Chargebacks: Vulnerable Suppliers Seek Fairness
July 31, 2006,
New York — In what looms as a defining moment in American retailing, aggrieved suppliers have joined forces to protest what they call a systematic, coercive and possibly illegal abuse of chargebacks and allowances that has picked their pockets, eroded their margins, raised their costs and whittled down their profits for years.
The dollars involved are huge, creating a new profit center for retailers, many hard-pressed by acquisition debt and struggling with an increasingly tricky retail environment as mounting consumer debt and higher gas prices leave low-income shoppers with fewer dollars to spend.
A case in point is Linens'n Things, where the money it took in from chargebacks was enough to make or break quarterly financial results. During the first quarter of 2004, the retailer reported vendor allowances totaled $7.9 million — and without the cash that came directly out of suppliers' pockets, it would have recorded a profit of only $30,000.
Then there's Nordstrom's, the upscale carriage-trade retailer, which reported that in 2004 vendor allowances brought in $206.4 million — accounting for almost a third of its $647 million pre-tax profit.
What's got suppliers up in arms is not the system of chargebacks itself, but the abuses committed by some retailers under its very broad umbrella. Indeed, most chargebacks and allowances are agreed upon in advance by suppliers; their terms have become institutionalized and rigidly codified. And wary suppliers, accustomed to a practice they find distasteful, if not verging on outright extortion, simply add up the costs and build it into the price of the product.
For decades, chargebacks have become an expected, and negotiated, bane of the business, with vendors asked to share the pain with retailers, paying part of the cost of advertising, paying slotting fees for new programs, new store charges, sharing the cost of markdowns when goods don't fly off the shelves, and then being hit with extra charges for late or short shipments, or when a label is out of place on a carton.
It is the abuses, vendors say, that stick in their craw, unfairly cost them money and drag at the bottom line — payment for ads that don't run; markdowns never accounted for; penalties for short shipments never verified.
Few chief executives will discuss the problem on the record for fear of alienating their customers. But Chuck Hansen, the hard-charging, outspoken former ceo of Pillowtex Corp. recalls that a customer charged the company $15 million, claiming a shipment of blankets never arrived (see separate story, page 11). When Hansen energetically challenged the claim, the retailer backed off and cut a check for $10 million. “Then the retailer went belly up and we had to eat the remaining $5 million,” he recalled. “And they do that all the time. If you scream loud enough they settle, but just for maybe 60 or 70 cents on the dollar. You have to eat up the rest.”
Mincing no words, Hansen claimed, “In some cases there's outright fraud. I'd say as much as 25% of all the chargeback dollars are fraudulent.”
A word like fraud is no stranger to Donald Kreindler, an attorney with Manhattan-based law firm Phillips Nizer, and a man at the heart of the increasingly contentious issue of chargebacks and vendor allowances. It was his suit against Saks on behalf an apparel producer that helped to make this a hot-button issue last year. And he's a leading figure behind the supplier confederation that's trying to change the rules of the game and get retailers to play fair.
Kreindler argues that retailers sometimes play fast and loose, going right up to the line and sometimes crossing over it. In a high-profile case he is handling, Kreindler represents apparel supplier International Design Concepts, which sold Oscar de la Renta-branded apparel to Saks before being forced out of business. His suit charges that Saks hit up the company for markdown money that totaled almost 35% of its total sales.
In some cases, Kreindler said, retailers clearly step over the line. “A lot of what is done violates the Uniform Commercial Code. For example, a buyer is obligated to give the vendor sufficient notice and the opportunity to investigate any claim. But frequently, they take the deduction. And if the claim is for a shortage, for example, it may be impossible to verify.”
Moreover, said Kreindler, the retailer bears the legal burden of keeping accurate records and making them available to suppliers. In the case of markdown money, for example, a retailer must be able to track sales, verify its claim and provide documentary evidence to the supplier when requested. “But you can't verify what the markdown actually is. You don't get the records that would enable you to verify it.”
A pervasive and thorny issue, he said, is compliance charges. “In the case of the back-door chargeback, the compliance chargeback, they take the deduction and don't ever tell you, and you have to ask.” Moreover, said Kreindler, when it comes to assessing a penalty for a late or short shipment, or a mislabeled package, the law requires that the charge be reasonable. “The amount charged must be what the problem cost the retailer. Anything more is an illegal penalty. Every charge must be reasonably related to the actual loss a retailer incurred through a shortage, for example.”
How much cash stores are siphoning out of their suppliers' pockets — in the form of legitimate chargebacks, and sometimes through abuse — is a question mark, said Kreindler. “No one knows the precise quantification, though everyone knows that it's a huge number.”
And it's not just chargebacks, said Kreindler: there are the add-on, back-door charges that can't be anticipated, that eat away at a supplier's bottom line. “Look what Federated has done with respect to converting May stores to Macy's. They're assessing a 5% charge for a supposed new store. It's not a new store; it's a name change.”
The tactics retailers use, Kreindler asserted, may border on the coercive and abusive.
“They have all of the buying power, and it's become more so with their acquisitions. There's only a handful of stores, and you have to be there. Unless you're Ralph Lauren, or maybe Liz Claiborne, and they want you, you're vulnerable.”