The Unsustainability of Extended Payment Terms

Anheuser-Busch InBevAccording to the New York Times, the major multinationals behind some of our favorite foods — like Mondelez, Mars, Kellogg, Church & Dwight, Anheuser-Busch InBev and Heinz — wait 90 or even 120 days before paying their suppliers.

These same companies often consider themselves to be socially and environmentally responsible.

I would claim, however, that a company applying these extended payment terms is not a responsible one.

Additionally, while large companies believe they gain from these extended payment terms in the short term, they hurt their resilience by doing so and increase their exposure to risk in the long run. Therefore, these companies and their stakeholders should address supplier payment terms as not just a moral issue, but also as a strategic one.

This trend of large companies extending supplier payment terms goes back to the financial crisis of 2008 when credit became scarcer and more expensive, leading companies to adopt more aggressive cash management practices to stay afloat. Still, it didn’t stop when things got better. As Wall Street Journal reporter Serena Ng explained in 2013: “What began as a way to preserve cash when markets dried up a few years ago has become a means of freeing up money to fund expansions, buy back stock and support dividend payouts at a time of lackluster sales growth and shrinking profit margins.”

In other words: What started as a survival strategy quickly shifted into a sort of a cash-cow strategy, making a lot of money for large companies. How much money?

“Procter & Gamble’s move to extend its payment terms to 75 days in 2013 has probably added $1 billion so far to its cash flow, according to one estimate,” reporter Stephanie Strom wrote in the New York Times this week.

What’s the explanation companies provide for extending their supplier payment terms? “Extending our payment terms allows us to better align with industry practice and ensures we compete on a level playing field, while simultaneously improving transparency and predictability of payment processes,” Valerie Moens, a spokeswoman for Mondelez, the multinational confectionery, food and beverage conglomerate, told the New York Times.

Another response came from Kris Charles, a Kellogg spokeswoman, who told the Times that extending payments to 120 days “gives Kellogg and our suppliers more flexibility to manage our businesses effectively through better cash flow management.”

Not surprisingly, some suppliers beg to differ. Stephen Brock, the owner of Supplied Industrial Solutions, which provided equipment to Anheuser-Busch InBev, told the Times that AB InBev’s decision to move to a 120-day period “… really had a dreadful effect on our bottom line …You still have a payroll to make, your own suppliers to pay, electric and other utility bills — they can’t wait four months for payment.”

It’s important to mention that, according to the Times report, this trend has not been applied in most cases to raw materials suppliers and thus is mostly hitting suppliers providing services like packaging, advertising, equipment and so on.

At the same time, I believe it doesn’t make much of a difference. An exploitation of a supplier is unacceptable no matter if it is a small farmer or a mid-size packaging or equipment company. In both cases this is an irresponsible practice.

It is even more infuriating given what these corporations write in their corporate social responsibility (CSR) reports. For example, Mondelez write: “We expect our suppliers to live up to the same standards we have set for ourselves …” If this was the case, wouldn’t we expect Mondelez to arrange for supplier payment terms that are similar to the ones it negotiated with its customers, which according to the Times is likely to be 30 days?

Or how about Kellogg, which writes in its Supplier Code of Conduct Resource Guide: “We seek business relationships with suppliers that are committed to responsible sourcing, while demonstrating our values and actively supporting our company’s vision and purpose. Responsible sourcing (or social accountability) has five main aspects: Business integrity; quality, health and safety; labor standards; sustainability and land use; and management practices.” Shouldn’t fair supplier payment terms be part of business integrity?

The problem though is not just the companies’ behavior. In a way this is a reflection of much broader problems: the markets’ short-termism and the failure of companies to acknowledge that they are responsible not only to their shareholders, but also to a broader set of stakeholders.

This race to the bottom is encouraged by Wall Street “pushing companies to extend terms because their competitors are,” explained Harvard Business School Professor V. G. Narayanan. The problem though is that this race couldn’t last very long – suppliers are not banks but businesses. And if these payment terms hurt their ability to operate and make them more fragile, then it will eventually hurt the large companies they work with as well — making them less resilient. As we enter an era where the world becomes more volatile, uncertain, complex and ambiguous, this risk potential gains even greater importance.

As Andrew Winston explained in an article in Harvard Business Review: “Innovation and adaptation are long-term activities, and maintaining a three-month horizon inhibits the creativity and investment needed to build resilience.”

He says that company leaders need to challenge Wall Street orthodoxy, and I couldn’t agree more. And fighting the market pressure to extend supplier payment terms to 90 or 120 days could certainly be a good first step.

Companies that don’t understand this hurt both their suppliers and shareholders, and certainly shouldn’t claim to be responsible. And if they do make such claims, it’s our job as stakeholders to remind them what responsibility is actually about.

Image credit: TruckPR, Flickr Creative Commons

Raz Godelnik

Raz Godelnik is an Assistant Professor and the Co-Director of the MS in Strategic Design & Management program at Parsons School of Design in New York. Currently, his research projects focus on the impact of the sharing economy on traditional business, the sharing economy and cities’ resilience, the future of design thinking, and the integration of sustainability into Millennials’ lifestyles. Raz is the co-founder of two green startups – Hemper Jeans and Eco-Libris and holds an MBA from Tel Aviv University.