Terms Pushback Strategy Gets Political: Is the White House Now Protecting Suppliers from Customers’ Unilaterally-Imposed Extended Terms?

A payment trend affecting credit teams across all industries is a customers use of the formal terms pushback strategy (TPS), in which a customer disregards its supplier-set trade terms and extends these terms to better fit its working capital and cash flow needs. Customers may characterize the TPS as supply chain management. Given that the small supplier has little negotiating leverage where an indispensable customer adopts a TPS, the White House has stepped in to try and protect the small supplier in the private sector from the downside of a TPS rollout by introducing the SupplierPay program. This voluntary program encourages companies to reduce their credit terms with small suppliers or to offer their small suppliers alternative financing arrangements (such as structured finance). This article considers the general TPS trend, how TPS affects a suppliers bottom line and what the SupplierPay program means for suppliers.

The Motivation for Extending Terms

The significance of trade credit in supplementing a customers working capital is self-evident. Absent trade credit, a customer faces a cash flow drain as they pay suppliers for their goods and services in advance of the customer's sale of the finished product or service to the end user. To ease the cash constraints that come with cash-in-advance (CIA) purchases, the customer may seek bank financing, but this form of financing significantly adds to the customer's operating expense.

When a supplier sells on credit instead of CIA, the customer is granted additional time to pay the supplier after receiving the goods or services. If credit terms are long enough, the customer may match its payment obligation with the supplier to the sale of its own goods or services, thus resulting in positive cash flow. Customers have discovered, however, that their cash flow improves and their working capital increases dramatically in many instances by pushing suppliers from normal to extended terms.

Has TPS Become a Best Practice for the Large Customer?

Private US companies report a 14.3 day increase in their average accounts receivable days (37.5-51.8 days) from 2012 to 2013. From the customer's point of view, TPS is attractive as it allows the customer to increase its liquidity by reducing cash tied up with its suppliers as well as reducing its reliance on more expensive bank financing. Trade credit is an interest-free loan for customers.

The Small Supplier as an Involuntary Working Capital Lender

Large companies appreciate that smaller suppliers likely need their business more than they need the small supplier. This leverage in the trade relationship allows large customers to unilaterally dictate credit terms to their suppliers. Proctor 8c Gamble Co., for example, extended supplier payment terms across its entire supply base from 45 days to 75 days, while Anheuser-Busch InBev pushed its days payable outstanding (DPO) from 30 days to 120 days.

Where a larger supplier (less reliant on the customer's business) could more effectively rebuff the TPS, smaller suppliers are often unwilling to lose such a large and reliable revenue stream and comply with it. But as a supplier's days sales outstanding (DSO) grows, so do the gaps in a supplier's cash flow. With the extended terms, the small suppliers may have difficulty purchasing inventory or meeting payroll. If the gaps in cash flow grow too wide to support operations, a supplier may be forced to borrow even larger amounts from third party sources at costly rates. There is a dramatic difference with the cost of capital, or borrowing costs, between the large supplier and the small supplier. The large supplier commonly has access to financing at about 3%, while the small supplier may have interest rate up to 20%. The President's SupplierPay proposal is based on improving a supplier's cash flow through shorter credit terms from sidebarkey customers allowing the small supplier to hire more workers thereby improving the US economy.

White House Strategy Encourages Private Companies to Return Small Suppliers from Extended Terms to Normal Terms

SupplierPay: What is It?

In July 2014, President Obama announced the rollout of SupplierPay, a voluntary program that asks larger companies to pledge to either pay their small business suppliers on reduced credit terms, or offer financing alternatives, such as structured finance (without extending terms as part of the financing arrangement). The goals of the program are to improve a small supplier's cash flow and working capital, thus helping suppliers avoid borrowing money to account for TPS, and to strengthen large customers' supply chains.

SupplierPay is the private sector follow-up to the previous White House-Small Business Administraion (SBA) joint venture, QuickPay, which required federal agencies to pay their small business contractors within 15 days. Since its inception in 2011, the White House and SBA estimate that QuickPay has expedited over $220 billion in payments to federal contractors, and saved small businesses over $1 billion.1 In addition to announcing the initiation of SupplierPay, President Obama also announced another renewal of QuickPay.

What Can a Small Supplier Expect from a Customer Participating in the SupplierPay Program?

Unlike QuickPay, SupplierPay is completely voluntary and does not provide a DSO hard cap or any firm standards for alternative financing. Instead, those companies that sign onto the program pledge to either reduce their DPO with small suppliers, or offer those suppliers some form of financing that will reduce the suppliers' cost of working capital. In other words, the DSO reduction or the reduced-cost working capital offered by the pledging companies will be relative to the parties' course of dealings/financing arrangements prior to adoption of SupplierPay. One of the primary criticisms of the programs is that the pledges vague language may be used by some participating companies to offer marginal DPO reductions in exchange for a boost in brand perception.

