As the Tesco profit-overstatement issue builds, it is inevitable that, in the coming months, most advance bookings of supplier investment will be challenged because of the degree of judgement involved and the resulting scope for interpretation in accounting for retail businesses…

The FT explains why auditing retailer accounts that are based on high-volume, low-value transactions can be very complex, resulting in auditors’ tendencies to focus instead on the systems, controls and processes involved. The article also adds some gems re the audit-techniques used such as examining a sample of agreements between supplier and retailer for accuracy, and that they may even contact the supplier for validation in some cases.

Hence there is a need for robust procedures in proposing, implementing and measuring the results of all trade investment, especially in unprecedented times.

This retrospective analysis of all commercial income, combined with the presence of their legal advisers and potential shareholder class-action moves by shareholders in the US, has to present a challenge re the purpose, scope and increasing clarification of the all trade investment monies paid by suppliers.

These monies should include:
- Rental of space
- Price support
- Promo support
- Over-riders
- % split between commercial income and operating profit/sales
- And more… (think shopper marketing, for starters)

It is inevitable that commercial income and its impact on profit forecasts will be the subject of increasing press coverage in the coming months, especially as other major retailers feel the need to reassess and explain how their procedures differ…

Big space – asset or liability?
In the meantime, shopper scientist Herb Sorensen, in his shopper-density mapping of retail stores, questions retailers’ use of large space. In fact, he makes a point that retailers needlessly tie up capital in real estate and inventory, thereby putting pressure on their ability to generate adequate levels of Return On Capital Employed.

Given that stores represent a high proportion of capital tie-up in retail, especially in the UK’s expensive real estate market, it follows that UK retailers are forced to focus on the Return side of the ROCE equation i.e. price, as the only real variable, with price wars a default option in most cases…

Incidentally, Sorensen even goes on to suggest that the building of increasingly larger stores has been driven by retailers’ desire to offer more inventory - requiring more space - on behalf of the brand suppliers. In fact, by paying for the space and other marketing services, suppliers’ trade investment strategies have backfired and as a result have failed to satisfy shopper-need. In practice, as shoppers tend not to shop the extra fixtures, this renders the additional inventory and space superfluous to requirements.

If this is the case, then following Tesco’s ‘re-audit’ of commercial income, redundant space may not be the only casualty…
As the resulting Tesco ‘revelations’ enter the public domain, other major retailers will need to explain how their systems and processes differ, or suffer serious hits to their share prices. In the same way, brand owners will need to anticipate and defend their use of trade investment to ‘encourage’ consumer demand, or be criticised for manipulating the consumer into buying in excess of real requirements…

Clarifying the opportunity window
However, as the smoke begins to clear, the real opportunity for suppliers will lie in the fact that a move to results-based reward, paid retrospectively, would solve many of the problems caused by advance booking of commercial income. Measurement against clear and unambiguous KPIs would reduce the judgement-element, and booking of the income could be tied down to actual sales performance in given periods of the financial year, or a conservative estimate agreed and used where necessary…

The resulting issue for retailers would be the negative impact on cashflow due to moving from payment-in-advance to after-the-event remuneration… Here a courageous supplier might try to point out that credit periods were always intended to bridge the gap between supply of goods to the retailer and receipt of payment from the shopper.

However, with average credit periods at 40 days+ on supplies that can include best-selling SKUs being delivered daily, but an average stockturn in retail of 15 times p.a., i.e. 24 days stock, it could be said that there is already adequate surplus in the cashflow pipeline…

Or is supplier credit perhaps the next financial crisis ticking away in the background?