Giving Credit Where Credit Is Due

One of the most uncertain aspects of a manufacturer's business is the extension of credit to retail customers. When the customers are new and unknown and — as is often the case in the gift industry — small, there are definite risks involved in providing merchandise without immediate payment. "Basically, a vendor is extending a retailer an unsecured loan," said James Dempster, CEO of a credit reporting organization called the Manufacturers Credit Cooperative. "Most people outside the credit community don't think of it that way, but … the vendor is extending his or her merchandise to the retailer on the basis of a promise to repay — nothing more than that. There's no security." Thus it is important that manufacturers understand the scope of the risks they face, and arm themselves with information that will minimize those risks.

Painting a portrait of common credit hazards in the gift industry, Dempster described a seasonal pattern. "A retailer has to gear up for the holidays, whether it's going to be a good Christmas or not. There's a great expression: 'You can't sell goods from an empty cart.' " Because of this, he noted, retailers will order a lot of product from manufacturers, merchandising their stores to the hilt. "And then the year doesn't turn out well for them. In January, right after Christmas, they're stuck with a lot of inventory and they don't have much cash and they have a lot of bills to pay. … That's when we see the bankruptcies." Dempster pointed out that January and February are the biggest months for Chapter 7 bankruptcies, or straight liquidations; Chapter 11 bankruptcies, the reorganizations generally favored by large retail chains; and Chapter 13 bankruptcies, reorganizations by individuals. Another seasonal plague that is "very, very common in the gift industry" is the no-asset insolvency. Dempster explained: "They'll just wait until the end of the Christmas season, sometimes have after-Christmas sales, and then just close the store in early January. The mail comes back, the telephone is disconnected. Just gone." In this situation, it is extremely difficult for manufacturers to collect payment for their merchandise.

Another risk is outright credit fraud, which exists at various levels of severity. Some retailers maintain a few manufacturer accounts that they always pay promptly, and then use those clean records when asked to give credit references at shows; thus, even if they are delinquent on most of their accounts, they are able to fool less vigilant manufacturers. Then there are the retailers who commit full-scale fraud, frequently changing the names of their stores, disappearing and reappearing in different locations, obtaining merchandise COD and then paying for it with bad checks.

The credit hazards are greater in the gift and decorative accessories industry, since many stores are small, struggling operations. Even the retailers who are honest and have every intention of paying for their merchandise must contend with a challenging business environment. According to the Small Business Administration, 25 percent of all small businesses fail in their first two years, and 50 percent fail within the first four years. Of those owners whose businesses fail within the first four years, 50 percent admit to having unpaid debts when they close their doors.

The situation is exacerbated by problems in the economy at large. J. Warren Wright, interchange manager of a credit reporting organization called the Gift Associates Interchange Network, pointed out that there were "a ton" of bankruptcies in early 2001 that will affect giftware manufacturers. The end of last year and the beginning of this one saw the bankruptcies of Natural Wonders, HomePlace, and Montgomery Ward, and the announcement of store closings by Sears. And, as the mass merchants go, so go the independent retailers. "When you have a climate where a lot of people are getting laid off, … people get a perception that, 'The economy is getting bad, so let's not spend our dollars frivolously, because we may have to buy essentials,' " Wright said. "So right now, you've got a really tight market in giftware." Dempster agreed: "When the consumer stops spending, it really puts a crimp in retail sales, and especially on what we call discretionary income items." And that which hurts the retailers, hurts the manufacturers.

What can a manufacturer do to guard against all of these credit woes? The key is information: the more you have, the safer you are. Wright's advice to manufacturers: "They have to analyze the credit worthiness of a new customer, they have to get how they pay their bills from their current suppliers. But they have to go a step further. They have to know the location, the region, and the risks that their customers face in their economic locales." He explained: "You really have to know your customer to be able to survive yourself. … If your customer is going to have problems, it's going to hurt you."

This means getting the answers to the following questions. How long has the retailer been in business? How much experience has the retailer had in this industry? What type of business is it: a corporation, a partnership, or a sole proprietorship? Dempster explained that, if partnerships or sole proprietorships fail, the owners are personally liable for their debts to manufacturers. If corporations fail and have no assets left, the manufacturers may be able to get legal judgments that entitle them to payment, but will find it impossible to collect that payment. Another question: How is the retailer paying other vendors, particularly those within the gift industry? What payment terms does the retailer usually obtain — COD, extended terms, etc. — and does he or she comply with those terms? Are there any judgments or liens against the retailer? Where is the store located? Is there good customer traffic in that location? If the store is in a mall, is the mall doing well or having problems? "If the mall has problems, … they're a risk," noted Wright. Is the store attractive and presentable? Manufacturers should also be alert to signs of fraud (see the box "How To Spot Credit Fraud" on page 48.) As Wright said, "It all gets back to knowing the customer."

How does a manufacturer cull all of this information? "You've got to be careful, because there are certain federal statutes that say that you can't ask for credit reports on individual owners without their permission," Wright pointed out. If the new customer in question is a private individual, that means that the manufacturer will have to ask the retailer for information directly. Another option is to turn to colleagues for information. "You've got to build up a relationship in the industry with other credit people," Wright advised. "They're going to be your greatest source of information, because if something is going to happen out there, they may hear rumblings before you do." Another powerful weapon in the search for knowledge is the outside organization that specializes in gathering credit information. Three of these are detailed below.