Will Companies Voluntarily Participate in SupplierPay?

Some in Congress criticize the program, contending that the federal government should not attempt to control credit terms for private companies, but many companies, including the following, have taken the SupplierPay pledge to pay their suppliers in a more-timely fashion:

* Apple

. AT&T

* Authentix

* Cardinal Health

* Coca Cola

* CVS

* Ericsson

* FedEx

* IBM

* Honda

* Intuit

* Johnson & Johnson

* Kelly Services

* Locheed Martin

* Milliken

* Molina Healthcare

* Nissan

* Opus Events Agency

* Philips

* PG&E

* Rolls Royce

* Rothschild North America

* Salesforce.com

* Textura Corp

* Toyota

* Walgreens

* Westinghouse

Keeping the Customer within Terms: Moving from an Accomodative Response to Qualifying for the SupplierPay Program

Possible credit team responses to a TPS and the competition within their sales niche can be found in a previous Business Credit article.2 While suppliers holding the leverage in the trade relationship may take a punitive response to keep their TPS-requesting customer within normal terms (credit hold or customer divorce), those suppliers who lack the leverage must settle for an accommodative approach that incentivizes the customer to keep its payments within terms, including:

* Cannot single out terms

* Robinson-Patman defense

* Contract controls

* Loan covenants

* Credit insurance

* Two price lists

* Early-pay discount

* Annual volume rebate

* Credit cards

These accommodative approaches are often ineffective where the customer unilaterally rolls out a TPS across its supplier base. Given that a number of major companies have taken the pledge, qualifying as a small supplier under the SupplierPay program may be an alternative response to a customers TPS.

Who Qualifies? Profile of the Supplier and the Customer

The Supplier

The SupplierPay program is intended to protect the small supplier. But what is the definition of a small supplier? The SupplierPay program pledge does not define "small supplier," but defers to the participating company. The program provides: "We [the pledging customer] will define 'small supplier,' and if we choose to offer these solutions to the entire supply chain we will continue to focus our efforts on the small suppliers that will benefit most."

Under the QuickPay program, small business contractors were determined according to the SB As Small Business Size Standards. The SBA defines a small business as one that is independently owned and operated, and is not dominant in its field. Depending on the industry, size standard eligibility is based on the average number of employees for the preceding 12 months or on sales volume averaged over a three-year period. For complete SBA sizing standards, go to http://www.sba.gov/ content/small-business-size-regulations.

Large suppliers may qualify under a customer's SupplierPay program despite exceeding the standards, but pledging companies are not obligated to offer the reduced terms or financing to suppliers who actually do qualify under the standards. Suppliers and customers alike may turn to the standards for guidance, but suppliers should appreciate that each pledging company presents a unique qualification process.

The Customer

SupplierPay is focused on those customers that are larger than the SBA-standard for small businesses in their industry and that have rolled out a formal TPS to improve their supply chain management, as opposed to customers that have pursued an informal TPS on account of liquidity constraints and lack of financing. Given the voluntary nature of SupplierPay, what's in it for the company? One commentator notes that companies can promote to the world that they are committed to a healthy supply chain for the small suppliers.

SupplierPay as a Response to Customer TPS

The TPS is the "new normal" with trade relationships, but the credit team's mission is to keep the customer on normal terms as opposed to extended terms. The SupplierPay program may help the credit team achieve this objective. 1

Given that the small supplier has little negotiating leverage where an indispensable customer adopts a TPS, the White House has stepped in to try and protect the small supplier in the private sector from the downsides of a TPS rollout by introducing the SupplierPay program.

The TPS Trend

There is a dramatic difference with the cost of capital, or borrowing costs, between the large supplier and the small supplier. The large supplier commonly has access to financing at about 3%, while the small supplier may have interest rate up to 20%.

1. Hudson, David. "SupplierPay and QuickPay: Strengthening Americas Small Businesses." The White House (July 11,2014).

2. See Blakeley, Scott. "What's Your Team's DNA, Accommodative or Punitive? How to Rebuff the Terms Pushback Strategy." NACM Business Credit Magazine (February 2014).

SCOTT BLAKELEY, ESQ.

Scott Blakeley is a principal with Blakeley & Blakeley LLP, where he practices creditors' rights and bankruptcy. His email is [email protected].

Scott, a recent presenter of the session "Customers Unilaterally Extending Credit Terms" at this year's Credit Congress and the webinar "Commercial Credit Scoring Models: Pros, Cons and Legal Considerations," is a regular contributor to NACM education programming. To see what he and our other experts are presenting in the future, visit www.nacm.org/event-calendar.