The reluctant risk takers

Some credit insurers are worried by what they see as high levels of risk in the IT market and may be preparing to withdraw certain lines altogether. What will this mean for resellers?

Credit is an issue that can really make a reseller's blood boil. Without it, even if the customer wants to buy, the reseller cannot sell.

One small reseller told vnunet.com's sister title Computer Reseller News: "We have fought distributors tooth and nail when seemingly ridiculous or indefensible decisions are made that are either cautious in the extreme or justified in the name of some faceless credit insurer. Someone else has cost them a packet and we are expected to pay for it."

Thankfully, it is not all bad news. There are distributors that take a more realistic approach and take on more of the risk themselves.

Unfortunately, not all of them have yet learned that to rely entirely on the insurer to cover their risk is no longer viable.

We have withheld the name of the distributor in the following reseller comment: "Computer 2000 [C2000] and Westcoast have adopted a 'partnership' approach and we have worked together to establish the credit we need to trade effectively and, together with other factors, the result is good business for all.

"On the other hand, when we re-approached Distributor X after a 'leave of absence' due to general channel stock fulfilment difficulties, we were informed that our previous credit limit was no more - although nobody had bothered to advise us - and that the distributor required further financial information including 2001-2002 accounts, even though these are not even required to be filed at Companies House yet."

As a result, Distributor X does not have any of this reseller's business - C2000 and Westcoast do. But while it is an emotive subject, resellers also need to be realistic and as unemotional about credit as possible.

Hugo Kirby, managing director of reseller Trams, explained that credit risk is just an inherent part of doing business and needs to be taken seriously when buying and when supplying.

"People who manage credit well don't have problems, but people who ignore it do," he said. "We use insurance but that doesn't provide 100 per cent cover, and if credit control is handled properly you should have few or no claims. We have had only three in 12 years."

Mike Nelsey, managing director of Scarborough-based reseller Enline, has no sympathy with businesses that don't keep their house in order.

"It is tough on the cruddy resellers who run things so tight or take all the money out of their business and leave nothing for working capital or rainy days," he said.

"The only exception to this is where there is a big deal and the benefit accrues all the way down the line, so everyone goes out on the limb."

Even when a risk has to be shared in this way, there is an argument for saying that the reseller should ask its bank, not put pressure on all their suppliers, according to Nelsey.

"It is the business principal's responsibility to ensure the liquidity of the company," he insisted. "If they can't get credit and keep to terms, or are short of cash through 'free and easy' business processes, they should get out."

Many may be forced to do just that over the coming year. Nitin Joshi, director at insolvency practitioner PKF, expects to see a steady stream of reseller failures over the next 12 months.

He also predicted that at least one major distributor will become insolvent as a result of vendor consolidation.

Eddie Pacey, credit manager at Ideal Hardware, said: "The risk of failure in many large value-added resellers has risen sharply, and continued suppression in business activity, pressure in margin and costs that sometimes are not cut quickly enough or cannot be cut further, add to the pressure.

"We will undoubtedly see high-profile failures and further mergers in the next two quarters."

Considering the catastrophic performance of some insurance companies in recent times, it is hardly surprising that pressure is being put on premiums, according to Pacey.

"Credit insurance companies find themselves under considerable pressure on two separate fronts: from above to reduce potential risk and increase premiums without losing business and premium income, and a channel that in general has performed poorly in recent times," he explained.

But Joshi pointed out that the insurers can't take all the blame. "Too much criticism has been levelled at credit insurers. They are not charities. The channel has an in-built cycle where failure and 'phoenix' businesses co-exist and the sector churns on a self-perpetuating basis," he said.

The low cost of entry into the market makes this 'churn' a fact of life, and in the current climate more failures can be expected, justifying the insurers' tough approach.

"It is not surprising that the channel is over-populated. There needs to be natural weeding out of resellers. Many do little more than act as a logistical point for onward resale to the corporates," explained Joshi.

"They are notoriously bad at organising their own management and information systems. They are not good at collecting outstanding monies and rarely put their trading partners on contract.

