Aug 14, 2024
Scott Blakeley, Esq.
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 continued increase in their average accounts-receivable days. This is despite the fact that customers are sitting on record cash holdings. I have discussed in articles 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.
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 inflationary enviornment, 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.
The TPS Trend
A. Why Are Customers Pushing Back on Supplier-Set Credit Terms?
A primary factor contributing to the spike in customer TPS is the expense of bank financing. Unwilling to pay the high-interest fees of 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. 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
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.
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 expensive for suppliers.
III. Inflation and the Impact on TPS
A. How Inflation Affects the Rate of TPS Rollout and the Supplier’s Cost of Capital?
Inflation has a significant impact on a supplier’s cash flow:
1. more expensive financing will drive more finance-needy customers to push back on their supplier- set credit terms, while
2. 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)
The takeaway for the credit team facing a formal TPS is to educate the sales team and management that extended terms has a much greater impact on eroding the profitability of the trade relationship in an inflationary environment, given the supplier’s increased cost of capital. 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 LC, where he advises companies regarding creditors’ rights, commercial law and bankruptcy law. He can be reached at seb@blakeleylc.com.