Even though the technology sector seems to be recovering from the dramatic slump, which has dogged it for the past five years, questions are being raised about the methods by which vendors are driving growth in their sales while desperately trying to boost revenue.
But does the mentality of attaining impressive sales figures at all cost give a true reflection of the buoyancy of the market place? Maybe not. A number of vendors still use somewhat artificial means of propping up their sales ledger.
Come the end of each quarter they try to move as much stock into the distribution channel as possible to artificially increase their top-line sales. The practice, while becoming increasingly looked down upon within the industry, still happens on a regular basis as unwanted products are forced onto distributors filling warehouses and collecting dust, while the vendor counts those shipments as sales
“Towards the end of every quarter we definitely feel the pressure form some of the vendors we work with,” said Justin Owens, director, Commtech Distribution. “They will be pushing for numbers come the end of the quarter and they basically want to ship as much kit as possible.”
This practice is known as a “sales-in” model and accountancy bodies and the Securities and Exchange Commission (SEC) have major problems with this as little or no money changes hands.
Above board
An increasing number of vendors are moving to the more transparent and above board model of “sales-out”. This is where money actually changes hands as the shipments have been ordered by a customer and move to a third party rather than directly into a warehouse where they are stored indefinitely. This is also known as a “sell through” basis.
However, vendors stuffing channels with unwanted kit is still a prevalent practice.
“While some of the vendors we work with only recognise a sales-out model, there are still a number who work on a sales-in basis,” said Owens. “They will constantly be looking for big orders come the end of quarter. The quid pro quo for us is that we get discounts on the kit for taking the orders.”
Such discounts can help ease the worry of having stock cramming warehouses but it can be a risky business.
“Before we buy we work out how much kit we are going to move over the quarter to maximise our discounts,” said Owens. “The thing you have to watch is currency movements as these can potentially wipe out any of the discounts you have banked on achieving.
“If we don’t move kit in time we can get credit extensions from the vendor but the issue is that if you don’t move kit into the following quarter you have to pay for it. This can have a negative impact on cash flow.”
Owens is no fan of the sales-in model and would rather all vendors ditch it making the channel and sales more transparent.
“The sales-in model catches up on distributors eventually,” he said. “It is obviously a good thing when it comes to getting additional discounts. But we are always being put under pressure to sell more kit. And if you can’t sell it, it doesn’t matter how cheap it is.”
The practice places intense pressure on the channel and can even put distributors at risk.
“I’m sure it is a concern for everyone It can really be a self-fulfilling prophecy. If it is only sitting in a warehouse it is eventually going to catch up with you. You are really fooling nobody. At the end of the day it has to be sold. It is easy to handle sales in if you are doing good sales every quarter but when it goes flat that is when you can get into trouble. When you have a warehouse full of the stuff you are just hoping that people don’t stop buying it. The sales-out model just makes more sense.”
Goal pressure
But the pressure achieve goals means that many vendors are reluctant to move away from flooding channel with product to help boost figures.
“I was talking to one of the directors in the UK who was saying the pressure from the States is huge at the end of each quarter,” said Owens. “Some of our vendors are changing to a sales out model. This is because many of their products are over distributed. But we have been lucky because our sales are based 50 per cent on hardware and 50 per cent on software licences, which obviously requires no storage. We typically haven’t ended up with lots of unsold kit.”
However, companies have begun to receive bad press and court actions for their channel stuffing exploits. Network Associates, for example, has had its channel-stuffing problems. Since 2001, the company has counted sales toward revenue on a sell-through basis, instead of a sales-in basis.
But prior to that, things were not so transparent. Clear One Communications, a global provider of videoconferencing equipment, has also changed the way it recognises revenue and engages distributors. But it has suffered the humiliation of a SEC investigation into the company’s sales practices.
In past years, Apple, Compaq, Novell and Palm have also dabbled in such practices.
“I think logically enough as vendors move through the quarter the pressure in terms of achieving targets increases,” said Martin Cullen, head of personal systems group, HP. “But I would suggest that the model of stocking up the channel at the end of the quarter is something that vendors are moving away from because you will always pay for it in the end. It is not a very secure business model. In effect what we are doing is taking a systematic approach where we are focusing as much as selling out as we are selling into the channel. Rather than rack and stack it we are now using much a more sustained approach to selling through the channel.”
Market downturn?
However, with a significant number of vendors using the sales-in model the worry is that any downturn in the market could leave both vendor and distributor exposed. This could become a problem sooner rather than later as concerns are growing about prospects for 2006.
Forrester Research reported early this month that CIO confidence has dipped in the US to the lowest level since the first quarter of 2004, which the research firm warns could translate into IT spending cuts. While 78 per cent of CIOs said they are increasing spending in 2005 over last year, the number is dropping to 64 per cent in 2006.
And as before the US economy calls the tune, especially in the IT sector. Should a downturn occur next year, the industry will need to be in good shape if it is not to slump back into the depression of the past number of years. The worry is that is the figures currently propping up the sector aren’t all what they appear and kit that has been counted as “sold” is just simply lying in storage there could be causalities.
But regardless of whether a downturn awaits the channel in 2006 it is about time vendors cleaned up their act across the board and stopped exposing the sector to such risky business.
The US economy calls the tune, especially in the IT sector. Should a downturn occur next year, the industry will need to be in good shape if it is not to slump back into the depression of the past number of years.
Stuffing the channel facts
When a company stuffs the channel, it is basically filling its distribution channels with more product than is needed. Since companies often record sales as soon as they ship products, channel stuffing can make it appear that business is booming. This is called a “sales-in” model. However, the reality of this is that the products not sold may well be returned to the manufacturer eventually. This means sales claimed may never actually occur and therefore the figures are unreliable using the sales-in model.
However, if you know how to analyse financial statements, you can determine whether a company is stuffing the channel by seeing if its accounts receivable growth is outpacing sales growth. Alternatively, calculate “days sales outstanding” (DSO). First, divide the last four quarter’s revenues by 365. Then divide accounts receivable by that number. This reveals how many day’s worth of sales the current accounts receivable represents. Between 30 and 45 days is typical. You can also follow the same process for the last quarter, dividing last quarter’s revenues by 91.25 (days in a quarter, on average).
A company with a low DSO is getting its cash back quicker and, ideally, putting it immediately to use, getting an edge on the competition. Rising numbers can signify channel stuffing.
Subscribers 0
Fans 0
Followers 0
Followers