The Kroger Company recently sent a letter to its vendors. The gist of the letter is that Kroger is adopting standard payment term of 90 days, though there is an option to be paid in 10 days at a discount of, currently, less than 0.72%. Here is the text of the letter:
Dear Valued Supplier,
I’m writing to inform you that as of August 1, 2018, The Kroger Co. will standardize its payment terms to Net 90 across all aspects of our business effective immediately.
We are making this change to (a) smooth our cash conversion cycle, (b) more efficiently manage our working capital in order to re-invest in our business, and (c) harmonize our terms with industry peers.
We appreciate our Supplier’s support in honoring our new payment terms for both existing and forthcoming business — a key to our growth, competitiveness, and mutual success in today’s environment.
In the meantime, please ensure that we do recognize it involves a modest extension of the average time Kroger will pay invoices. As such, we are partnering with Citibank, a core relationship bank of Kroger, to provide suppliers the option of receiving full payment on invoices before they are due, at a very small discount based on our strong credit profile. In many cases, the early payment option will save suppliers money in lieu of financing Kroger receivables through other means of capital.
The early payment option may reduce Days Sales Outstanding (DSO) and enable you to take advantage of:
• Early visibility of payment date, amount, invoice details and deductions or credit memos
• Payment within one day of Kroger invoice approval (10 days on average)
• A very competitive discount rate. For example, the discount rate of a $1MM invoice paid on Day 10 would be less than 0.72%
To learn more about the early payment option, you may contact Citi or Kroger at:
Vice President, Citibank
Email address: firstname.lastname@example.org
The Kroger Co.
Email address: Matthew.Hodge@Kroger.com
Use of the early payment tool is optional, and intended to help our long-term business partners with the migration to our new standard payment terms, which are not considered optional to Kroger.
We appreciate your support and hope that you will find our efforts mutually beneficial.
Sr. Vice President, Merchandising
The Kroger Co.
Vice President & Treasurer
The Kroger Co.
Vice President, Finance & Controller
The Kroger Co.
Vice President, Enterprise Sourcing
The Kroger Co.
The production and vendor side of the produce industry is in an uproar, partly because these vendors don’t want to extend 90-days’ credit, partly because they don’t want to, in effect, factor their invoices and take a discount, and partly because the conditions of the PACA Trust — which serve to increase the odds that produce industry vendors will be repaid in the event of Kroger’s insolvency — preclude produce vendors from extending terms beyond 30 days.
So produce firms that accept Kroger’s terms will not only be squeezing their cash flow but, quite possibly, put their whole business at risk.
The concern being whispered amongst the produce supply chain is that if produce firms accept 90-day payment from Kroger, surely every supermarket in America will soon impose the same terms. In effect, this would repeal the PACA Trust when selling to large retailers.
There is a bit of a bad smell to this, as FMI, the supermarket industry association, fought long and hard back in 1995 to repeal the PACA Trust in Congress and failed. So to repeal it just for big supermarkets with great market power is unsettling. Indeed, if Kroger insists on shoving this down the throats of its produce vendors, one can anticipate there will be a powerful effort to find a legislative solution that Kroger won’t like very much.
Right now, the PACA Trust is a “virtual” trust. It means that, in law, the funds derived from selling covered items, notably fruits and vegetables, are reserved for the vendors, such as farmers or wholesalers that sell the products.
Retailers don’t like this because it weakens their credit ratings since other vendors may not have access to these funds in the event of bankruptcy or other failure to pay.
But to firms such as Kroger, for whom insolvency is unlikely, it is a small inconvenience as Kroger has full use of the funds.
The most likely legislative fix would be to transform the PACA Trust from a virtual one, where Kroger has full use of the funds, to an actual one. In this format, Kroger would be required to put all the proceeds of its PACA-covered sales into an actual trust fund, and Kroger would be denied use of any of this cash until the produce vendors are paid.
This would be much worse for Kroger… so much so that Kroger should seriously reconsider whether it even wants to face this battle.
