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The Toys “R” Us Bankruptcy Tragedy and the 5 Lessons Suppliers Must Learn to Protect Their Revenue

Toys “R” Us, the long-venerated toy store so ubiquitous with Christmas and children’s birthdays, is now in the midst of what appears to be its final death throes; a nationwide liquidation sale as part of its Chapter 7 bankruptcy proceedings.  Although bargain hunters may not find rock bottom prices typically associated with liquidation sales (many prices have only been cut by 10 or 20 percent), the merchandise must still go – one way or another.  While Toys “R” Us executives are determined to liquidate the merchandise, one group not thrilled about the move is suppliers who provided merchandise and services to the retailer but have not yet been paid.

As indicated in our 2017 Perceptions Study, the most important issue with suppliers, when an invoice has been submitted to customers, is prompt payment.  Ninety percent of respondents to our study identified this as critical.  Suppliers are furious with Toys “R” Us and the bankruptcy judge for not requiring the retailer to either pay suppliers for their merchandise or return the merchandise.  Rather than return it, Toys “R” Us has chosen to use that merchandise as part of its liquidation sale while suppliers stand by empty handed.  To compound the issue for suppliers, the bankruptcy judge has also approved bonuses to Toys “R” Us executives upwards of $14 million.

Recipe for disaster

How did the Toys “R” Us operation become such a mess?  The beginning of the end started with the $6.6 billion leveraged buyout of Toys “R” Us in 2005 by KKR Group, Bain Capital and Vornado Realty Trust.  The significant debt, coupled with increased competition from the likes of Amazon and Walmart, was too much for the retailer to overcome.  Servicing the debt kept Toys “R” Us from investing in new e-commerce initiatives as well as other strategies that would have allowed it to compete more effectively in an evolving marketplace.

When bankruptcy plans were announced in September of last year, the plan was to use Chapter 11 bankruptcy protection to allow the retailer to restructure and eventually reemerge healthier after the traditionally robust holiday season.  With end-of-year sales significantly less than anticipated, the Toys “R” Us bankruptcy was converted to Chapter 7, in line with a new, going out of business strategy.

What are suppliers to do?

Suppliers who have not been paid and are out a significant amount of inventory and revenue must now find a way to stabilize their balance sheets.  Lego, for example, has claimed the retailer owes it up to $30 million, MGA Entertainment indicated they are owed $21 million and Playmobile says the retailer owes it $500,000.  There are ways some suppliers can receive their merchandise back, but the details are a bit murky and center around whether orders were shipped together or separately.  Larger suppliers with healthier balance sheets may be able to weather the storm better than smaller organizations who rely mostly on Toys “R” Us and the holiday season to make their year.  The fact remains that many suppliers are swimming in the wake of the Toys “R” Us bankruptcy and may not survive.

Chapter 7 bankruptcy is sometimes an ugly fact of life in a free market economy and laws surrounding this particular form of bankruptcy provides some protection to the company that files.  One such protection is a stay or an Order of Relief, meaning all efforts to collect outstanding debts by creditors must cease.  In the case of Toys “R” Us, suppliers don’t have much recourse and the unfortunate lesson to be learned for suppliers is to ensure they have strategies in place to mitigate the damage when customers go out of business.

Following are 5 strategies supplier organizations should consider before a valued customer, like Toys “R” Us, declares Chapter 7 bankruptcy.

1. Diversify Your Customer Portfolio

This may sound like common sense, but this strategy is often easier said than done.  When times are good, suppliers often ride the wave of increased revenue by providing goods and services to their loyal and trustworthy customers with little regard to what may happen a year or two down the road.  Because the economic climate can be unpredictable, it’s important for suppliers to operate their organizations with the assumption that all revenue is at risk.  That means continually working to diversity your customer portfolio; securing new customers that are different in terms of size, scope and location (expanding into international markets can often be an effective hedge against domestic economic uncertainty).  If an unhealthy customer hits a rough patch, healthy customers can help make up the shortfall and allow the supplier to weather the storm.

2. Develop and Implement a Written Credit Policy

Developing a credit policy should be a common-sense strategy a savvy company practices to better manage the risk it assumes when extending payment terms to its customers.  The 2017 Perceptions Study indicates that only 69 percent of respondents have a written credit policy, illustrating that some organizations still have not done all they can to mitigate threats to their revenue.  Credit rating information for most customers is readily available and should be used to help determine criteria around extending credit terms.   Furthermore, a written credit policy can be very general or very customized; it really depends on the company extending the terms. Although, every credit policy serves the same goal (i.e. to safeguard a company’s receivables in a fair and consistent manner), they can still differ from organization to organization in both length and content.  The reason why the content of the policy differs can be due to many factors such as a company’s cash flow, profit margin, how competitive the market or industry is, company location, customer locations, production needs or the size of the company.

3. Use Credit Groups

There are local, regional and national industry credit groups designed to help supplier organizations exchange information when identifying potential customers.  Such information proves helpful when assessing potential risk and extending payment terms in line with a company’s payment history.  Industries with robust credit groups include printing, building and construction, drug and pharmaceutical, HVAC and Plumbing, Landscaping, wine and spirits and more.  The National Association of Credit Management is a good place to start when investigating the benefits of credit groups.

4. Consider implementing a COD Policy

It may be a challenge for suppliers, and wholesalers, to implement a cash on delivery policy for strategically-important customers the size of Toys “R” Us.  If the customer is financially healthy, they will likely have enough clout to negotiate 30 or 60-day terms and avoid a COD relationship.  Smaller customers may not have that negotiating power and therefore may be more open to such an engagement.  Critical for the supplier is being able to determine the financial health of the customer and being savvy enough to protect inventory and revenue by implementing needed safeguards.  As stated earlier, having a written credit policy and leveraging publicly available credit rating information can go a long way in avoiding unneeded financial turmoil.

5. Consider Invoice Financing Options

Receiving payment early on outstanding invoices, via customer-driven solutions like supply chain financing or third-party solutions such as factoring, does not prohibit outstanding payments from being frozen by a bankruptcy court.  Invoice financing is not a cure-all, but it can help to protect some receivables prior to a bankruptcy filing if some of those outstanding payments have been made early.

Unfortunately, once a customer enters Chapter 7 bankruptcy protection, there is little a supplier can do to recoup the revenue associated with those outstanding invoices.  The Toys “R” Us story should be a cautionary tale for any supplier and a clear reminder that steps must be taken to ensure receivables are protected and revenue derives from healthy, reliable customers.

Ernie Martin is Founder and Managing Director of Receivable Savvy. He brings over 25 years of experience in financial supply chain management, marketing and communications and draws upon his extensive experience to share knowledge and best practices with AR professionals. He currently chairs the Vendor Forum of the Federal Reserve Bank of Minneapolis and his resume includes time at several well-known brands and companies such as Tungsten Network, Delta Airlines, CIGNA Healthcare and Georgia Pacific as well as a number of years as an independent consultant.

 

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