The number of retailer bankruptcies has risen in recent years

The number of retailer bankruptcies has risen in recent years

Difficult trading conditions on the high street, increased online competition, rising costs and low consumer confidence are pushing retail bankruptcies to record-highs. Yet while the store closures and redundancies are widely reported, the fallout is also reverberating further along the supply chain.

The fashion retail industry has seen a worrying rise in the number of bankruptcies, with Nine West, Toys 'R' Us, Bon-Ton Stores and Rockport Group among the most high profile collapses. Company voluntary arrangements (CVA), a form of insolvency process, have also become commonplace, particularly in the UK, as struggling businesses seek to walk away from certain liabilities and negotiate lower rents to help avoid financial collapse.

In some cases, retailers deemed at risk of defaulting on payment terms can lose their supplier credit insurance. The cover is seen as standard in the retail clothing industry and provides suppliers with protection in the period between an order being accepted and payment being made in case the retailer cannot pay its bills.

There is no doubt the global retail sector is going through a turbulent time as cost bases spiral, consumer spending falls and the pressure to go digital becomes fiercer than ever. Currency fluctuations, tariff uncertainty, increasing competition, and the need for speed-to-market have only added to the pressure.

Retail chain Chapter 11 debt from June 2015 to April 2018

Source: Reorg Research

But while the obvious impact of a retailer going into administration or filing for a CVA will be the closure of stores and hundreds, sometimes thousands, of redundancies, it is often not widely reported that the fallout is also undoubtedly felt further down the supply chain.

Suppliers, both large and small, will be acutely aware of the challenges facing retail at the present time, and know that any impact on their customers' business will have a knock-on impact on their own. Yet how they deal with it – and prepare – can differ widely.

Who loses out?

Mark O'Hanlon, a senior manager at Kurt Salmon, part of Accenture Strategy, believes there is an element of naivety on both sides in such situations, but that ultimately it will be the supplier who loses out.

During his career he has worked in food industry roles at both Marks & Spencer and Sainsbury's, where the vast majority of contracts are governed by standard terms.

"When insolvency happens, it's only a matter of time. You have to act very very quickly in order to secure your rights over the goods. It is really a race against time"

"When a supplier is first set up on the retail system, they'll be asked to sign up to a very basic set of standard terms and conditions. Beyond that, there are few contracts written down or established, and often there's really nothing that is in the supplier's favour," he explains.

"There are a whole gamut of relationships between suppliers and retailers, and some of those I would characterise as just straight trading relationships where it's good old fashioned negotiation, and some of those are at the other end of the extreme, which are absolutely about a partnership."

But as O'Hanlon is quick to point out, "the exposure and the risk is the same." This is particularly true when longer lead times are in place. At what point does a retailer take ownership of the product? If a company falls into bankruptcy, this question becomes more pertinent than ever.

The challenge to the supplier

The challenges facing suppliers can, of course, vary depending on location and business size, but one recurring theme is that of increasingly long payment terms. A survey last year found many clothing suppliers are waiting 3 to 6 months for bills worth hundreds of thousands of dollars to be paid.

One Turkey-based clothing supplier, who spoke to just-style on the condition of anonymity, notes: The longer the payment terms, the higher the finance costs.

The company, which supplies to over 50 countries, mainly in the European Union (EU), says: "The main challenge is to [meet buyers] face-to-face and have time to discuss the product. Most of the time, the buyers set a price based on the retail price and their target knowledge without any insight into the product and its components.

"And if they have not paid on time, this means we struggle with cash flow. In order not to affect our own supply chain, our finance [team] starts looking for credit."

A Hong Kong-based fashion supplier that recently saw one of its large customers go into administration also spoke to just-style anonymously. He also points to the challenge of increasingly longer payment terms now being negotiated by buyers.

"Payment terms are getting longer: 60-90 days is normal but 120 days is becoming more common. When that becomes normal you're basically funding the business of your customer."

He explains: "Besides the cashflow problems for us as a supply chain management company, when you go down to the factory level and a supplier of fabrics and trims goes bust, and the company in the middle goes bust, the whole chain can collapse. We're stuck in the middle, so we have to pay the factories early but we get paid much later. So there is that extra time in the middle where retailers are cashing in."

He says the issue is being compounded by the fact that suppliers are increasingly being consolidated. "There are more and more suppliers that are hungry for business and when they don't offer the kind of terms a buyer wants or they don't have a very special USP, they find it hard to keep customers."

Securing the right contract

So what type of contracts are being agreed between buyers and suppliers? Guido Schlossmann, president and CEO of Synergies Worldwide Sourcing Co, says it is first of all important to distinguish between pre-shipment and post-shipment risk.

Post-shipment risk

"Customers are asking more and more for open account terms [where the goods are shipped and delivered before payment] even for countries such as Bangladesh," he explains. "What a supplier can do to protect itself from bankruptcy, or even to protect itself when a bankruptcy happens, is to bridge the gap between its cashflow constraints and the open contract by seeking vendor financing."

This is a more favourable alternative to bank financing in terms of flexibility and handling procedures, Schlossmann says.

Vendor financing offers two options: recourse and non-recourse financing. The latter includes export insurance, which means if a customer goes bust, the supplier doesn't have to pay back any advance provided by the financing company.

"The option should be to go for non-recourse financing," Schlossmann recommends. "There are also financing companies that will guide you in purchase order documentation processing that the supplier does directly with the customer."