The Manufacturers Credit Cooperative (MCC) is basically what it sounds like. The organization was founded 23 years ago after a group of exhibitors standing around swapping news at a trade show decided to formalize the information exchange. The group now contains almost 1,500 manufacturers, importers, and craftspeople, who notify MCC of accounts that are more than 60 days past due, bad checks, refused CODs, and other credit problems that they experience with their customers. For an annual fee of $345, the manufacturers obtain information on roughly 20,000 retailers of giftware and home furnishings. MCC sends out detailed monthly reports with information on specific retailers as well as data on overall economic conditions and other situations its manufacturers should be aware of. It also sends out emergency alerts several times a month, informing its members of frauds or of events "with extremely ominous credit connotations to the vendor." MCC also recently launched a Web site, www.mcccredit.com. The site is designed to allow members to get instantaneous and constantly updated credit information by using a password-protected entry system. Dempster summed up the purpose of MCC: "When vendors have had no prior experience with a retailer, they're able to look in the database and get an instantaneous idea of whether their credit is good or not so good or questionable, and then they can decide how they want to structure the sale." MCC, based in Plano, Texas, can be reached at (972) 422-7852.

The Gift Associates Interchange Network (GAIN), which is affiliated with MCC, was founded roughly a decade ago with the goal of creating an information database that contained the shared data from several credit groups. GAIN has approximately 235 members, who use the organization to obtain information on more than a million retailers of gifts, collectibles, stationery, tabletop items, books, and toys. GAIN membership costs $495 a year and requires manufacturers to be very involved: Members must attend a GAIN meeting at least every 18 months to share their credit knowledge, and they must report every month on the status of their retailer accounts. According to Wright, while GAIN members have access to MCC data, they also get some data that MCC members can't, such as GAIN's flash notices and more detailed credit records. GAIN volunteers information on each member's dealings with a particular retailer, including the name of the manufacturer, the date of the first sale, the date of the most recent sale, the largest amount of credit extended to the retailer, the average time it takes the retailer to pay, the total amount owed, and the amount of time the retailer's account has been past due. More information on the Buffalo, New York-based GAIN can be obtained from its Web site, www.gaingroup.com, or by phone at (716) 878-2873.

Manufacturers searching for credit information can also turn to Dun & Bradstreet, an international company that provides a range of credit data and financial services. Jan Rowland, vice president of analytical services, explained that Dun & Bradstreet's database contains information on nearly 2.5 million retailers, roughly a million of whom sell giftware products. By measuring each retailer against its profiles of businesses that practice credit fraud, Dun & Bradstreet assigns higher risk scores to retailers likely to prove troublesome. Again by using its business models, the company assigns credit scores that gauge the likeliness of the retailer paying on time. A third figure is the financial stress score, which determines the likeliness of the retailer closing its doors within the next one or two years. Dun & Bradstreet also reports on the promptness and faithfulness with which the retailer pays non-giftware bills (from utilities, banks, etc.). Lastly, the company provides demographic and trend information. "We include quite a diverse set of information to give us the fullest picture of the business' behavior, in order to make the most accurate decision," Rowland explained. Manufacturers can obtain a single credit report for roughly $25, or subscribe to more sophisticated services (e.g., frequent credit reports, financial consultations, and credit data that can be plugged into the manufacturer's own computer systems) at an annual cost ranging from the low thousands to $100,000. Dun & Bradstreet, headquartered in Murray Hill, New Jersey, can be contacted via its Web site, www.dnb.com, or by phone at (908) 665-5000.

Unless a retailer is practicing credit fraud or in imminent danger of going out of business, a manufacturer doesn't have to reject the retailer's business outright upon discovering negative credit information. Rather, it's a matter of limiting the amount of credit extended, or setting up other methods of payment. "The vendor may ask for payment up front, prepayment, or use of the credit card. We try to help the vendor structure the sale in such a way that it can actually take place — not just turn down credit. We're not trying to do that," Dempster explained. Wright advised manufacturers to minimize their risk, perhaps by asking for 50 percent of the payment on the first order up front. If things progress well with the retailer, the credit terms can be adjusted later on. Rowland summed things up: "It could be that you don't want to turn any customers away, but if you understand the risk profile of a particular customer, you can set your relationship and your terms accordingly, so you can ensure that you'll be profitable for each of your customers."

• Retailer names, addresses, credit references, or other data that are the same as those of previous offenders (If you've been victimized before, fraudulent operators may view you as a target.)
• A business name that is confusingly similar to that of another successful local or national business
• A business name that sounds prestigious (e.g., "American," "National," "Universal")
• Retailers who are unfamiliar to your sales representative for the territory (Have your rep visit the retailer and examine the store.)
• Retailers who are reluctant to submit financial statements, or who submit statements from another country
• Information on the credit application that cannot be verified
• Credit references that are unfamiliar to you and not known within the industry
• Credit reference addresses that have suite numbers (They may be residences.) Similarly, credit reference telephone numbers that lead you to an answering service (Phones answered with only the digits of the number are often answering services.)
• Credit references who give an immediate good report over the phone, without taking the time to check any records
• The planned overbuy, consisting of a medium to large order received immediately after a trade show
• Orders placed by out-of-state companies
• Orders for merchandise that seems unrelated to the retailer's line of business
• Orders from unfamiliar customers marked "immediate" or "rush" delivery, or requests that are unusually demanding
• The refusal of the lead carton in a multiple-carton shipment tagged with only one COD tag (Always put a COD tag on each carton.)
• Inordinate complaints about returns, shipping, prices, and quality (Fraudulent operators use these as excuses to delay payment.)
• Reorders sent more frequently than your average reorder, or reorders sent before the previous invoice to that retailer is paid