NEW YORK — As consolidation continues to sweep the retail landscape, vendors are becoming increasingly concerned about getting caught in a chargebacks squeeze. And they’re beginning to fight back.
Vendors are taking a tougher stance over chargebacks, even as their concerns mount, that the mergers of groups such as Federated Department Stores Inc. and May Department Stores Co., and Sears, Roebuck and Co. and Kmart Holding Corp. could result in increased pressure from retailers on margins as the two retail giants gain unprecedented power in their respective sectors. Meanwhile, the industry is eyeing whether a Securities and Exchange Commission probe into Saks Inc.’s accounting methods and its improper collections of vendor markdowns a few years ago could spread to other retailers.
“This [the Saks probe] could open a whole area of exploration at other retailers,” said Michael Appel, managing director of Quest Turnaround Advisors. “There are two pieces — retailers using their leverage over vendors to take chargebacks they may not be entitled to, and whether that can be construed as being anticompetitive.”
Appel and other executives said smaller retailers are at a competitive disadvantage because they don’t have as much clout over vendors to demand allowances.
“I would be surprised if [the SEC] does not look beyond Saks because Saks is not the only store that vendors are complaining about,” said Emanuel Weintraub, chief executive officer of Emanuel Weintraub Associates management consultants.
“Potentially, it could be a big problem. Saks is taking the brunt of it,” said one former retail ceo, who said it wouldn’t be unheard of for a buyer or merchandise manager at a big retailer to threaten to cut off a vendor that doesn’t play ball with markdown money.
According to Allan Ellinger, a principal at Marketing Management Group, the chargebacks scenario has cost the vendor side of the industry “billions [of dollars] over the last 15 years.” The consultant believes the problem has “worsened as business has gotten harder.”
He observed, “What used to be an issue for branded apparel vendors is now also a problem for private label vendors. As department store executives move into different tiers of distribution, they take the bad habits with them. Every retailer today, with the possible exception of Wal-Mart, is putting enormous pressure on the vendor structure.”
One change from a few years ago is that many vendors now are starting to stand up to their customers.
“My clients are starting to get more aggressive in their negotiating stance. They are not willing to be patsies anymore. They are starting to look at ways to minimize their exposure, and some are taking the stance that they don’t mind losing the account because they feel that, at the end of the day, they may lose the account anyway,” Ellinger said.
He believes the Saks Fifth Avenue disclosures are “simply the tip of the iceberg. SFA is very small as a department store organization in the scheme of things, compared with other bigger retailers.” In his view, the audit committees of larger department store chains should be looking at their methods of dealing with chargebacks and ensuring their procedures are in order.
But what began as an internal Saks investigation into vendor markdowns at SFA has since broadened to cover wider issues concerning accounting controls at both SFA and Saks Inc., according to an April 14 Saks Inc. filing with the SEC. In it, Saks says: “Controls over the selection and application of its accounting policies related to leasehold improvements and tenant allowances and purchase discounts received from vendors were, as of Jan. 29, 2005, ineffective to ensure that such transactions were recorded in accordance with accounting principles generally accepted in the U.S.”
Saks also said that, due to the deficient controls, misstatements in property and equipment, deferred rent liabilities, rent expense, depreciation expense, cost of goods sold and inventory were not identified. Dale Bridges, a Saks Inc. controller, and Don Wattrow, a Saks Fifth Avenue executive vice president of administration, have been put on leave. It’s not determined yet if any personnel at Saks Inc. or its SFA division will be charged or fined for any wrongdoings. The SEC won’t provide any details about its investigation.
The deficiencies mean Saks Inc. must restate financial results back to 2002, delay its 2004 10-K report and postpone its annual shareholders meeting until it completes its probe and institutes proper controls. Filing delays puts Saks in violation of certain loan covenants, though Saks is seeking waivers. Without them, the company’s liquidity could be affected and vendors might seek tougher credit terms.
Speculating on what could be a concern for retailers, one consultant said, “It’s an issue of timing and when people record certain accounting transactions. The retailer is entitled to markdown money, the vendor disagrees, but [the retailer] books it as a credit and it flows down to the earnings to pump them up for the season.”
The retailer covers the difference by paying the vendor less on the next season’s shipment. New government rules of full disclosure require that markdown money has to be taken and charged to the vendor in the year the retailer bought the merchandise.
