Apparel suppliers and manufacturers throughout the COVID-19 pandemic have been hit particularly hard as many of their retail clients either missed, canceled or deferred payments for goods.
Major apparel wholesalers have been eating the costs of these failed payments and have had to write them off in the form of “bad debt,” including Nike, PVH, Adidas, Hanesbrands, Guess, Levi’s, Columbia Sportswear and 7 for All Mankind parent Delta Galil. As the second-quarter earnings season heats up, many expect even more wholesalers will bear the brunt of these costs. But now, it’s going to be the wholesalers’ job to figure out how to improve on these relationships, or if worse comes to worse, exit them entirely.
A “bad debt” expense is a financial transaction that a company records in its books to account for any debts it has given up on collecting. The expense is a contingency that must be accounted for by all businesses that extend credit to customers, as there is always a risk that payment will not be received. It does not necessarily mean that cost can never be recouped again, but it shows that companies are put in an extremely tough position that often requires more creativity to keep the relationship in the positive going ahead.
Foster Finley, global co-head of the transportation and infrastructure practice at global consultancy AlixPartners, noted that despite the extreme circumstances brought about by COVID-19, the issue of bad debt certainly is not a new phenomenon within retailer-supplier relationships.
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“This is not the first time in the history of North American retail that there have been issues of a retailer or even a wholesaler taking possession of goods from a channel provider and then having problems,” Finley told Sourcing Journal. “In some of the quasi-fashion cycles or seasonable areas, we’ve had circumstances where somebody orders far more winter jackets than are going to be sold during the winter season. And it could be due to bad planning or due to an unseasonably warm winter.”
In some situations, retailers may offer to pay suppliers and wholesalers for the items they sell, and hope to return the items they didn’t sell with no obligation, which can often be the root cause of the problem.
In other cases, manufacturers may maintain the ownership of the goods, but will keep them in the retailer’s warehouse or distribution center. With this scenario, manufacturers aren’t going to have the guarantee that the product is being marketed or promoted in good faith. Additionally, the faster the goods churn and the greater the need for the wholesaler to monetize the goods, the less practical the arrangement becomes. However, some manufacturers believe they may have better control in these situations as they can at least ensure they get some of their goods back in these deals, according to Finley.
“They think if the retailer isn’t going to move the items quickly enough, or if they’re not going to get paid for it, they can get it back and instead put them through another retailer or another channel where they may not have the risk of default or the interminably long wait periods before they get grossed up,” Finley said.
Despite where the products are located or if they are even sold at all, much of the relationship traditionally hinges on the ability to pay off credit, especially now in a situation where cash flow is incredibly tight.
However, wholesalers don’t always have access to a retail client’s real-time credit line, and thus have to make determinations on whether to right-size a credit line (either by expanding or contracting it, depending on the financial status) based on continued conversation. Credit lines are typically backward-looking views on the customer, so accessing reports normally reflect where a business stood 90 or even 180 days ago.
“A whole lot of bad stuff can be happening already and you don’t necessarily see it because there’s a relatively significant delay before you ship something and you’re only going to get paid in three or four months’ time,” said Brandon Spear, president of global B2B payment and credit solutions provider MSTS. “It’s one of the nuances of the retail industry which makes it increasingly complex to manage. There are those typically long payments cycles. What we’ve seen in other industries is it’s incredibly important to be proactive with those customers, to not wait until the bills don’t get paid.”
Admittedly, these conversations are not easy to have, because there’s a solid chance that the wholesaler is still going to learn that they won’t be able to be paid in full within their allotted 45- or 90-day timeline. But the constant communication is crucial to establishing the proper credit line that the customer can handle at the moment.
“You don’t want to be a source of working capital for other parts of that customer’s business,” said Spear. “You need to make sure that if they are buying $100 a week and they have 10 weeks’ worth of credit with you, that you’re giving them $1,000 worth of credit lines—you’re not giving them $5,000 so that they can actually push the terms way out, not pay you in 10 weeks, but pay in the much longer cycle.”
While wholesalers may have their hands tied in these situations, they definitely aren’t powerless in that they’re essentially taking on the role of an unsecured creditor. In many ways, it’s going to come down to how much the wholesaler/manufacturer is willing to tolerate the retailer’s decision making, especially if it becomes too costly to continue a working relationship with them.
“You could say, ‘Look, the next time we sell you something, you’ve got to either pay for it up front cash on delivery,’ which is pretty unusual and a lot of the retailers would just scoff at that and say, ‘No way,’” Finley said. “But it’s a matter of negotiation. Think about this, many manufacturers are designers and own the brand, but make it in Mexico, Vietnam, China or Europe, take your pick. So it’s not even directly going through their fingers but you can say you’re going to agree with these terms or not. And if they become too onerous as the retailer, you’re simply going to walk away, right?”
With the e-commerce boom from the pandemic in full effect, wholesalers more than ever now have the opportunity to bypass third-party retail channels if they feel they want to take potential sales into their own hands.
When Nike disclosed a bad debt charge of $178 million in its most recent earnings report, the ahtletic wear maker also unveiled a major development within its own retail strategy with the launch of its Consumer Direct Acceleration initiative. Already surpassing its initial goal to sell 30 percent of its goods through its own e-commerce channels, Nike now seeks to funnel 50 percent of sales through its digital channels by 2023. Whether the performance apparel and footwear giant maintains strong relationships with its partners or not, it may feel less burdened by the strain of uncertainty of other black swan events occurring in the future if it keeps a larger share of its product under its under roof.
Unfortunately, not every wholesaler or supplier is in a position of strength that Nike holds of being a world leader in its field. According to Spear, companies making this leap to direct sales, particularly with their own e-commerce presence, still might require skillsets they don’t currently have.
“For sure there’s going to be a ton more of wholesalers going direct,” Spear said. “What it obviously does, though, is stretch those businesses because they don’t necessarily have the corporate muscle on either how to deal with a consumer direct initiative. Even if they kind of were supplying bulk and then selling in smaller bulk quantities now, and then they might have thousands of customers instead of tens or hundreds, that also creates and fuels a lot of what we see around the outsourcing game. More often than not, these firms don’t have the competencies or the scale in house to do it themselves, which is why they’ve often relied on retailers and other channels to get to market.”
In this case, the shift away from using other channels to sell may instead shift toward another direction: outsourcing more of their supply chain.
“In many cases, this has all been in house,” Spear said. “We’ve seen more customers saying, ‘Well, this is a pretty risky world we live in right now. We’re great at making our products, we’re great at making shoes or clothes or whatever they may. But we’re not necessarily the best at managing this risk.’ You can shift this risk from your own balance sheet [to] who’s better equipped to deal with that.”