would contribute towards the overall costs of the purchase price. As the scope of ICT is fairly large with hardware and software-digital information, it would be better if we viewed solutions to mitigate credit risks into tangible and intangible goods.

“Shocks to a supplier’s working capital, should a large uninsured bad debt from the insolvent buyer occur, may trigger liquidity issues for the supplier as well if they themselves are waiting to receive the monies to pay off their own suppliers,” concludes Seah.  

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