One can imagine the Congressional hearings already. Top Kroger executives, such as CEO Rodney McMullen, sitting in suits defending their multi-million-dollar pay packages and disproportion between the CEO and most employees:
McMullen’s total compensation dipped 2 percent in 2017 and fell barely under the $10 million mark at $9.94 million, according to Cincinnati-based Kroger’s (NYSE: KR) newly released proxy statement filed with the Securities and Exchange Commission. He received nearly $10.2 million in 2016.
Despite the reduction, McMullen’s pay is vastly higher than the company’s average worker, a ratio that public companies are required to report for the first time this year. McMullen made 547 times the median pay of $21,075 for a Kroger employee, according to Kroger’s filing.
They will be speaking to irate representatives and senators who intended to protect farmers and wholesalers and will not take kindly to the idea that Kroger has used its market power to compel these people to exempt themselves from the laws put in to protect them.
After Kroger executives testify, putting everyone to sleep with cash flow metrics, some apple grower from the Upper Midwest will come up to testify about his child not being able to get the medicine he needed because Kroger wouldn’t release the funds. Some California fruit grower will tell of his grandfather crossing the country, planting an orchard, and the family finally losing the farm because they couldn’t pay the mortgage since Kroger was holding the money.
Kroger has made a terrible mistake, and if it does not recant, it will have released forces that it won’t be able to control.
One disturbing thing about the Kroger letter is that it doesn’t seem to allow any exemption for pre-existing contracts. It just says this new policy starts Aug. 1 for both new and existing business. It is, of course, a free country, and Kroger — or any buyer — in the end has the right to decide the terms on which it will buy things, and vendors have the right to decide the terms on which they will sell things.
But to apply a rule like this to pre-existing contracts goes far beyond a buyer asserting its policies; it is a sign of a top executive management team that is prepared to behave unethically to further its goals.
Here is the funny part, though…. Applying this policy to produce almost guarantees that Kroger will pay more, not less, for fruits and vegetables. It almost guarantees that Kroger will not get the best quality. It almost guarantees that Kroger will find produce is unavailable when supplies are tight, so it will have more out-of-stocks, etc.
Produce is not like Pampers. It doesn’t roll off a factory in uniform quality, in required quantities, at a fixed price.
When Kroger imposes a 90-day pay period, it will find that many vendors can’t or won’t supply Kroger. This restricts the supply chain. Instead of being able to have 10 firms bidding, it will have five – and that will produce less competition for the Kroger business and thus higher prices.
Also Kroger will be a less desirable customer, so if a firm has a particularly good deal to offer, it won’t call Kroger first. And when the hurricane hits and everyone has to be cut back, growers will supply Wegmans, Schnuck’s and Fresh Direct and Aldi and Lidl at 80% of their order and clip Kroger back to 20%.
There is no particular indication that Kroger took any of this into consideration when adopting this rule. It smells like an accountant looking at a spread sheet saying, “Wow, we can have this much more cash, forever, if we pay everyone slower.”
There is no indication that anyone who worked on this actually knows anything about produce. Kroger can make any rules it wants but, in the end, Kroger will pay for its folly a thousand ways.
The truth is that Kroger has it almost entirely backwards. There is no company in produce like a P&G or Nestle, so there are few companies in the produce industry that can raise money cheaper than Kroger.
Carrying inventory is a supply chain cost. In the end, it must be reflected in the price of the product. When Kroger shifts this cost from itself to some radish grower in Ohio, it is increasing supply chain costs, not decreasing them.
So, in the end, this policy will make Kroger less competitive.
It would be smarter for Kroger to commit to paying for produce in 10 days. Then, the company would be the preferred buyer and it would gain preferential access to inventory and the best quality. It would drive costs out of the supply chain by allowing the one with access to cheap capital to carry the inventory, and it would expand the number of vendors seeking to do business with Kroger, thus reducing prices.
It is terrible if a big buyer uses its market power to hurt small suppliers, but it is even worse when it does it not realizing that it will only hurt itself more.