Suppliers' vulnerability from extensions of credit to retailer major customers: unpaid or slowly paying receivables are another risk posed by customers that account for 10 percent or more of revenue.

Increased concentration at the retail level has made it more likely that significant portions of a supplier's sales are made to two or three large customers. As a result, suppliers have become more vulnerable to sizable, sudden reductions or cutoffs in sales. In addition, increased retailer clout has led to suppliers' incurring greater inventory risk and assuming promotional and other costs that were traditionally borne by the retailer. These effects of increased sales concentration have been described and discussed previously in this publication and elsewhere. (1)

Vulnerability to revenue loss has attracted attention because firms are required to reveal the existence of, and sales percentage made to, their major customers, defined as any organization that accounts for 10 percent or more of a firm's consolidated revenue. (2) However, large retailer customers present a second major vulnerability to their suppliers--the possibility that these firms might prove unwilling to pay their accounts on a timely basis or, at the extreme, be unable to pay those accounts at all.

Financial difficulties experienced by a firm's customers could lead to uncollectible accounts and attendant reductions in earnings, net receivables and cash inflows. For example, in mid-January of 2002, Rayovac Corporation (now Spectrum Brands) was poised to report earnings of $16.5 million (32 cents per share) for the quarter ending December 30, 2001, meeting analysts' consensus estimates. However, the battery manufacturer wound up reporting only $400,000 of earnings (one cent per share) instead. The earnings decline occurred because Rayovac increased its bad-debt reserve by $16.1 million in response to Kmart's Chapter 11 bankruptcy filing. Even though Kmart represented less than seven percent of Rayovac's sales, its bankruptcy caused Rayovac's quarterly earnings to fall by more than 97 percent (from 32 cents to one cent per share).

Even a supplier's financially strong customers can create cash flow problems when they use their clout to delay payments. Ten years ago, the CEO of a small firm that supplies lighting to several large retailers observed that "it doesn't matter what the terms are. They're going to pay you whenever they want." (3) Since that time, the few studies that have systematically examined trends in payables have found strong evidence of payables stretching on the part of many major retailers. (4)

In this research, the focus is on manufacturers that supply major retailers. The concerns those suppliers express in their 10-Ks about vulnerabilities to retailers' slow payment or nonpayment of receivables are examined. In addition, the extent to which accounts receivable have become concentrated at those firms is reported and evaluated.

Sample Firms

We compiled a database that includes 108 publicly held manufacturer-supplier firms that reported one or more retailer major customers in their 2006 Securities and Exchange Commission (SEC) Forms 10-K. Suppliers must be publicly traded in order for the major-customer disclosure to be available. Some manufacturers were placed in the database because it was common knowledge that they did extensive business with one or more mass merchants (for example, Kimberly-Clark, Mattel and Procter & Gamble). However, the great majority of firms were discovered by searching for major-customer disclosures in 10-Ks filed by any and all firms with standard industrial classification (SIC) numbers suggestive of manufacturers that sell to retailers. (5) Only firms that identified their retailer major customers were considered, but this constituted the great majority of firms that disclosed the existence of major customers. (6)