Dealer credit squeeze – why it's happening and what's to be done
The average IT distributor selling product at a consistent 5% margin require additional sales of £1,000,000 to break-even for every bad debt of £50,000. This is why credit insurance is so prevalent within distribution.
The IT sector is characterized by short product cycles, consistently high failure rates, and reductions in price and product margins. So credit insurance provides the assurance of payment, subject to the policy conditions. In the past, distributors have also used credit insurance actively to grow business while minimising risk.
The channel has always been a finance-hungry sector and distributors have actively employed credit insurance as a tool to fast-track credit. They have used information and satisfactory trading history to increase credit availability to their customers within their policy's discretionary limit (the level to which they can trade under certain criteria prior to gaining direct approval from the credit insurer).
This has enabled flexible growth and provided much needed finance for the channel; indeed trade credit undoubtedly remains the largest single element of finance in the channel.
Realistically, the risk from bad debt therefore lies more with the insurers than the distributors. Losses from bad debt principally end up on the credit insurers books and they often pay 85-95% of the value.
The amount of risk underwritten within distribution continues to be predominantly with Euler Trade Indemnity (ETI) with estimates ranging from 60%-70% of the insured business transacted.
To put this into context the Office of Fair Trading considers a 40% threshold as the normal indicator of market dominance and as a result they concluded that Dixons does not dominate the home PC market as its share is below this level. In this context it would suggest that ETI are twice as powerful in this market than PC World are on the high street.
Where credit's due
Other insurers including Gerling Namur, Coface, NCM, Amlin, Hiscox and Royal Sun Alliance make up the remaining 30%-40% but it is also worth noting that there are some distributors who do not use credit insurance at all, but these are very much in the minority.
As a result much has been made of credit insurers’ actions and the issues relating to credit availability/ capacity (the total amount of credit available to a company via an insurer).
But these issues are not new and neither are they affecting the whole of the channel in quite the same way. Yes, there are probably tighter constraints on the channel as a whole - but system builders and retailers have been hit much harder than other types of reseller.
This should come as no surprise, given market concerns over consumer and corporate spending and confidence, price reductions, margin erosion and intense competition.
Under these circumstances, any move by a credit insurer, in particular ETI because of its market position, to reduce the level of its exposure to these businesses can potentially have a serious impact on the company.
In a number of situations there have been those who have blamed insurers, not only ETI, for causing businesses to fail through their actions - a self fulfilling prophecy if you will. Removal of insured limits will automatically impact the ability of the business to trade and removes any leverage the distributor has to gain payment.
Why should I pay you first when I can't continue to trade with you on a credit basis? Plus the result ends up being claims made on the insurance policy if it precipitates failure.
Subsequently it is more effective if these reductions are controlled and credit availability/capacity is trimmed rather than slashed.
This may take the form of reducing credit limits available to the level of actual trading experience or an active reduction in limits for smaller suppliers and as a result can reduce an insurers exposure very noticeably and hence the squeezing effect on the business itself. (cont'd)
Less Credit/More Squeeze
Brian Burke is a manager at Dun & Bradstreet's Computer and Communications Market Intelligence Centre.
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