And Schlossmann says it is imperative to have a clause put into any purchase agreement stipulating retention of title in order to protect a supplier, which answers the question: at what point does a retailer gain ownership of product?

"That means even though you hand over the goods to the customer, you still have rights to the goods unless they are fully paid for. Most suppliers have no idea about this. They are very naive and are taking a big risk."

According to the Hong Kong supplier, buyers that do not give retention of title of the goods, and do not allow suppliers to sell goods made but unpaid, if even when the buyer goes bust, is an archaic arrangement beyond unfair. "It's like forcing your whole supply chain to drown with you when they don't have to (be buried with the emperor like terra cotta warriors or workers mummified with the pharaoh)."

The key to shortening risk, Schlossmann explains, is by offering different delivery terms such as Cost Insurance and Freight (CIF), or by having your own import company.

"If it does come down to insolvency, I strongly recommend being very fast in contacting the administrator and finding out your rights and getting advice from a specialised law firm in insolvency and bankruptcy," he says. "A lot of [suppliers] don't know how to protect themselves in their purchase agreements and they have limited knowledge in terms of law...but it is essential they try all efforts to do so because without a proper law firm representing them, they may lose everything."

Pre-shipment risk
If a retailer goes into bankruptcy and an order is already in production, that order is then under full risk, Schlossmann says. Even if there is non-recourse vendor financing in place, it will not cover pre-shipment.

"There is not much you can do here. It really depends on negotiation power, and the relationship with the customer. Theoretically you could agree payment terms with the customer, which consist of a down-payment of 30-40% on order placement, then the balance either at the time of shipment or after shipment, so at least you can recover the cost of the goods."

In Russia this is common business practice across all industries, yet in Europe retailers usually work on open account terms, Schlossmann explains.

"The only chance a supplier has is to have a letter of credit to secure the pre-shipment risk. But even then it's actually not properly covering the risk process. In some cases you can manipulate a letter of credit and step out of your payment obligation."

Again, Schlossmann says a relationship with the supplier can help; having intelligence about a customer. Also, an agency can often play an important role in guiding suppliers on clauses in their purchase agreements. And in some cases, suppliers affected by an insolvency have been known to join forces to try and reach the best outcome – often a fruitful approach.

"When insolvency happens, it's only a matter of time. You have to act very very quickly in order to secure your rights over the goods. It is really a race against time."

Learning from mistakes

Those suppliers that have been burnt by a customer insolvency and lived to tell the tale are often the ones that now have more stringent protections in place.

The Turkey supplier says it checks the credit scores of its business partners with international ratings companies before agreeing to payment terms. If it sees any risk, the company will then offer secure payment terms such as a letter of credit or other bank insured payment terms.

The Hong Kong supplier, meanwhile, says it was forced to learn from its mistakes when a large customer went into administration earlier this year.

"What we had before was the lowest level credit insurance," he says. "It doesn't cover everything, nor does it pay back everything. The client was able to sell the stock we had supplied to them, which they had not paid for, through a new buyer - a very bad practice in our industry.

"Now we're putting into place more stringent risk management, which is kind of contradicting that we want to get more business at the same time. But when we see something that doesn't sound right, we have to cut, no matter what."

Another way the company is looking to mitigate risk is to focus more on supplying fast fashion; catering for speed-to-market and thereby shortening payment times. "It means there won't be as much in the pipeline but it speeds everything up and it decreases the risk."

The firm is a member of the Better Buying platform, which asks suppliers to rate the performance of apparel retailers and brands with the aim of creating "a race to the top" when it comes to purchasing practices.

Results have already found the length of a relationship between buyers and suppliers has little impact on the nature of buying practices. And while buyers perform well in some areas, improvements are needed in others, such as sourcing and order placement, and planning and forecasting.

The Hong Kong supplier says the platform has the potential to be a powerful tool but believes other initiatives are needed, like a financial tool to help with costings, ensuring retention of title for suppliers, or a forum for suppliers to share strategies or visions. "Guidelines are just guidelines. Even when we play back what happens."

Where do suppliers go from here?

Kurt Salmon's O'Hanlon believes that contrary to the Better Buying survey results, relationships do make a difference.

"There have been situations where suppliers have been in some difficulty and have approached the retailer – and this happens more often than you might think – and said, "We are struggling to meet our banking covenants and we need your help." And the retailer will often look very favourably on that honest conversation.

"There are lots of ways a good supplier and a good buyer can actually have a meaningful conversation, if and when a supplier is in that situation; and those conversations do happen," he says.

Inevitably, if a supplier hasn't invested in the relationship, it risks losing business to another supplier, O'Hanlon explains. With this in mind, he points to the need for a supplier to limit its exposure to risk by not putting all of its eggs in one basket.

"You have to be looking at your retailer base and have a clear view about what you think the health of your customer base looks like. If I'm supplying to BHS, then I want to be sure I have other retailers I'm currently supplying to and I'm limiting my exposure."

There is no doubt the tailspin effect of a retailer bankruptcy can be devastating for business, employees and the companies that supply it. Mitigating financial risk is, therefore, imperative.

There is help for smaller suppliers in the UK after the government said it was consulting on a set of reforms that will give greater protection to staff and small suppliers of insolvent businesses under new plans to crack down on directors and employers behaving irresponsibly. Among its goals are new ways to protect payments to smaller firms in a supply chain that can be hit hardest when large companies become insolvent.