"This causes all sorts of problems and often makes the business unattractive to funders who like to know worst-case scenarios when they are lending. A badly organised dealer does not help itself."

Continued reseller failures could also make distributors very nervous. According to Jon Atherton, general manager at Enta technologies, it is certainly true that distributors are looking hard at the debt they do and do not insure.

"We are looking closely at insuring debt due to the increased costs and the lack of credit being given. A company trading for two years with little profit would have received credit three years ago, but sadly this is not always the case today," he said.

"Distribution needs to look not only at its top 50 clients but at its bottom 200 on credit accounts."

But for the moment at least, most of the major distributors seem to be holding their nerve. "It is certainly a concern, but I think the situation is under control," said Steve Miller, chief financial officer at Ingram Micro.

"We have a tremendous amount of capacity remaining. Far less than half of the £250m of credit we can make available is being used right now.

"We have a small number of accounts in which we have a crunch but I'd be concerned about those, whatever their credit limit."

C2000 takes a similar line. Credit manager Nick Tiltman suggested that it is not a matter of increasing or heightening the level of risk-taking, but more about taking ownership of the risk.

"In my view, whether the debt is insured or not should have no impact on your decision to do business with that reseller, although obviously it will affect the level of line you can offer," he said.

Different levels of risk need to be managed in different ways, according to Tiltman. "If there is less available insurance you need to find ways of 'hedging' your risk using various means, such as third-party financiers, assignment programmes and owned risk," he explained.

"There are a multitude of ways to ensure that trading can continue when insurance is not available or only available at a level that may restrict your business."

The virtual withdrawal of credit insurance from the channel seems to be accepted as almost inevitable now in distribution circles. But Pacey doubted whether this will be allowed to happen.

"The alternatives are not always palatable and are frequently more expensive. I've not heard anyone say they will not insure their buildings, vehicles or people, so covering the biggest asset on the balance sheet is clearly paramount," he said.

"Your chances to borrow money or re-finance your business without having receivables secured and backed with an efficient credit management function are pretty well nil."

Selective non-recourse financing of major accounts can be looked at in cases where there is some form of alternative security.

But Pacey warned: "No one, at the end of the day, is going to take a flyer on a business that has filed poor results two years on the trot and where the balance sheet is shot to ribbons."

The numbers really do count when it comes to credit, and distributors are trying to look at different ways to offer credit. But their attitude could stiffen if there is an increase in failures.

Miller insisted that the level of exposure to bad debt that Ingram and other distributors are experiencing now is certainly no worse than last year.

However, he does foresee tougher times in 2003. Distributors are more likely to start asking for regular and up-to-date accounts and for more flexibility from resellers in terms of how they deal with finance.

"If an account can't justify the credit and won't look at other methods, we will walk away from it. We are not in the business of investing risk capital," he explained.

If the risk does become higher for distributors and resellers, the market will not grind to a halt, but some companies simply won't be able to attract credit.

"It will affect new companies and those with poor balance sheets adversely, because ultimately credit risk is measured on both the perceived profitability and management of the target company and the balance sheet," said Kirby.

"The key for resellers is to work with the distributors, agree payment terms and stick to them. If you can't do so then tell them before they put you on stop."

In the end distributors will be compelled to start taking more risks if they want to ensure that their businesses do not decline any further.

They will be able to rely on their largest and most secure accounts only so much. As Atherton pointed out, in most distribution companies the top clients generate a lot of the turnover - and therefore the cash flow - but very little margin.

"We are not looking at our top clients' credit, but how to increase the smaller ones with greater gross margin. Here we would take a risk," he said.

Most distributors seem to be pursuing a similar strategy, extending their exposure where they feel it is merited and backed up by good information.

However, many resellers tend to be suspicious of talking to distributors about their business in depth, perhaps with some justification if the comments made by the anonymous resellers at the start of this article are to be believed.

A suspicion that distributors will try to divert the business though a less risky route also tends to make many resellers somewhat taciturn, especially while trading conditions are so testing.