Without citing Saks, market sources said vendors historically have been subjected to an onslaught of chargebacks from retailers. Typically, retailers have stringent regulations on how merchandise should be received to speed the flow to the floor, but chargebacks have become profit centers at some retailers. Vendors have been penalized for purported shipping delays or packaging mistakes, charged full shipping costs instead of cheaper bulk rates and inflicted with administrative costs for producing ads, having the wrong hangers, mixing the pinks with the blues and sometimes just for shipping “inferior goods.” Retailers and vendors also sometimes fight over how merchandise is displayed. Markdowns are sometimes disputed, but electronic systems can reduce discrepancies.
Much of the bickering stems from financial pressures that trickle down from the senior ranks each season. “Buyers have a lot of pressure. They’re told, ‘Find more money, find more money,’” said one former luxury store executive. They often find it by obtaining markdown money from vendors. “Every season, there is a request for money. It’s referred to as a tin cup,” said one source.
While the Saks problems in the markdown area reportedly stem from the bridge market, retail sources said other areas, such as moderate and better-priced apparel, also have a lot of markdown money negotiations occurring after the season. Saks has agreed to pay back, or otherwise compensate, certain resources, including Onward Kashiyama USA, a total of $21.5 million due to the improper collection of markdown allowances. Vendor lawsuits are rare because they don’t want to jeopardize their business relationships with stores. Onward Kashiyama sued Saks for $9,275,643 for “substantial deductions and credits which were not allowed under the terms of the agreement,” according to legal papers. The vendor no longer supplies Saks.
Saks Inc. has said a majority of the improper collections occurred during the company’s 2000, 2001 and 2002 fiscal years and a lesser amount occurred during the 1999 and 2003 fiscal years. None occurred in 2004.
Victor Wahba, director of the apparel group and partner in charge of the New York office of accounting firm Weiser LLP, believes the disclosure by Saks regarding its chargebacks problem could bring some positive changes to the retail sector.
“I think you’ll see that the definition of chargebacks will be much clearer, and hopefully, retailers will become more transparent about their policies….While I think retailers will be forced to look at their systems and how they process their deduction information, I do not believe it will put them in a gun-shy mood, where they will become more inclined not to ask for the deductions,” Wahba predicted.
Andrew Jassin, a principal at The Jassin-O’Rourke Group, disclosed that there have been rumblings in the marketplace about possible class-action lawsuits over the issue of chargebacks against any number of retailers. His firm has been hired as an expert consultant on the issue by a group exploring its options on how to deal with the problem, and his firm is in the “process of looking for individuals and companies that have been put into jeopardy because of retailer chargebacks.”
Jeffrey Knopman, president of Profit Solutions Group Inc., a chargebacks recovery firm, said, “Retailers have not stepped up and acted like responsible citizens in the true sense of the word. Retailers proclaim that the vendors are trading partners, but that partnership seems to be unilateral in the favor of the retailer, not bilateral.”
Knopman noted the financial pressures on firms are significant. “When a firm projects X amount and then only nets Y amount after the chargeback, the vendor’s bank sees a shortfall and then decides it can’t lend the full amount that the vendor was expecting. Maybe the vendor now gets only 75 cents on the dollar instead of 95 cents. That’s a huge financial burden. Where does the vendor come up with the money to make up the difference?” Knopman said.
Jane Hali, senior vice president of Ampersand Consulting, a division of Here & There Fashion Services, was a buyer in the Seventies and Eighties. She pointed out, “Retail is a co-effort on the part of vendor and retailer….The problem is really one of forecasting the rest of the season. Buyers have to forecast what the margin will be, and they have to do it before the end of the season to make sure the season ends on a certain percentage. It sometimes gets messy because you are forecasting the [end result] while the [selling period] is still ongoing.”
However, there are things that vendors can do to protect themselves.
Donald Kreindler, an attorney at Phillips Nizer, said he has many clients who are impacted by what he characterized as retailers’ “excessive” demands for assistance from their vendors, whether it’s called markdown money, chargebacks or some allowance.
“It is very hard to know the percentage, but it’s very substantial. I’ve heard of markdowns charged by one or more retailers by as much as 35 percent of the wholesale sales price of the goods, and even more than that,” the attorney said.
He added it can be hard for vendors confronted by retailers to fight back, since many manufacturers fear that, if they don’t agree, then the retailer won’t bother to order from them the following season.
He counsels clients to keep good records of all orders. “Clients who have good documentation and can respond promptly when claims of chargebacks are made are in a stronger negotiating position and tend to have greater success in negotiating a favorable, or at least fair, settlement with the retailer,” the attorney said.