But Kirby insisted that, if a business is well run, there is no need for concern. "If you have a large deal going through which is going to mess up cash flow or need a one-off temporary limit increase, then the distie may be able to help if they know. So the rule is: talk to them," he said.

Increasingly, distributors are prepared to listen to anyone with a genuine story, and some have people who will come out and talk to you about your business and about credit lines face to face.

As the insurers walk away and distributors start to shoulder more of the credit risk burden in the market, if they want to get the credit, resellers are going to have to communicate more, provide detailed information and implement their own tight finance policies.

This is not simply a matter of getting tougher with customers, according to Tiltman, but implementing a credit policy and level of risk that works for the reseller's business model.

"Using the services offered by distributors and agencies such as Graydon and ensuring that customers are creditworthy is just common sense," he said.

"If you have had a lax credit policy in the past and have relied on an insurer picking up your bad debts and not worried about it just because you were insured, your costs will have risen in terms of premium and first loss."

According to Pacey, resellers perhaps should be thankful that there are distributors which "frequently look beyond the profit and loss and balance sheet and understand the market and channel more than insurance underwriters".

But he added that we only have ourselves - and he refers to the entire channel here - to blame for the current situation.

"Much of what we see is our own doing. It is the result of a selfish, blinkered vision, a reluctance to see the writing on the wall as far back as 1999-2000 and a passion for mimicry," said Pacey.

It is perhaps time for everyone to start making their own decisions and their own assessments of what does and does not constitute a risk.

TAKE THE MONEY BUT DON'T OPEN THE BOX

The difficulty of financing business may hasten a move toward agency selling, where the distributor accepts orders and invoices the end-user directly - subject to their creditworthiness - and subsequently pays the reseller a commission.

While many resellers remain nervous about such an initiative it is, according to some distributors, becoming more acceptable.

Legal complexities may prevent any great movement here, however. The recent Privy Council ruling on the case of Brumark Investments will make it harder for banks to agree to such arrangements, and they are now much more inclined to push resellers towards factoring and tighter control of receivables.

Essentially, the ruling bars the bank from claiming funds from unpaid sales invoices automatically when one of its customers goes down.

This means that outstanding sales invoices cannot be used as security for overdrafts or loans. It also means that banks will be reluctant to lend money to businesses that do not 'own' their own debts but are paid on a commission basis.

This may drive resellers to look at alternative financing options and providers much more in the future.

SIX-POINT PLAN FOR CREDIT HEALTH

London reseller Trams said that by following these six key points you can take control of your credit.

• Subscribe to Graydon or Equifax, which recommend credit limits for companies.
• Get a recommended credit limit for your customer before you give them any credit.
• Don't trade over that limit.
• Review that credit limit regularly in the light of payment record. Bad payers usually mean that something is wrong.
• Chase your money firmly but fairly.
• Have a formal process, i.e. statements twice a month, warning letters after a certain number of days overdue, solicitors' letters after however many days overdue, and stick to it. Solicitors will work with you in this sort of process, and the cost is low at about £10 a letter.

SUMMARY:

• Credit insurers are tightening the rules, compelling distributors to look harder at reseller credit and call for more information.
• Resellers that are well capitalised and open with their accounts and their financial situation can expect to get credit from distributors.
• Distributors will draw a line when they think the risk is too high, but may offer alternative financing deals. They will expect resellers to consider these or walk away from the business.
• Agency models may become more popular where credit cannot be granted to the reseller, but changes to the law are making this more problematic.

CONTACTS:

Computer 2000 (0870) 060 3344
www.computer2000.co.uk

Enline (0870) 550 2015
www.enline.com

Enta (01952) 428 888
www.entagroup.com

Ideal Hardware (020) 8286 5000
www.ideal.co.uk

Ingram Micro (01908) 260 422
www.ingrammicro.co.uk

PKF (020) 7831 7393
www.pkf.co.uk

Trams (020) 7544 1200
www.trams.co.uk

Westcoast (0118) 952 1500
www.westcoast.co.uk